EXERCISE 1-1 Estimating Goodwill and Potential Offering Price LOZ Plantation Homes Compainy is considering the acquisition of Condominiums, Inc. early 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, $1,500,000, and $950,000, respectively, Plantation Homes believes that an average of these earnings 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 earnings: Depreciation on baildings (each year) Depreciatioa on equipment Extraordinary loss (year 2014) Sales commissions (each year) 960,000 50,000 300,000 250,000 leach year) C. The normal fite of return on net assets for the industry is l 5%. Required: A. Assume further that Plantation Homes feels that it must earma 25% return on its investment and that good will is determined by capitalizing excess earnings. Based on these assmptions, calculate a reasonable ofler ing price for Condominiums, Inc. Indicate how much of the price consists of goodwill. Ignore tax effects B. Assame that Plantation Homes feels that it must earn n l 5% ntum on its investment, but that average excess earnings ure to be capitalized for three years only. Based on these assumptions, calculate a reasonable offer ng price for Condominiums, Inc. Indicale how much of the price consists of goodwill. Ignone tax effects EXERCISE 1-2 Estimating Goodwill and Valuation LOZ7 Alpha Company is considering the purchase of Beta Coinpany, Alphs has collected the following data about Bieta CompanyEsrimated Book Values Market Values Total identifiahle assets Total liabilities 585000 750,000 320,000 Owners' equity $265,000 Cumulative total net cash eamings for the pust tive years of $850,000 inclodes extraordinary cash gains of $67,000 and nonrecurring cash losses of $48,000. Alpha Company expects a return on its investment or 15%. Assume that Alpha prefers to ue cash earnings rather than accrual-based earnings to estimate its offering price, and that it estimates the total valuation of Beta to be equal to the present value of cash-based earaings (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. Compule (a) an offering price based on the inlormation above that Aljpba might be wiling to pay, and (b) the amount of goodwill included in that price B. Compute the amount of goodwill actually recorded, assoming the negotiations result in a final purchase price of $625,000 cash. EXERCISE 1-1 Estimating Goodwill and Potential Offering Price LOZ Plantation Homes Compainy is considering the acquisition of Condominiums, Inc. early 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, $1,500,000, and $950,000, respectively, Plantation Homes believes that an average of these earnings 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 earnings: Depreciation on baildings (each year) Depreciatioa on equipment Extraordinary loss (year 2014) Sales commissions (each year) 960,000 50,000 300,000 250,000 leach year) C. The normal fite of return on net assets for the industry is l 5%. Required: A. Assume further that Plantation Homes feels that it must earma 25% return on its investment and that good will is determined by capitalizing excess earnings. Based on these assmptions, calculate a reasonable ofler ing price for Condominiums, Inc. Indicate how much of the price consists of goodwill. Ignore tax effects B. Assame that Plantation Homes feels that it must earn n l 5% ntum on its investment, but that average excess earnings ure to be capitalized for three years only. Based on these assumptions, calculate a reasonable offer ng price for Condominiums, Inc. Indicale how much of the price consists of goodwill. Ignone tax effects EXERCISE 1-2 Estimating Goodwill and Valuation LOZ7 Alpha Company is considering the purchase of Beta Coinpany, Alphs has collected the following data about Bieta CompanyEsrimated Book Values Market Values Total identifiahle assets Total liabilities 585000 750,000 320,000 Owners' equity $265,000 Cumulative total net cash eamings for the pust tive years of $850,000 inclodes extraordinary cash gains of $67,000 and nonrecurring cash losses of $48,000. Alpha Company expects a return on its investment or 15%. Assume that Alpha prefers to ue cash earnings rather than accrual-based earnings to estimate its offering price, and that it estimates the total valuation of Beta to be equal to the present value of cash-based earaings (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. Compule (a) an offering price based on the inlormation above that Aljpba might be wiling to pay, and (b) the amount of goodwill included in that price B. Compute the amount of goodwill actually recorded, assoming the negotiations result in a final purchase price of $625,000 cash
