Valuation is generally required when parties involved in transaction / deal/scheme etc. fail to arrive at a mutually acceptable value or agreement etc. However, it becomes necessary when:-

  • Shares are not quoted
  • Shares relate to Private Limited Companies
  • Court directs
  • AOA or any agreement requires
  • Transfer of large block of shares
  • Statute so require(like Wealth Tax Act, FEMA, Income Tax Act )

Stock exchange price is mostly determined by bull and bear effects than other effects like net assets, earning, yield etc. It is basically determined on the basis of inter-action of supply & demand & may not reflect a true value of shares.

Two factors are considered important: asset employed & profit earned on the basis of which valuation is done.

Methods of valuation of shares:

  1. Net Assets Method:–

Net assets available to equity shareholders

No. of equity shares

Following should be considered while arriving at net assets:-

Particulars Basis of valuation
Fixed assets

  1. Tangibles
  2. Intangibles
  

Current cost

Current cost

(Inherent goodwill not to be recorded & purchased goodwill eliminated & new valuation should be done)
Investments

  1. Quoted
  2. Unquoted
  

Market price

Book value

(after adjustment of known loss or gain)
Inventory

  1. Finished goods
  2. Raw material & WIP
  

Market price

Book value

( after adjustments of obsolete, unusual inventories)
Trade receivables Book value- Bad & Doubtful Debts
Development expenses Current entry value
Miscellaneous expenditure & losses Fictitious assets -Not to be taken into account
Unrecorded assets & liabilities Realizable value for assets & amount payable for liabilities

Liabilities should be deducted to arrive at net assets.

  1. Short & long term liabilities including o/s & accrued intt.
  2. Tax provisions
  3. All liabilities not provided in the account
  4. Prior period items which decrease profits of earlier years net of income adjustment.
  5. Preference share capital including dividends arrears & proposed dividend.
  • Proposed equity dividend will be deducted if ex-dividend value of shares is needed.
  • If shares are partly paid up then notional call shall be made & value should be added to assets taking shares as fully paid up.
  • This method can be used to value shares when the firm is liquidated. It gives the real worth of the business. It is generally applied when two companies are going to be merged or amalgamated & also when controlling shares are being acquired.

Illustration: b Balance Sheet of A Ltd.

Liabilities Rs. Assets Rs.
Share Capital

7500 equity shares of Rs.100 each, paid up Rs.80

1000, 5% Preference Shares of Rs.100 each

Reserves & Surplus

Term Loan

  

600000

 

100000

200000

50000

 Fixed Assets

Investments

Inventory

Cash & Bank

Trade Receivables

P&L A/C

 270000

200000

80000

80000

100000

220000
  950000   950000

Current cost of Fixed Assets Rs.220000 & inventory Rs. 100000. 50% of trade receivable is doubtful. Arrears of dividend are due for payment.

Sol. Net assets available to equity shareholders

Particulars Rs.
Fixed Assets

 Investments

Inventory

Cash & Bank

Trade Receivable

 

Less: Outsiders Liabilities

Term Loan

Preference Capitals

Preference Dividend @ 5%

  

220000

200000

100000

80000

50000

650000

 

(50000)

(100000)

(5000)

 
Net Assets 495000

Value of equity shares

Net Assets                                    495000

Add: notional call (7500*20)     150000

                                                       645000

Value per fully paid up share =625000/7500= Rs.86

Value per partly paid up share=86-20=Rs. 66

 

  1. Yield Method-Valuation is done on the basis of rate of return/rate of dividend. 

    If block of shares is large- rate of return should be used & if it is small- rate of dividend should be used.

    1. Earning Yield Method:Stages for yield based valuation:-
      1. Determination of future maintainable profit:-Steps:-
        1. Calculations of past average profits:– Select the no. of years to be averaged & adjust the following from the profits-
          1. Eliminate non-recurring items like loss by fire, lump sum compensation paid, abnormal repair etc.
          2. Profits or losses from non-trading assets
          3. Capital profit or loss/ expense/receipt included in P/L
          4. Adjustment of interest, commission, remuneration, depreciation.
          5. Any other type of adjustment required to be made as per auditor’s qualification/prov. to be made/adjustment of tax payable.

 

  1. Averaging past year profits:-In case profits:-
    1. Are fluctuating- history of earnings of Company has to be studied
    2. Do not show trend- average of the cycle may be used.
    3. Shows trend of rising or falling profits- weighted average method may be used

 

  1. Ascertaining Normal rate of return (NRR) ( This is generally predetermined)
  2. Finding out capitalization rate = 100/NRR
  3. Capitalized value of future maintainable profit
  4. Value per share

 

 

  1. Dividend Yield Method:

The calculation is same as in above method except Future maintainable profit will be taken as amount of Dividend declared which the company expects to maintain in the future and in place of Normal rate of return , Normal rate of dividend shall be used.

 

Example:-

Profits =100000

Normal Rate of return= 20%

Total no. shares=20,000

Dividend =Rs. 4

Tax rate 30%

 

  • Earning yield method:

Rate of earning (Capitalization rate) =100/20=5

Capitalized value of Future maintainable profit =100000*5=500000

Value per share =500000/20000= Rs. 25 per share

 

  • Dividend yield method:

Normal Rate of dividend (Capitalization rate) =100/20=5

Amount of Dividend or Future maintainable profit =20000*4= Rs. 80,000

Capitalized value of amount of Dividend= 80000*5=4, 00,000

Value of a share= Capitalized value of amount of Dividend /Total no. of shares

=400000/20000=Rs. 20 per share

  • Mean Between asset & Yield based valuation:

It is the average of the results of the results of the above two methods. it a compromise formula for bringing parties to an arrangement. such average is called Fair Value of share.

b

  • Valuation of preference shares:

    For the valuation of preference shares following are considered:-

  1. Market expectation rate (risk free rate + small risk premium)
  2. Ability to pay dividend by the company can be known by the ratio of:-

Profit after tax

Preference dividend

  1. Ability of the company to redeem shares.
  • Value of each preference shares can be derived by the following formula

Preference Dividend Rate *100

Market Expectation Rate

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