How to calculate goodwill from annuity method?
Calculating Goodwill using Annuity Method
Goodwill is an intangible asset that arises when one company acquires another company for a price greater than the fair value of the net assets acquired. The annuity method is one of the methods used to calculate goodwill, and it is based on the future earnings or cash flows of the acquired company. Here are the steps to calculate goodwill using the annuity method:
Step 1: Calculate the average annual earnings
- Determine the earnings of the acquired company for the past few years.
- Calculate the average annual earnings by adding the earnings of the past few years and dividing the sum by the number of years.
Step 2: Determine the expected future earnings
- Estimate the expected future earnings of the acquired company for the next few years based on the current market conditions and the company’s performance.
- Calculate the average of the expected future earnings by adding the estimated earnings and dividing the sum by the number of years.
Step 3: Determine the annuity factor
- Calculate the annuity factor based on the number of years and the discount rate.
- The discount rate is the rate of return required by the acquirer to compensate for the risk of investing in the acquired company.
- The annuity factor is calculated using the following formula: AF = (1 - (1 + r)-n) / r, where AF is the annuity factor, r is the discount rate, and n is the number of years.
Step 4: Calculate the value of the annuity
- Multiply the average expected future earnings by the annuity factor to get the value of the annuity.
Step 5: Calculate the value of net assets acquired
- Determine the fair value of the net assets acquired, which includes tangible assets, intangible assets, liabilities, and equity.
- Calculate the difference between the fair value of the net assets acquired and the purchase price to get the value of goodwill.
Step 6: Calculate the value of goodwill
- Subtract the value of the annuity from the value of net assets acquired to get the value of goodwill.
Conclusion
The annuity method is one of the methods used to calculate goodwill, and it is based on the future earnings or cash flows of the acquired company. To calculate goodwill using the annuity method, you need to determine the average annual earnings, expected future earnings, annuity factor, value of the annuity, value of net assets acquired, and the value of goodwill.
How to calculate goodwill from annuity method?