ACTIVITY CHAPTER 3

1. UNFLEDGED Co. is contemplating on acquiring IMMATURE, Inc. The following

information was gathered through a diligence audit:
• The actual earnings of IMMATURE, Inc. for the past 5 years are shown below:
Year Earnings
20x1 2,400,000
20x2 2,600,000
20x3 2,700,000
20x4 2,500,000
20x5 3,600,000
Total 13,800,000

• Earnings in 20x5 included an expropriation gain of ₱800,000.

• The fair value of IMMATURE’s net assets as of the end of 20x5 is
₱20,000,000.
• The industry average rate of return is 12%.
• Probable duration of “excess earnings” is 5 years.

Requirements:

a. How much is the estimated goodwill under the multiples of average excess
earnings method?
Ans.
Solution:
Total earnings for the last 5 years 13,800,000
Less: Expropriation gain Normalized (800,000)
earnings for the last 5 years 13,000,000
Divide by: 5
(a) Average annual earnings 2,600,000
Fair value of acquiree's net assets 20,000,000
Multiply by: Normal rate of return 12%
(b) Normal earnings 2,400,000
Excess earnings (a) – (b) 200,000
Multiply by: Probable duration of excess earnings 5
Goodwill 1,000,000

b. How much is the estimated goodwill under the capitalization of average excess
earnings method? Use a capitalization rate of 25%
Ans.
Solution:
Average earnings (13.8M – 800k expropriation gain) ÷ 5 yrs 2,600,000
Normal earnings in the industry (20M x 12%) (2,400,000)
Excess earnings 200,000
Divide by: Capitalization rate 25%
Goodwill 800,000
c. How much is the estimated goodwill under the capitalization of average earnings
method? Use a capitalization rate of 12.5%
Ans.
Solution:
Average earnings (13.8M – 800k expropriation gain) ÷ 5 yrs 2,600,000
Divide by: Capitalization rate 12.5%
Estimated purchase price 20,800,000
Fair value of XYZ’s net assets (20,000,000)
Goodwill 800,000

d. How much is the estimated goodwill under the present value of average excess
earnings method? Use a discount rate of 10%.
Ans.
Solution:
Average earnings (13.8M – 800k expropriation gain) ÷ 5 yrs 2,600,000
Normal earnings in the industry (20M x 12%) (2,400,000)
Excess earnings 200,000
Multiply by: PV of an ordinary annuity @10%, n=5 3.79079
Goodwill 758,158