Benjamin O'Henry has owned and operated O'Henry's Data Services since its beginning ten years ago. From all appearances, the business has prospered. In the past few years, you have become friends with O'Henry and his wife. Recently, O'Henry mentioned that he has lost his zest for the business and would consider selling it for the right price. You are interested in buying this business, and you obtain its most recent monthly unadjusted trial balance which follows:
O'Henry's Data Services Unadjusted Trial Balance November 30, 20XX
Cash……………………………… $9,700
Accounts receivable……………………… 7,900
Prepaid expenses………… 2,600
Furniture, fixtures, & equipment 151,300
Accumulated depreciation $15,600
Accounts payable………… 3,800
Salary payable………………
Unearned service revenue 6,700
Benjamin O'Henry, capital 137,400
Benjamin O'Henry, withdrawals 2,000
Service revenue………… 14,300
Rent expense……………
Salary expense………… 3,400
Utilities expense……… 900
Depreciation expense
Supplies expense……
Total…………………………………………. $177,800 $177,800
Revenues and expenses vary little from month to month, and November is a typical month. Your investigation reveals that the unadjusted trial balance does not include the effects of monthly revenues of $2,100 and monthly expenses totaling $2,750. If you were to buy O'Henry's Data Services, you would hire a manager who would require a monthly salary of $3,000.
The most you would pay for the business is 20 times the monthly net income you could expect to earn from it. Compute this possible price. The least O'Henry will take for the business is his ending capital. Compute this amount. Under these conditions, how much should you offer O'Henry? Give your reason.
And what is your analysis and thinking?
To compute the possible price you would pay for the business, you need to calculate the monthly net income you could expect to earn from it.
First, you need to adjust the trial balance by adding the monthly revenues and expenses to get a more accurate picture of the business's financial performance.
Revenue adjustments:
- Add the monthly revenues of $2,100 to the service revenue account.
- The adjusted service revenue will be $14,300 + $2,100 = $16,400.
Expense adjustments:
- Add the monthly expenses of $2,750 to the existing expenses.
- The adjusted salary expense will be $3,400 + $3,000 = $6,400.
- The adjusted total expenses will be $6,400 + $900 = $7,300.
Now, you can calculate the monthly net income by subtracting the adjusted total expenses from the adjusted service revenue.
Monthly net income = Adjusted service revenue - Adjusted total expenses
Monthly net income = $16,400 - $7,300 = $9,100.
To calculate the possible price you would pay, you multiply the monthly net income by 20.
Possible price = Monthly net income * 20
Possible price = $9,100 * 20 = $182,000.
Next, to compute the least O'Henry will take for the business, you need to find the ending capital from the unadjusted trial balance.
Ending capital = Benjamin O'Henry, capital - Benjamin O'Henry, withdrawals
Ending capital = $137,400 - $2,000 = $135,400.
Under these conditions, you should offer O'Henry at least his ending capital, which is $135,400. This is because the least he will take for the business is his ending capital, and it represents his equity in the business.
However, based on the maximum price you would pay, which is $182,000, you should offer O'Henry an amount within this range considering factors such as negotiation and the actual value of the business. It's also important to consider the financial implications of hiring a manager with a monthly salary of $3,000.
Ultimately, the final offer will depend on your assessment of the business's profitability, growth potential, and your negotiation with O'Henry.