Valuation of Goodwill - Annuity method

1 Rupee today in not equal to 1 rupee one year later.. This is The Concept of Time value of money. In calculating the goodwill by Annuty method the same concept is used.. We take a discount rate which takes into effect inflation, risk & other factors.. then we discount our future super profits/ Future maintainable profits by this Rate... Then we sum up all the discounted figures..

There are mathematical Formulas for above computation...

Goodwill = FMP/ Future Super profits * PVAF ( No of years, rate of discount)

Goodwill = Super Profit X Present Value of Annuity

Here,

Super Profit = average maintainable profit after tax – normal/reasonable return on capital employed

Calculation of maintainable profit (Example)

Calculation of Capital Employed

Note:

1.       Income from non – trade investment is not to be considered in calculating maintainable profit

2.       Debenture being long term liability, it is a part of capital employed. Hence, debenture interest is to be added back with maintainable profit

3.       Current year profit should not include income from non-trade investment

4.       Average capital employed is calculated when current year profit given in the balance sheet or undistributed.