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.
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.
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
To check your answer and calculate the possible price and ending capital, let's go through the steps again:
1. Adjust the trial balance for the under-reported expenses and revenues:
- Add the under-reported revenue of $2,100 to the reported service revenue of $14,300, resulting in a total revenue of $16,400.
- Add the under-reported expenses of $2,750 to the reported expenses of $3,400 and $900, resulting in a total expense of $7,050.
2. Calculate the pre-tax income for November:
- Subtract the total expenses of $7,050 from the total revenue of $16,400, resulting in a pre-tax income of $9,350.
3. Multiply the pre-tax income by 12 to estimate the yearly income:
- Multiply $9,350 by 12, which equals $112,200 per year.
4. Calculate the possible price you would pay for the business:
- Multiply the annual income of $112,200 by the factor of 20, which equals $2,244,000.
5. Calculate the least amount Benjamin O'Henry will take for the business (ending capital):
- The ending capital in the trial balance is reported as $137,400.
Now, let's compare your answer to the correct calculations:
Your calculation for the possible price ($187,000) is incorrect. The correct price based on 20 times the monthly net income is $2,244,000.
The correct calculation for the least amount Benjamin O'Henry will take (ending capital) is $137,400, as mentioned in the trial balance.
Based on these calculations, you can offer a price between $137,400 (O'Henry's ending capital) and $2,244,000 (20 times the monthly net income). The specific offer amount depends on your negotiation with O'Henry.