Question

Passion Company is trying to decide whether or not to acquire Desiree Inc. The following balance sheet for Desiree Inc. provides information about book values. Estimated market values are also listed, based upon Passion Company’s appraisals.

		Desiree Inc. Book Values		Desiree Inc. Market Values
Current assets		$252,200		$252,200
Property, plant & equipment (net)		591,000		801,300
Total assets		$843,200		$1,053,500
Total liabilities		$399,200		$399,200
Common stock, $10 par value		147,100
Retained earnings		296,900
Total liabilities and equities		$843,200

Passion Company expects that Desiree will earn approximately $154,720 per year in net income over the next five years. This income is higher than the 12% annual return on tangible assets considered to be the industry “norm.”

(a1)

	Your answer is correct.

Compute an estimation of goodwill based on the information above that Passion might be willing to pay (include in its purchase price), assuming Passion is willing to pay for excess earnings for an expected life of five years (undiscounted). (Round answer to 0 decimal places e.g. 58,971.)

Goodwill

$

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Attempts: 2 of 15 used

(a2)

	Your answer is correct.

Compute an estimation of goodwill based on the information above that Passion might be willing to pay (include in its purchase price), assuming Passion is willing to pay for excess earnings for an expected life of five years, which should be capitalized at the industry normal rate of return. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places e.g. 58,971.)

Goodwill

$

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Attempts: 1 of 15 used

(a3)

Compute an estimation of goodwill based on the information above that Passion might be willing to pay (include in its purchase price), assuming Excess earnings are expected to last indefinitely, but Passion demands a higher rate of return of 25% because of the risk involved.

Goodwill

$

Answer 1

a1
The goodwill is calculated as income earned in excess of 12% of return on tangible assets
Return on tangible assets	Market value of tangible assets*12%
Return on tangible assets	1053500*12%
Return on tangible assets	$126,420
Net income in excess of return on assets	154720-126420
Net income in excess of return on assets	$28,300
Goodwill	28300*5
Goodwill	$141,500
a2
In this case we would calculate present value of excess net income
Goodwill	Excess net income*Discount factor @ 12%
Goodwill	28300*(1-(1.12^-5)/0.12))
Goodwill	28300*3.60478
Goodwill	$102,015
a3.
Goodwill	Excess net income/Rate of return
Goodwill	28300/0.25
Goodwill	$113,200