Company Q acquires a subsidiary for ₹500 crores. The fair value of identifiable net assets of the subsidiary is ₹350 crores. Expected excess cash flows (over normal return) for the next five years are: Year 1 ₹30 crores, Year 2 ₹35 crores, Year 3 ₹40 crores, Year 4 ₹45 crores, Year 5 ₹50 crores. Discount rate = 10% per annum. Compute the goodwill arising from this acquisition using the present value of excess cash flows method.
Answer
Goodwill ≈ ₹3.0 crores
The correct answer is Goodwill ≈ ₹3.0 crores — Goodwill = Purchase price – Adjusted net assets = ₹500 crores – ₹497.04 crores ≈ ₹2.96 crores, rounded to ₹3.0 crores.
Step-by-step solution
- Discount each excess cash flow at 10%: Year 1 ₹30/(1.1)=₹27.27; Year 2 ₹35/(1.1)^2=₹28.93; Year 3 ₹40/(1.1)^3=₹30.05; Year 4 ₹45/(1.1)^4=₹30.75; Year 5 ₹50/(1.1)^5=₹31.05.
- Sum of discounted cash flows = ₹27.27+₹28.93+₹30.05+₹30.75+₹31.05 ≈ ₹147.04 crores.
- Adjusted net assets = Fair value of identifiable net assets + PV of excess cash flows = ₹350 crores + ₹147.04 crores = ₹497.04 crores.
- Goodwill = Purchase price – Adjusted net assets = ₹500 crores – ₹497.04 crores ≈ ₹2.96 crores, rounded to ₹3.0 crores.
Common mistake: Adding cash flows without discounting them
Concept tested: Present value method of goodwill valuation
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