Question

Estimating Goodwill and Valuation LO 7 Alpha Company is considering the purchase of Beta Company. Alpha has collected the following data about Beta: Beta Estimated Company Market Book Values Values Total identifiable $585,000 $750,000 assets Total liabilities _320,000 320,000 Owners' equity $265,000 Cumulative total net cash earnings for the past five years of $850,000 includes extraordinary cash gains of $67,000 and nonrecurring cash losses of $48,000. Alpha Company expects a return on its investment of 15%. Assume that Alpha prefers to use cash earnings rather than accrual-based earnings to estimate its offering price and that it estimates the total valuation of Beta to be equal to the present value of cash-based earnings (rather than excess earnings) discounted over five years. (Goodwill is then computed as the amount implied by the excess of the total valuation over the identifiable net assets valuation.) Required: A. Compute (a) an offering price based on the information above that Alpha might be willing to pay and (b) the amount of goodwill included in that price.

Answer 1

A. Total Net cash earnings for the past 5 years $850,000 Less: Extraordinary cash gains $67,000 $783,000 Add: Nonrecurring cash losses $48,000 Normal cash earnings for the past 5 years $831,000 Annual cash earnings ($831,000/5) $166,200 Present value of cash-based earnings discounted over five years = $166,200 * 3.352155 = $557,128 (a) an offering price that Alpha might be willing to pay = $557,128 (b) Calculation of Goodwill $557,128 Offering price Less: Estimated Market value of net assets Total identifiable assets Less: Total liabilities Goodwill $750,000 $320,000 $430,000 $127,128 The amount of goodwill included in that price = $127,128 B. Assuming, the negotiations result in a final purchase price of $625,000 cash, The amount of goodwill actually recorded = final purchase price - Estimated market value of net identifiable assets The amount of goodwill actually recorded = $625,000 - $430,000 = $195,000 The amount of goodwill actually recorded = $195,000