Question

Goodwill—effect on ROI and operating income Goodwill arises when one firm acquires the net assets of another firm and pays more for those net assets than their current fair value. Suppose that Target Co. had operating income of $180,000 and net assets with a fair value of $600,000. Takeover Co. pays $900,000 for Target Co.’s net assets and business activities.Required: a. How much goodwill will result from this transaction?b. Calculate the ROI for Target Co. based on its present operating income and the fair value of its net assets.c. Calculate the ROI that Takeover Co. will earn if the operating income of the acquired net assets continues to be $180,000.d. What reasons can you think of to explain why Takeover Co. is willing to pay $300,000 more than fair value for the net assets acquired from Target Co.?

Answer 1

Answer:

a. 300000 dollars

b. 0.30 or 30 percent return

c. 0.20 0r 20%

Explanation:

a. To get the goodwill

= 900000 - 600000

= $300,000

b. return on investment

= operating income ÷ fair value

= 180000/600000

= 0.3

= 30%

c. return on investment takeover will earn

assets = 300000 + 600000 = 900000 dollars

takeover income = 180000

ROI = 180000/900000

= 0.2*100

= 20%

d. They are willing to pay this given that they would be earning 20 percent return on investment.