Valuation of Goodwill - Annuity method

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Hi. How to determine Goodwill by Annuity method. Pl advise in simple language.

thanks.

Monika Singhal

 

 

Replies (2)

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)

 

2004

2005

2006

Profit before tax

***

***

***

Add: Abnormal Loss

***

***

***

Less: Abnormal Income

***

***

***

Add/Less: Stock Adjustment

***

***

***

Add: Capital Expenditure charged to revenue

10000.00

 

 

         (-) depreciation – say 10%

(1000.00)

(900.00)

(810.00)

Less: Income from non trade investment

          (shares, securities, bond, certificate)

***

***

***

Less: Estimated future expenditure

***

***

***

Maintainable profit before tax

***

***

***

 

 

Traditional

Approach

Leverage

Approach

Average Maintainable profit before tax(simple/weighted)

***

***

Less: Provision for taxation (Assume 50%, if not mentioned)

***

***

Add: Debenture Interest

Net of Tax

Full Interest

Average Maintainable Profit after Tax

***

***

 

Calculation of Capital Employed

 

 

Rs.

Fixed Assets (Revalued Figure)

 

***

Trade Investment (Market Value)

 

***

Current Assets (Revalued Figure)

 

***

Less: Current Liabilities

(creditor, bills payable, outstanding expenses, Bank OD etc.)

 

***

Capital Employed

 

***

Less: ½ of current year profit after tax

 

***

Average 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.

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