Case #1 Tooney Lunes Inc. (TLI) is a manufacturer of children's clothes, mainly casual wear and is incorporated under the Canada Business...

Case #1

Tooney Lunes Inc. (TLI) is a manufacturer of children's clothes, mainly casual wear and is incorporated under the Canada Business Corporations Act. Seventy percent of its shares are owned by the Mickelodeon Group (MG), a Canadian publically traded corporation and the remaining thirty percent is publically traded on the Toronto Stock Exchange. TLI has a wholly owned subsidiary, Bickey Bouse Inc. (BBI) that is engaged in the production and sale in Canada of t-shirts and other merchandise that use famous cartoons and other characters that MG owns the likeness of.

MG has been licensing these cartoons and characters to various companies to produce its products, but the company has begun to be dissatisfied with their various licensing arrangements they are presently in. MG would like to acquire an existing manufacturing company so that they will have direct access to the Canadian market so that they can sell their manufactured clothes with the cartoons and characters on them. The acquired company would remain largely autonomous in its operations, except that MG would transfer existing licensed products to the acquired company as the current licensing arrangements will be expiring. The acquired company would be responsible for selecting other MG cartoons and characters to manufacture on clothing according to their market research. The acquired company would pay substantial licensing and royalty fees directly to MG for those of MG's cartoon characters that it accepted to manufacture. Accordingly, MG instructed TLI to be on the lookout for potential acquisition targets.

Recently, TLI managers have learned that a diversified company, Canale Enterprises (CE), was interested in selling its wholly owned manufacturing subsidiary, Bunny Chevron Inc. (BCI). BCI had a small selection of successful products, but the company had recently focused its efforts elsewhere and was manufacturing less. Therefore, BCI seemed to be just the right type of company for TLI to acquire on behalf of MG.

TLI has reached an agreement in principle with CE to acquire BCI for a purchase price of $225 million. All companies have an income tax rate of 30%. The method of acquiring this company has yet to be decided, although three alternatives are presently being considered (Exhibit I). The directors of TLI (who are the same directors of MG) wish to obtain advice as to the potential financial reporting implications of the various options in Exhibit I. They will be using your report on which to base their decision of which acquisition structure to pursue.

Required:

Prepare a report to the directors of TLI giving them the advice they seek   

Exhibit I- Potential Acquisition Structures

1.    TLI will issue 9 million new common shares to CE in exchange for 100% of the shares of BCI. TLI's shares are presently trading on the Toronto Stock Exchange at approximately $25 per share. The new share issuance would comprise 45% of TLI's outstanding shares after the exchange. Share issuance costs of $1,500,000 will be incurred in connection with the new share issuance. TLI will elect the members of the Board of directors.

2.    TLI would pay $225 million cash to CE for the BCI shares. TLI would obtain the cash by borrowing the funds from the Royal Bank of Canada. The loan would be secured by the assets of BCI and guaranteed by MG. The bank will be reviewing the financial statements of TLI and MG on a regular basis as part of the loan terms, as certain key ratios will have to continuously be met.

3.    TLI will pay $200