Question

Exercise 1-3 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. Desiree Inc. Book Values Market Values Current assets $273,900 $273,900 Property, plant & equipment (net) 683,900 799,200 Total assets $957,800 $1,073,100 $438,700 Total liabilities Common stock, $10 par value Retained earnings Total liabilities and equities $438,700 175,600 343,500 $957,800 Passion Company expects that Desiree will earn approximately $167,203 per year in net income over the next five years. This income is higher than the 13% annual return on tangible assets considered to be the industry "norm." (al) (a2) 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 present value factor calculations to 5 decimal places, e.g. 1.25124 and final answer to o decimal places e.g. 58,971.) return. (Round Goodwill Click if you would like to Show Work for this question: Open Show Work

Answer 1

Solution:

Calculation of Goodwill for expected life of 5 years capitalized at industry rate of return

Annual return on Tangible Asset as per Industry Total Assets market value for Desire Inc. Normal Earning Working 13% $1,073,100 $139,503 ($1,073,100 * 13%) Expected earning for Desire Inc. $167,203 Therefore, Goodwill $27,700 ($167,203 - $139,503) Present Value of Annuity Factor of $1 @12% for 5 years = (1-(1/1.1345)}/0.13 = 3.51723 Goodwill for 5 years capitalized at industry normal rate of return = $27,700 * 3.51723 = $97427