Knight Furniture Co., Inc. - Page 6




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                    The funds available for redemption of stock will                  
               be determined by the Board of Directors.  The notes can                
               be paid off early without penalty at the discretion of                 
               the Board of Directors.                                                
          Petitioner amended its bylaws on May 25, 1989, to include the               
          option to pay 10 percent of the sales price and give a 10-year              
          note for stock redemptions, because its sales volume dropped in             
          the previous 2 years and the board was concerned about whether              
          the company could survive a stock redemption.  Petitioner’s                 
          policy has been to pay cash for stock redemptions.                          
               Petitioner adopted a formula by which it would value its               
          stock.  The formula price per share was determined as 10 times              
          the average earnings per share for the previous 5 years, plus the           
          book value, then divided by 2.  The redemption price per share,             
          based on the formula, was $2,682.62, $2,798.07, and $2,836.52 in            
          1995, 1996, and 1997, respectively.  Petitioner used this formula           
          consistently for every redemption.  If all of the Pedigo family             
          members had sought redemption of their stock, the redemption                
          would have required $1,975,750, $2,044,847, and $1,697,657 in               
          liquid assets in 1995, 1996, and 1997, respectively.                        
               The only shares redeemed during the years in issue were 138            
          shares that Paul Pedigo inherited in 1993 and sold in 1996 for              
          $370,201.56.  Paul Pedigo was not an officer or employee and was            
          not involved in petitioner’s business.  He had been a music                 
          educator for 30 years and retired shortly after the redemption of           
          his shares.  Paul Pedigo wanted to invest the money to provide              





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