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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
Accounts payable…………
Salary payable………………

Unearned service revenue
Benjamin O'Henry, capital
Benjamin O'Henry, withdrawals 2,000

Service revenue…………
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.

Can someone check my answer and tell me if it's right?
Adjust the trial balance for the under-reported expenses
($2,750) and revenues ($2,100).

This means that revenue for November was 14,300+2100 = 16,400

Expenses was the reported amounts of 3,400 and 900, plus the
under-reported amount of 2,750 for a total of $7,050.

This means that pre-tax income was about 16,400-7050 =
9,350. Multiply this by 12 and you have $112,200 per year.

I would pay 20x November's income of 9350 = 187,000.

  • accounting -

    Income Statement for Benjamin O'Henry
    After Adjustment
    Sales Revenue 14,300 16,400
    Salary Expense 3,400
    Utilities Expense 900
    Total Expense 4,300 7,050
    Net Income 10,000 9,350

    Income Statement for Buyer

    Sales Revenue 16,400
    Salary Expense 3,400
    Utilities Expense 900
    Managers Salary 3,000
    Total Expense 10,050
    Net Income 6,350

    Statement of Owners Equity
    Beginning Capital 137,400
    Add: Retained Earnings 9,350
    Less: Withdrawals 2,000
    Ending Capital 144,750

    The sales revenue is adjusted for unrecorded revenues of $2,100 and the expenses are adjusted for the unrecorded expenses of $2,750. In the income statement of the buyer, the salary of manager at $3,000 per month is added.

    The most you would pay for this is 20 times the monthly net income. The monthly net income expected is $6,350. The maximum amount that can be paid is 6,350 X 20 = $127,000.

    The least Benjamin will accept is the ending capital which is $144,750.

    We have a situation where the expected price is 144,750 and the buyer wishes to pay $127,000. Let us see, if the buyer should pay more. The expected price that Benjamin is asking for is the difference the assets and liabilities in the balance sheet ( this is the owners equity). The balance sheet is based on historical and so does not take into account the changes in price. The business has some fixed assets, that may be worth more. Also over the years, the business builds goodwill which is not reflected in the price. The worth of the business can be more.

    From the buyers perspective, he is willing to pay $127,000 for a business which generates $6,350 per month. On an annual basis that comes to 76,200. If we calculate the return on investment it is 60%, which is quite high, so there is a scope for increasing the price further. If we accept Benjamin’s offer of $144,750 then the rate of return comes to 76,200/144,750= 52.6%, which is also quite high.

    You may negotiate with Benjamin but should be prepared to offer a maximum amount of $144,750 which is what Benjamin wants

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