Question

Shepherd Corporation is considering acquiring RentCo by exchanging its stock (value of $10 per share) for RentCo's only asset, a tract of land (adjusted basis of $150,000 and no liability). The yearly net rent that RentCo receives on the land is $50,000. Shepherd anticipates that it will receive the same net rent for the land over the next 20 years. At the end of that time, it would sell the land for $400,000. Assume that Shepard uses a 10% discount rate and is in the 25% state and Federal income tax bracket for all years. Determine what type of reorganization is being contemplated by this transaction by answering the questions below.

Round dollar amounts to the nearest dollar and round the number of shares to the nearest whole number.

a. Compute the net (after taxes) yearly cash flow. $_________

b. Compute the NPV of yearly cash flow. $_______

c. Compute the net cash flow from sale of land. $______

d. Compute the NPV of cash flow from sale of land. $_______

e. Compute the NPV of the Rentco stock. $______

f. What is the maximum number of shares that RentCo shareholders can expect Shepherd to offer for 100% of their RentCo stock?
________ shares

g. What type of reorganization is this contemplated transaction?
Either "Type A" or "Type C"

Answer 1

Answer a)

Net Rent Earnings	$50,000
Less: Tax @ 25%	($12,500)
Net (after taxes) yearly cash flow	$37,500

Answer b)

Yearly Cash inflow	$37,500
Present Value Factor of Annuity for 20 years at 10% Discounting Rate	8.51356
NPV of yearly cash flow	$319,259

Answer c)

Proceeds from sale of Land	$4,00,000
Less: Tax @ 25%	($1,00,000)
Net cash flow from sale of land	$3,00,000

Answer d)

Net cash flow from sale of land	$3,00,000
Present Value Factor at 10% discounting rate for 20 years	0.149
NPV of cash flow from sale of land	$44,700

Answer e)

NPV of yearly cash flow	$3,19,259
NPV of cash flow from sale of land	$44,700
NPV of the Rentco stock	$363,959

Answer f)

NPV of the Rentco stock	$3,63,959
Value per Share	$10
Maximum number of shares	36,396

Answer g)

"Type C", as all the transfer of Land from the seller to the acquirer is in exchange of the voting stock.