Estimating Goodwill and Valuation

Alpha Company is considering the purchase of Beta Company. Alpha has collected the following data about Beta:

Beta Company Book ValuesEstimated Market Values
Total identifiable assets$585,000$750,000
Total liabilities320,000320,000
Owners” equity$265,000

Cumulative total net cash earnings 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 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 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:

  1. 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.
  2. Compute the amount of goodwill actually recorded, assuming the negotiations result in a final purchase price of $625,000 cash.

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