SECTION 4. EXAMPLE OF

REPLACEMENT COST AND COMPARATIVE SALES COST METHODS

On Date 1, Manufacturer A purchased all the assets of Manufacturer B for a lump-sum payment of $31,000,000. The assets of Manufacturer B included quantities of finished goods and raw material inventory that were larger than the normal trading volume. The inventories are in good condition and the raw materials include minimal obsolete or subnormal goods. On the date of sale, Manufacturer B's books reflected finished goods inventory having a book value of $4,000,000 and raw materials having a book value of $300,000.

Manufacturer A expects to sell the acquired finished goods inventory to customers in the ordinary course of business. An appraiser hired by Manufacturer A determined that under the circumstances the expected retail selling price of the acquired finished goods inventory to customers was $6,000,000. It was also determined that the cost of disposing of the finished goods inventory, including sales commissions, freight and shipping charges, was $1,000,000. Manufacturer A calculated that it would incur a holding cost of $50,000 based on the average amount invested in holding the inventory, the period of time that would reasonably be expected to be necessary to dispose of the inventory, and the available established finance rate for the period. After taking into consideration Manufacturer A's investment in the assets of Manufacturer B, the risks Manufacturer A would incur during the time it took to dispose, in the ordinary course of its business, of the quantity of acquired inventory, and a fair division of the profit on the finished goods inventory between Manufacturer A and Manufacturer B, it was determined that the allocation of profit to Manufacturer A should be $450,000.

The appraiser determined that the replacement cost of the raw materials was $310,000. The appraiser computed a fair value of approximately $4,100 for purchasing, handling, and storage costs to acquire and accumulate the raw materials. Finally, the appraiser determined that there were minimal obsolete and subnormal goods, which would decrease the value of the inventories by approximately $100. In the ordinary course of business, Manufacturer B did not resell the raw materials without further processing. Manufacturer A also does not expect to resell in the ordinary course of business the raw materials without further processing.

Using the comparative sales method for finished goods and replacement cost method for raw materials, the fair market value of inventory for purposes of

latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. In making the inventory valuation determination, it is necessary to allow for a fair division between the buyer and the seller of the profit on the inventory, taking into account that the quantity of inventory purchased may be greater than the quantity of inventory usually purchased. See Knapp King-Size Corp. v. United States, 527 F.2d 1392 (Ct. Cl. 1975).