Question

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 $1,215,000 and net assets with a fair value of $5,400,000. Takeover Co. pays $8,100,000 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. $2,700,000

B. 22.5%

C. 2.22%

D. Target Co was a profit making company

Explanation:

a. Calculation to determine How much goodwill will result from this transaction

Goodwill=$8,100,000- $5,400,000

Goodwill=$2,700,000

Therefore the goodwill that will result from this transaction is $2,700,000

b. Calculation to determine the ROI for Target Co.

Using this formula

Return on investment = Operating income / Net assets * 100

Let plug in the formula

Return on investment=$ 1,215,000 /$5,400,000 * 100

Return on investment= 22.5%

Therefore the ROI for Target Co is 22.5%

c. Calculation to determine the ROI that Takeover Co.

Using this formula

Return on investment = Operating income / Net assets * 100

Let plug in the formula

Return on investment= $180,000 / 8,100,000 * 100

Return on investment=2.22%

Therefore the ROI that Takeover Co is 2.22%

d. Based on the information given the reason

why TAKEOVER CO. is willing to pay the amount of $300,000 more than the FAIR VALUE for the NET ASSETS that was ACQUIRED from Target co., was because Target Co was a profit making company.