Illustration
5: Adjusting Returns for Goodwill - Procter
and Gamble
In
2006, Procter and Gamble completed a $ 57
billion acquisition of Gillette, motivated
by synergy considerations. The acquisition
had a major effect on P&G's balance sheets,
reproduced for 2005 and 2006 below:
In
effect, the $57 billion purchase price has
been widely distributed across the balance
sheet, with goodwill and intangible assets
increasing by $ 52 billion and the remaining
$ 5.4 billion distributed across fixed assets
(about $4.4 billion) and non-cash working
capital (about $ 1 billion). P&G reported
pre-tax operating income of $14,150 million
in 2006 and an effective tax rate of 30%.
To
compute the return on capital at P&G in 2006,
we have to make a judgment on whether we leave
goodwill as part of invested capital or to
exclude it. If we leave goodwill as part of
capital invested, the estimated return on
capital is depressed significantly by the
acquisition aftermath:
This
estimate of the return, though, is predicated
on the assumption that none of the goodwill
is for growth assets. If we go to the other
extreme and assume that all goodwill is for
growth assets, the return on capital increases
sharply:
For
an intermediate solution, we considered the
premium of $ 15 billion that P&G paid over
the market value (prior to the acquisition
bid) of Gillette to be either an overpayment
or for synergy, which would be reflected in
earnings quickly. Consequently, we left this
amount in capital invested and netted out
the rest.
As
can be seen from the computations, the final
measure of return on capital is a function
of how we deal with goodwill in the computation
of capital invested.
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