Question

Average profit earned by a firm is ₹ 1,00,000 which includes undervaluation of stock of ₹ 40,000 on an average basis. The capital invested in the business is ₹ 6,30,000 and the normal rate of return is 5%. Calculate goodwill of the firm on the basis of 5 times the super profit.

Answer 1

$$\begin{gathered} \mathrm{Average}\mathrm{normal}\mathrm{profit}=(\mathrm{Average}\mathrm{Profit}+\mathrm{Undervaluation}\mathrm{of}\mathrm{stock}\mathrm{on}\mathrm{average}\mathrm{basis}*) \\ =₹(1,00,000+40,000)=₹1,40,000 \\ \mathrm{Capital}\mathrm{Employed}\mathrm{in}\mathrm{the}\mathrm{business}=₹6,30,000 \\ \mathrm{Normal}\mathrm{Profits}=\left(\mathrm{Capital}\mathrm{Employed}\times \frac{\mathrm{Normal}\mathrm{Rate}\mathrm{of}\mathrm{Return}}{100}\right)=₹\left(6,30,000\times \frac{5}{100}\right)=₹31,500 \\ \mathrm{Super}\mathrm{Profits}=\mathrm{Average}\mathrm{Normal}\mathrm{Profits}-\mathrm{Normal}\mathrm{Profits}=₹(1,40,000-31,500)=₹1,08,500 \\ \mathrm{Goodwill}=\mathrm{Super}\mathrm{Profits}\times \mathrm{No}.\mathrm{of}\mathrm{years}\mathrm{of}\mathrm{purchase}=₹(1,08,500\times 5)=₹5,42,500 \\ *Stockhasbeentakentobeclosingstockifnothingisspecifiedinthequestion \end{gathered}$$