In the capitalisation method of calculating goodwill, what does the term "capital" refer to?

Net assets, i.e., total assets (excluding goodwill and fictitious assets) minus external liabilities

The correct answer is option 3- Net assets, i.e., total assets (excluding goodwill and fictitious assets) minus external liabilities.

Under capitalisation method of calculating goodwill, the term capital refers to Net assets, i.e., total assets (excluding goodwill and fictitious assets) minus external liabilities.

Capitalisation of Average Profits: Under this method, the value of goodwill is ascertained by deducting the actual firm’s capital in the business from the capitalized value of the average profits on the basis of normal rate of return. This involves the following steps:
(i) Ascertain the average profits based on the past few years’ performance.
(ii) Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalised value of average profits as follows: Average Profits × 100/Normal Rate of Return
(iii) Ascertain the actual firm’s capital (net assets) by deducting outside liabilities from the total assets (excluding goodwill and fictitious assets).
Firms’ Capital = Total Assets (excluding goodwill) – Outside Liabilities. Where outside Liabilities include both long term and short term Liabilities.
(iv) Compute the value of goodwill by deducting net assets from the capitalised value of average profits, i.e. (ii) – (iii).