Hey yensog, so basically speaking, there will be a financial department that will be testing the value of Goodwill inside a company. When a company purchase another the rest amount of money spent that cannot be allocate anywhere else, it will be allocated under goodwill. This goodwill is put up as a test of discounted value of future cash to the period of eternity. Sometimes, due to over optimism, business will make mistake in assuming the risk that is related into that cash flow and the growth that will be generated from that business, thus making the entire value of goodwill significantly higher than what it should be. The formula is:
(FCF*(1+SG))/(R-LG) for FCF is free cash flow, SG will be the expected growth short term, R being the cost of capital (expected return that you will get from the business) and LG is long term growth to eternity.
Note: As this value has always been higher than what it seems to be, I always like to deduct it by the earning power value of the business that that business has purchased thus correcting the value marginally, as testing the value at different discounting percentage you will receive a different number constantly this will be even more inconsistent.
Hope this helps,
Anymore question just ask away,
Robert
SGH Price at posting:
31.5¢ Sentiment: None Disclosure: Not Held
