Average profit earned by a firm is Rs 1,00,000 which includes

22 :-  Average profit earned by a firm is Rs 1,00,000 which includes undervaluation of stock of Rs 40,000 on an average basis. The capital invested in a business is Rs 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.

Solution:-

Calculation of Actual average profit
Actual average profit = Average profit + Undervaluation of stock
                                  = 1,00,000 + 40,000
                                  = Rs 1,40,000

Calculation of Normal profit
Normal profit = Capital employed x Normal rate of return
                      = 6,30,000 x  5%
                      = Rs 31,500

Calculation of Super profit
Super profit = Average profit – Normal profit
                   = 1,40,000 – 31,500
                   = Rs 1,08,500

Calculation of Goodwill of the firm
Goodwill = Super profit x No. of years purchased
               = 1,08,500 x 5
              = Rs 5,42,500