Goodwill Valuation

What is Goodwill Valuation?

Goodwill of a company is its long-term intangible asset which physically does not exist; it arises when a purchased company’s acquisition cost is excluded from the fair value of tangible assets of the company. Like goodwill, other types of intangible assets are:
Human resources: the knowledge, experience, and skills of employees,
Intellectual assets: the collection of data, computer programs, and drawings etc.

How to value intangible assets like goodwill?

To value intangible assets is not an easy task nor can one get the exact amount, however, two methods; simple estimate and calculated intangible value (CIV) method are used to estimate value which then used in asset-based valuation approach of business valuation.

Simple estimate

Value of intangible assets = Value of equity – Value of tangible assets
Where value of equity is calculated either by using market capitalization divided by number of shares or using one of earning based methods

Calculated intangible value (CIV) method

In which, by perpetuity formula, company’s post-tax profit is discounted with the cost of capital. After calculating the value of intangible assets, the value of a company by using asset-based approach will be calculated as under:
Total value of the company = Value of tangible assets + calculated intangible value (CIV)

Example

Your company reported a profit before tax of \$100 and the value of its tangible assets is \$300. An average return of the industry is 6%. Currently prevailing tax rate is 35% and your company’s cost of capital is 12%. Calculate the value of the company using CIV method.
Current pretax profit = \$30
Less: Industry ROA * Tangible assets (6%*\$300) = \$18
Excess annual return = \$12
Post tax excess return \$12*(1-0.35) = \$7.8
By considering constant perpetuity \$7.8/0.12 = \$65
Therefore,
The value of total company = \$300 + \$65 = \$365