Thanks to visit codestin.com
Credit goes to www.scribd.com

Scribd
Upload
75 views2 pages

Answers To Questions Answers To Exercises Exercise 1-1 Part A Normal Earnings For Similar Firms ($15,000,000 - $8,800,000) X 15% $930,000

This document contains sample exercises and solutions for determining goodwill in business acquisitions. Exercise 1-1 calculates goodwill for the acquisition of Condominiums Inc. in two parts: 1) using a perpetuity model that yields $394,668 in goodwill, and 2) using an annuity model that yields $225,279 in goodwill. Exercise 1-2 values goodwill for Beta at $127,129. Exercise 1-3 discusses three methods to calculate goodwill for an acquisition and determines the strongest approach discounts excess earnings over 5 years.

Uploaded by

sameer
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
75 views2 pages

Answers To Questions Answers To Exercises Exercise 1-1 Part A Normal Earnings For Similar Firms ($15,000,000 - $8,800,000) X 15% $930,000

This document contains sample exercises and solutions for determining goodwill in business acquisitions. Exercise 1-1 calculates goodwill for the acquisition of Condominiums Inc. in two parts: 1) using a perpetuity model that yields $394,668 in goodwill, and 2) using an annuity model that yields $225,279 in goodwill. Exercise 1-2 values goodwill for Beta at $127,129. Exercise 1-3 discusses three methods to calculate goodwill for an acquisition and determines the strongest approach discounts excess earnings over 5 years.

Uploaded by

sameer
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
You are on page 1/ 2

CHAPTER 1

ANSWERS TO QUESTIONS
ANSWERS TO EXERCISES

Exercise 1-1

Part A Normal earnings for similar firms = ($15,000,000 - $8,800,000) x 15% = $930,000

Expected earnings of target:


Pretax income of Condominiums, Inc., 2005 $1,200,000
Subtract: Additional depreciation on building ($960,000  30%) (288,000)
Target’s adjusted earnings, 2005 912,000

Pretax income of Condominiums, Inc., 2006 $1,500,000


Subtract: Additional depreciation on building (288,000)
Target’s adjusted earnings, 2006 1,212,000

Pretax income of Condominiums, Inc., 2007 $950,000


Add: Extraordinary loss 300,000
Subtract: Additional depreciation on building (288,000)
Target’s adjusted earnings, 2007 962,000
Target’s three year total adjusted earnings 3,086,000
Target’s three year average adjusted earnings ($3,086,000  3) 1,028,667

Excess earnings of target = $1,028,667 - $930,000 = $98,667 per year


$98,667
Present value of excess earnings (perpetuity) at 25%: = $394,668 (Estimated Goodwill)
25%
Implied offering price = $15,000,000 – $8,800,000 + $394,668 = $6,594,668.

Part B Excess earnings of target (same as in Part A) = $98,667

Present value of excess earnings (ordinary annuity) for three years at 15%:
$98,667  2.28323 = $225,279

Implied offering price = $15,000,000 – $8,800,000 + $225,279 = $6,425,279.

Note: The sales commissions and depreciation on equipment are expected to continue at the
same rate, and thus do not necessitate adjustments.

1-1
Exercise 1-2

Part A Cumulative 5 years net cash earnings $850,000


Add nonrecurring losses 48,000
Subtract extraordinary gains (67,000)
Five-years adjusted cash earnings  $831,000  $831,000
Average annual adjusted cash earnings  5
 $166,200
 
(a) Estimated purchase price = present value of ordinary annuity of $166,200 (n=5, rate= 15%)
$166,200  3.35216 = $557,129

(b) Less: Market value of identifiable assets of Beta $750,000


Less: Liabilities of Beta 320,000
Market value of net identifiable assets 430,000
Implied value of goodwill of Beta $127,129

Part B Actual purchase price $625,000


Market value of identifiable net assets 430,000
Goodwill purchased $195,000

Exercise 1-3

Part A
Normal earnings for similar firms (based on tangible assets only) = $1,000,000 x 12% = $120,000

Excess earnings = $150,000 – $120,000 = $30,000

(1) Goodwill based on five years excess earnings undiscounted.


Goodwill = ($30,000)(5 years) = $150,000

(2) Goodwill based on five years discounted excess earnings


Goodwill = ($30,000)(3.6048) = $108,144
(present value of an annuity factor for n=5, I=12% is 3.6048)

(3) Goodwill based on a perpetuity


Goodwill = ($30,000)/.20 = $150,000
Part B
The second alternative is the strongest theoretically if five years is a reasonable representation of
the excess earnings duration. It considers the time value of money and assigns a finite life.
Alternative three also considers the time value of money but fails to assess a duration period for
the excess earnings. Alternative one fails to account for the time value of money. Interestingly,
alternatives one and three yield the same goodwill estimation and it might be noted that the
assumption of an infinite life is not as absurd as it might sound since the present value becomes
quite small beyond some horizon.

Part C

Goodwill = [Cost less (fair value of assets less the fair value of liabilities)],
Or, Cost less fair value of net assets
Goodwill = ($800,000 – ($1,000,000 - $400,000)) = $200,000
1-2

You might also like