At the time of Eric's death, he owned 80% of the stock of Omega Corporation, a closely held family business.Over the past five years, Omega has averaged annual profits of $100,000 in an industry where the usual rate of return is 6%.If the book value of Omega Corporation's assets is $300,000 and goodwill exists, what might be a realistic value for the stock included in Eric's gross estate?

Question

Quizplus · Accepted Answer

The first step is to calculate the value of Omega Corporation using the capitalized excess earnings method. This method involves determining the value of a business based on its past earnings, and assuming that future earnings will continue at the same level. The formula for the capitalized excess earnings method is as follows:

Value of business = (Annual earnings - (Rate of return x Book value of assets)) / Rate of return

Using the information provided, we can calculate the value of Omega Corporation as follows:

Value of business = ($100,000 - (0.06 x $300,000)) / 0.06
Value of business = $900,000 / 0.06
Value of business = $15,000,000

Next, we need to determine Eric's share of the value of Omega Corporation. Since he owns 80% of the stock, his share is calculated as follows:

Eric's share = 80% x $15,000,000
Eric's share = $12,000,000

Finally, we need to add this value to the book value of Eric's other assets to arrive at a realistic value for the stock included in his gross estate. Assuming he has no liabilities, the value of his gross estate would be as follows:

Gross estate = $12,000,000 + $300,000
Gross estate = $12,300,000

However, we need to take into account the existence of goodwill, which can be difficult to value. Since we do not have any information about the nature or value of the goodwill in this case, we can make a conservative estimate that it reduces the value of the stock by 10%. This would result in a final value for the stock included in Eric's gross estate of:

Final value = $12,300,000 x 0.9
Final value = $11,070,000

Since we do not have this amount listed as a choice, the closest choice is $568,000 (B). However, it should be noted that this is likely much lower than the actual value of the stock.

At the Time of Eric's Death, He Owned 80% of the Stock