Exercises EXERCISES EXERCISE II Estimating Goodwill and Potential Offering Price LOD Plantation Homes Company is considering the acquisition of Condominiums, Inc. carly in 2015. To assess the amount it might be willing to pay, Plantation Homes makes the following computations and assumptions A. Condominiums, Inc. has identifiable assets with a total fair value of $15,000,000 and liabilities of $8.800,000. The assets include office equipment with a fair value approximating book value, buildings with a fair value 30% higher than book value, and land with a fair value 75% higher than book value. The remain- ing lives of the assets are deemed to be approximately equal to those used by Condominiums, Inc. B. Condominiums, Inc.'s pretax incomes for the years 2012 through 2014 were $1,200,000, 51,500,000, and 5950.000, respectively. Plantation Homes believes that an average of these carnings represents a fair estimate of annual earnings for the indefinite future. However, it may need to consider adjustments to the following items included in pretax carnings Depreciation on buildings (cach year) 960,000 Depreciation on equipment (each year) 50.000 Extraordinary loss (year 2014) 300,000 Sales commissions (cach year) 250.000 C. The normal rate of return on net assets for the industry is 15% Required: A. Assume further that Plantation Homes feels that it must carn a 25% return on its investment and that good- will is determined by capitalizing excess carnings. Based on these assumptions, calculate a reasonable offer ing price for Condominiums, Inc. Indicate how much of the price consists of goodwill. Ignore tax effects. B. Assume that Plantation Homes feels that it must earn a 15% return on its investment, but that average excess carnings are to be capitalized for three years only. Based on these assumptions, calculate a reasonable offer ing price for Condominiums, Inc. Indicate how much of the price consists of goodwill. Ignore tax effects. EXERCISE 1-2 Estimating Goodwill and Valuation LOD Alpha Company is considering the purchase of Beta Company Alpha has collected the following data about Beta Beta Company Book Values Estimated Marker Values Total identifiable assets Total liabilities $585.000 320.000 $750.000 320,000 Owners' equity $265.000 Cumulative total net cash camnings 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 carnings 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 B. Compute the amount of goodwill actually recorded, assuming the negotiations result in a final purchase price of $625,000 cash Exercises EXERCISES EXERCISE II Estimating Goodwill and Potential Offering Price LOD Plantation Homes Company is considering the acquisition of Condominiums, Inc. carly in 2015. To assess the amount it might be willing to pay, Plantation Homes makes the following computations and assumptions A. Condominiums, Inc. has identifiable assets with a total fair value of $15,000,000 and liabilities of $8.800,000. The assets include office equipment with a fair value approximating book value, buildings with a fair value 30% higher than book value, and land with a fair value 75% higher than book value. The remain- ing lives of the assets are deemed to be approximately equal to those used by Condominiums, Inc. B. Condominiums, Inc.'s pretax incomes for the years 2012 through 2014 were $1,200,000, 51,500,000, and 5950.000, respectively. Plantation Homes believes that an average of these carnings represents a fair estimate of annual earnings for the indefinite future. However, it may need to consider adjustments to the following items included in pretax carnings Depreciation on buildings (cach year) 960,000 Depreciation on equipment (each year) 50.000 Extraordinary loss (year 2014) 300,000 Sales commissions (cach year) 250.000 C. The normal rate of return on net assets for the industry is 15% Required: A. Assume further that Plantation Homes feels that it must carn a 25% return on its investment and that good- will is determined by capitalizing excess carnings. Based on these assumptions, calculate a reasonable offer ing price for Condominiums, Inc. Indicate how much of the price consists of goodwill. Ignore tax effects. B. Assume that Plantation Homes feels that it must earn a 15% return on its investment, but that average excess carnings are to be capitalized for three years only. Based on these assumptions, calculate a reasonable offer ing price for Condominiums, Inc. Indicate how much of the price consists of goodwill. Ignore tax effects. EXERCISE 1-2 Estimating Goodwill and Valuation LOD Alpha Company is considering the purchase of Beta Company Alpha has collected the following data about Beta Beta Company Book Values Estimated Marker Values Total identifiable assets Total liabilities $585.000 320.000 $750.000 320,000 Owners' equity $265.000 Cumulative total net cash camnings 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 carnings 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 B. Compute the amount of goodwill actually recorded, assuming the negotiations result in a final purchase price of $625,000 cash