Question

Average profit earned by a firm is ₹ 80,000 which includes undervaluation of stock of ₹ 8,000 on an average basis. The capital invested in the business is ​₹ 8,00,000 and the normal rate of return is 8%. Calculate goodwill of the firm on the basis of 7 times the super profit.

Answer 1

$$\begin{gathered} \mathrm{Average}\mathrm{Normal}\mathrm{Profits}\mathrm{of}\mathrm{the}\mathrm{firm}=(\mathrm{Average}\mathrm{Profits}+\mathrm{Undervaluation}\mathrm{of}\mathrm{Stock})=₹(80,000+8,000)=₹88,000 \\ \mathrm{Normal}\mathrm{Profits}=₹\left(\mathrm{Capital}\mathrm{Employed}\times \frac{\mathrm{Normal}\mathrm{Rate}\mathrm{of}\mathrm{Return}}{100}\right)=₹\left(8,00,000\times \frac{8}{100}\right)=₹64,000 \\ \mathrm{Super}\mathrm{Profits}=\mathrm{Average}\mathrm{Profits}-\mathrm{Normal}\mathrm{Profits}=₹(88,000-64,000)=₹24,000 \\ \mathrm{Goodwill}=\mathrm{Super}\mathrm{Profits}\times \mathrm{No}.\mathrm{of}\mathrm{years}\mathrm{of}\mathrm{Purchase}=₹(24,000\times 7)=₹1,68,000 \end{gathered}$$