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Read the passage carefully and answer the next 5 questions

The books of a business showed that the firm's capital employed on December 31, 2024, Rs. 5,00,000 and the profits for the last five years were: 2020-Rs. 40,000; 2021-Rs. 50,000; 2022-Rs. 55,000; 2023- Rs.70,000 and 2024-Rs. 85,000. You are required to find out the value of goodwill based on 2 years purchase of the super profits of the business, given that the normal rate of return is 10%.

Goodwill is -

Solution

✅ Correct Option: 1

Average Profit Calculation:

Total profits for 5 years = Rs. 40,000 + Rs. 50,000 + Rs. 55,000 + Rs. 70,000 + Rs. 85,000 = Rs. 3,00,000

Average Profit = Total ProfitsNumber of Years\frac{\text{Total Profits}}{\text{Number of Years}} = 3,00,0005\frac{3,00,000}{5} = Rs. 60,000


Normal Profit Calculation:

Normal Profit = Capital Employed × Normal Rate of Return

Normal Profit = Rs. 5,00,000 × 10100\frac{10}{100} = Rs. 50,000

This represents the profit that any business with this capital should normally earn at the market rate.


Super Profit Calculation:

Super Profit = Average Profit - Normal Profit

Super Profit = Rs. 60,000 - Rs. 50,000 = Rs. 10,000

Super profit represents the excess earnings above normal expectations, which is the basis for goodwill valuation.


Goodwill Calculation:

Goodwill = Super Profit × Number of Years' Purchase

Goodwill = Rs. 10,000 × 2 = Rs. 20,000

The answer is Option 1: Rs. 20,000

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