The Mcquire Company is considering acquiring 100% of the Sosa Company. The management of Mcquire fears that the acquisition price may be too high. Condensed financial statements for Sosa Company for the current year are as follows:

Income Statement2012

Revenues................$100,000

Cost of Goods Sold...........40,000

Gross Margin..............60,000

Operating Expenses............35,000

Pretax Income..............25,000

Income Tax Expense............10,000

Net Income...............15,000

You believe that Sosa might be currently acquired at a price resulting in a price to earnings (P/E) ratio of 8 to 12 times. Also, the fair market value of Sosa’s net assets is approximately $105,000, and the difference between book value and the value implied by the purchase price= is due solely to depreciable assets with a remaining useful life of 10 years. Sosa Company is heavily involved in research and development of new baseball bats that enable the batter to hit the ball further. You estimate that $30,000 of the acquisition price might be classified as in-process R&D. Sosa’s net income is expected to grow an average of 10% per year for the next 10 years and remain constant thereafter.
Required:
A. If the acquisition occurs on January 1, 2013, determine the amount of income from Sosa Company that would be included in consolidated income assuming the following P/E ratios are used to determine the acquisition price, based on earnings for the year 2012. Suppose that the FASB revoked its requirement that in-process R&D be capitalized and amortized, as the result of extensive lobbying. Instead, in-process R&D will be expensed in the year of acquisition.
1. P/E ratio = 10
2. P/E ratio = 12
B. Now assume that FASB does require (as is currently the case at this writing) that in process R&D be capitalized (assume an amortization period of 20 years). How would your answer to part Achange?

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Balance Sheet Year Ended 12/31/11 Year Ended 12/31/12 Cash Receivables Inventory Fixed Assets (net) Total Assets 4,000 10,000 31,000 50,000 595,000 $ 4,000 14,000 27,000 55,000 100,000 Current Liabilities Long-term Liabilities Common Stock Retained Earnings Total Liabilities and Equity 15,000 25,000 20,000 35,000 95,000 17,000 18,000 20,000 45,000 $100,000