Valuing “Cost in Excess of Net Assets” in Subsequent Years Payto Inc. acquired the business of Sayto Inc. on 1/1/06 at a cost of $800,000 in excess of the current value of Sayto’s net assets.

Sayto’s operations had been unprofitable for the two years preceding the business combination and thus did not possess superior earning power. Payto paid the $800,000 so that it could readily es¬

tablish itself in this high-risk industry. Payto expects Sayto’s operations to report profits within three years. The cost in excess of current value was assigned to goodwill.

1. Assume that at 12/31/08, Sayto’s operations are still unprofitable. Management is uncertain whether Sayto’s operations will ever be profitable. What are the implications of this situation?

2. What if Sayto were only marginally profitable for 2008 (Payto earning only 6% return on its investment), a situation expected to continue?

Financial Analysis Problems