Question

During the past several years the annual net income of Avery Company has averaged $540,000. At the present time the company is being offered for sale. Its accounting records show the book value of net assets (total assets minus all liabilities) to be $2,800,000. The fair value of Avery’s net identifiable assets, however, is $3,000,000. An investor negotiating to buy the company offers to pay an amount equal to the fair value for the net identifiable assets and to assume all liabilities. In addition, the investor is willing to pay for goodwill an amount equal to the above-average earnings for three years. On the basis of this agreement, what price should the investor offer? A normal return on the fair value of net assets in this industry is 15 percent.

Answer 1

Answer: $4,620,000

Step-by-step explanation:

To calculate the price the investor should offer, we need to consider the fair value of the net identifiable assets and the goodwill based on the above-average earnings.

1. Calculate the fair value of net identifiable assets:

The fair value of the net identifiable assets is given as $3,000,000.

2. Calculate the goodwill:

The above-average earnings are given as $540,000. To calculate the goodwill, we need to multiply the above-average earnings by the number of years, which is 3.

Goodwill = Above-average earnings x Number of years

Goodwill = $540,000 x 3 = $1,620,000

3. Calculate the total price:

The investor is offering to pay the fair value for the net identifiable assets and assume all liabilities, which means they are paying $3,000,000 for the net identifiable assets.

Additionally, they are willing to pay $1,620,000 for goodwill.

Total price = Fair value of net identifiable assets + Goodwill

Total price = $3,000,000 + $1,620,000 = $4,620,000

Therefore, the investor should offer a price of $4,620,000 to buy the company.

Answer 2

The investor should offer $3,270,000 for Avery Company, which includes $3,000,000 for the fair value of net identifiable assets plus $270,000 for goodwill, calculated based on above-average earnings for three years.

Step-by-step explanation:

To calculate the price the investor should offer for Avery Company, we first need to identify the fair value of the company's net identifiable assets, which is $3,000,000. Next, we calculate the normal return on these assets by applying the industry standard of 15%. The normal return is $450,000 (15% of $3,000,000).

Given that the average annual net income is $540,000, the above-average earning (amount of earnings above the normal return) would be $90,000 ($540,000 - $450,000). The investor is willing to pay for goodwill an amount equal to above-average earnings for three years, which is $270,000 ($90,000 multiplied by 3).

Therefore, the total offer price by the investor would combine the fair value of the net identifiable assets and the goodwill amount: $3,000,000 (fair value) + $270,000 (goodwill) = $3,270,000.