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    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

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    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.

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    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

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    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.

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    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.

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    19 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

    Uploaded by

    sameer
    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.

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    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

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