P is making an affer for S. To determine a fair offering price. P makes the foll
ID: 2535913 • Letter: P
Question
P is making an affer for S. To determine a fair offering price. P makes the following assumptions;S has identifiable assets with total fair value of $20,000?000 and liablites of $8,000,000. the assets include land with fair vlue of 20% less than book value and buldings with a fair value 40% above book value. All othe assets are fairly stated . Normal reruns for theindustry are 20%. S's pretax income for year was $2,000000 . P feels the annual average of these years fairly respent the expected annual income for S for the next 4 years. however, it needs to consider adjustments to the following items included in the pretax income.
Annual depreciation on buildings. $400,000
Extraodinary gain in second year $200,000
Annual pension cost $600,000
P desires to earn 16% on its investments and eetermine that goodwill will be calculated on 4 years of capitalied exess earnings. How much should P offer S? how much of that price represents Goodwill?
Explanation / Answer
Net assets value ( Assets - Liabilities ) i.e S 20 Million-8 Million = 12 Million
Net income after adjustments : 2 Million- Extra ord. gain 200,0000 + annual pension cost 600,000 = 2. 4 Million
Capitalised value of net income at expected rate of return = 2.4 Million/ 16 % = 15 Million
Goodwill = Capitalised value - net assets value
i.e $ 15 Million - 12 Million = 3 million
Note : Depreciation is an admissible item of cost and hence need not be added back to arrive at net income.
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