Excess Earnings Valuation Example

Step 1:

Determine average stabilized pre tax earnings of company for the past three years.

$80,000

Step 2:

Determine average fair market value of assets used in the business for the same three-year period.

$500,000

Step 3:

Apply a fair rate of return, say 10% on the assets computed in Step 2 (10% x $500,000).

$50,000

Step 4:

Subtract Step 3 from Step 1. This equals excess earnings attributable to goodwill.

$30,000

Step 5:

Capitalize the excess earnings in Step 4 at a selected rate, say 50%, to yield the value of goodwill (2 x $30,000).

$60,000

Step 6:

Add tangible assets of the company (Step 2) to the capitalized goodwill value (Step 5). This sum equals fair market value.

$560,000