Adamu and Zainab are partners in a firm. They agree to value the firm's goodwill on the ba… — JAMB UTME

Adamu and Zainab are partners in a firm. They agree to value the firm's goodwill on the basis of $3$ years' purchase of the average super profit of the past $4$ years. The net profits of the firm for the last $4$ years were $\mathcal{N}45,000$ , $\mathcal{N}55,000$ , $\mathcal{N}60,000$ , and $\mathcal{N}80,000$ . The capital employed in the business is $\mathcal{N}400,000$ , and the normal rate of return expected on capital employed in a similar business is $10\%$ . What is the value of the firm's goodwill in Naira?

Answer: 60000 Naira

Answer

The value of the firm's goodwill is 60,000 Naira.

Goodwill under the super profit method is obtained by taking the excess of average annual profits over normal expected profits and multiplying by the number of years' purchase. The average profit is 60,000 Naira and normal profit is 40,000 Naira (10% of 400,000 Naira). The super profit is 20,000 Naira, which when multiplied by 3 years' purchase gives 60,000 Naira.

Step-by-Step Solution

Calculate the average annual profit of the firm over the 4-year period

Average profit = 60,000 Naira

Sum the total profits of the four years (240,000 Naira) and divide by 4.

Calculate the normal profit expected from the capital employed

Normal profit = 40,000 Naira

Multiply the capital employed (400,000 Naira) by the normal rate of return (10%).

Determine the super profit of the firm

Super profit = 20,000 Naira

Subtract normal profit (40,000 Naira) from average annual profit (60,000 Naira).

Compute goodwill using the 3 years' purchase multiplier

Goodwill = 60,000 Naira

Multiply the super profit (20,000 Naira) by the agreed 3 years' purchase.

Key Concept

Valuation of Goodwill using the Super Profit Method

Estimated Time:1m 30s

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