Discussion Problem no.

1 - (Estimating Goodwill - Direct Valuation)

Entity Y is contemplating on acquiring Entity X. Relevant information follows;

 Entity X's average annual earnings in the past 5 years were P1,000,000
 Entity X's net assets as at the current year-end have a fair value of P8,000,000
 The industry average rate of return equity is 12%
 The Probable duration on entity B's "Excess earnings" is 5 years.

Required:

1. Goodwill is equal to the average excess earnings capitalized at 25%. How much is the goodwill?

Average annual earnings P 1,000,000

Normal earnings on average net assets
(8,000,000 X 12%) (960,000)
Excess earnings P 40,000
Divide by: Capitalization rate 25%
Goodwill P 160,000

2. Goodwill is measured by capitalizing the average earnings at 12%. How much is the goodwill?

Average annual earnings P 1,000,000

Divide by: capitalization rate 12%
Estimated purchase price P 8,333,333
Fair value of net assets (8,000,000)
Goodwill P 333,333