In goodwill valuation under capitalization method what happens to goodwill if normal rate of return increases while average profit and actual capital remain the same?

Correct answer: Goodwill will decrease

Under the capitalisation method based on average profit, capitalised value is calculated as Average Profit × 100 ÷ Normal Rate of Return. Goodwill is then found by subtracting actual capital from this capitalised value. If average profit stays fixed while the normal rate rises, the same profit is capitalised at a higher required return. The resulting capitalised value must therefore fall.

For example, with average profit ₹50,000, capitalised value at 10% is ₹5,00,000, while at 20% it is ₹2,50,000. If actual capital remains unchanged, subtracting it from the smaller capitalised value gives lower goodwill. Thus option A, “goodwill will decrease,” is correct. A higher rate does not increase goodwill in this method; it reduces the value attributed to the business’s earning advantage. The conclusion assumes the capitalisation formula and no other figures change.