Valuation:

Valuation of Shares
CA Final Paper 1 Financial Reporting Chapter 9 Unit5
Prof. Deepak Jaggi

Learning Objectives
(1) To Understand why Independent Valuation of
Equity Share is required
(2) To Know the Various Methods of Share
Valuations
(3) Techniques of arriving at Value of Shares under
various Methods
(4) Understand the Logic of Various Methods
(5) Valuation of Preference Shares

Valuation of Shares
Valuation of shares involves the use
of financial and accounting data
Depends on the valuer's judgment,
experience and knowledge
Any valuation based purely on
quantitative data is not realistic.

Circumstances Warranting Valuation

(1) Sale of shares by one person to

another
(2) Merges, acquisitions and capital
restructuring.
(3) Purchase and sale of shares in private
companies and other unquoted shares

Contd

Circumstances Warranting Valuation

Continued..

(4) Transfer of shares in an Indian

company by a non-resident
(5) Valuation for tax purposes e.g.
gift-tax, wealth tax etc.
(6) When shares are pledged as a
collateral for a loan.
Contd

Circumstances Warranting Valuation

Continued..

(7) Determine the amount payable to

dissentient shareholders under section
494 of the Companies Act.
(8) Compensating shareholders when the
undertaking is nationalized.

Contd

Circumstances Warranting Valuation

Continued..

(9) Conversion of shares of one class

into another
(10) Valuation of shares held by an
investment company

Need for Valuation

For the shares not listed in Stock Exchange

For the listed shares when there is no transactions

Market quotation of listed shares may not show true
value

Continued..

Need for Valuation

Continued
Valuations statutorily required
Shares of Private Limited Companies
Large block of shares under transfer

Logic of Main Methods of Share

Valuation
A Parent when wishes to Marry his / her
Daughter would always prefer that would be
Son In law should have
A

Apna Ghar, Apni

Kamai i.e.
Gaadi, Bank
Regular Revenue
Balance,
Income i.e.
Investments etc.
ie.
PROFITS
ASSETS

A+B
Dono Ho Jayen
to Mazza aa
Jayen i.e.
ASSETS +
PROFITS

Main Methods of Share

Valuation
1. Asset
based

Net Assets Method

2. Profit
based

Yield Method

3. Asset &

Fair
Value
Method
Profit based
Continued

Other Methods of Share

Valuation
Market Price
Approach
Method
Others

Price Earnings Multiple

Book Value Multiple

DCF Approach
i.e. Discounted Cash
Flow Approach

Method I
Net Assets Method

Different Names
Balance Break Up
Asset Intrinsic
Value
Sheet
Backing Value
Method Method Method Method

Method I
Net Assets Method Continued

Pessimistic Approach
Liquidation Assumption

Method I
Net Assets Method Continued
Valuing large no. of shares
controlling interest
Takes into account the
real worth of business
Also related to market
value of the assets
Does not give weight to
earning capacity

Method I
Net Assets Method Continued

Suitability
Amalgamation Sick Company

Unquoted
Equity Shares
forming part
of wealth

Lenders

Method I
Net Assets Method Continued

Steps to solve the question

1. Net Assets
for Equity
Share Holders

2. Value per
Share
Conti.

Method I
Net Assets Method Continued
Step 1. Net Assets for Equity Share Holders (NA for ESH)
Closing Capital Employed
+ Goodwill as per Valuation
+ Investments
- Proposed Dividend
- Amount due to Preference Shareholders
Preference Share Capital
Premium on Redemption (if any)
Preference Dividend (If unpaid)

Add : Notional Call

(for Partly Paid up Shares)

XX (Revised values of assets & Outside liabilities)

XX
XX
XX (If Ex Dividend, Ignore if Cum Dividend)
------------------XXX

X
X
X
---------------XX
--------------------X

NA for ESH

X
-------------------X
Conti.

Method I
Net Assets Method Continued
Step 2- Value per Share (VPS)
Fully Paid up: NA for ESH / Total No. of Equity
Shares
Partly Paid up
VPS of Fully paid up - Notional Call
per Share

Method I
Net Assets Method Question
Practice Manual (Question No.14)
The Following is the summarized Balance Sheet of N Ltd. as on 31st March, 2012
Liabilities
4,00,000 Equity shares of Rs.10 each fully paid
13.5% Redeemable preference shares of
Rs.100 each fully paid
General Reserve
Profit and Loss Account
Bank Loan (Secured against fixed assets)
Bills Payable
Creditors

Rs. Assets
40,00,000 Goodwill
Building
20,000
Machinery
Furniture
16,00,000 Vehicles
3,20,000 Investments
12,00,000 Stock
6,0,000 Debtors
31,00,000 Bank Balance
1,28,20,000

Rs.
6,0,000
24,00,000
22,00,000
10,00,000
18,00,000
16,00,000
11,00,000
18,00,000
3,20,000
1,28,20,000

Continued

Method I Net Assets Method Question

Practice Manual (Question No.14) . Conti..
Further Information:
(i) Return on capital employed is 20% in similar businesses.
(ii) Fixed assets are worth 30% more than book value. Stock is overvalued by
Rs.1,00,000, Debtors are to be reduced by Rs.20,000. Trade investments, which
constitute 10% of the total investment are to be valued at 10% below cost.
(iii) Trade investments were purchased on 01.04.2011. 50% of Non-Trade
Investments were purchased on 01.04.2009 and the rest on 01.04.2010. NonTrade Investments yielded 15% return on cost.
(iv) In 2009-2010 new machinery costing Rs.2,00,000 was purchased, but wrongly
charged to revenue. This amount should be adjusted taking depreciation at 10%
on reducing value method.
(v) In 2010-2011 furniture with a book value of Rs.1,00,000 was sold for RS.60,000.
(vi) For calculating goodwill two years purchase of super profits based on simple
average profits of last four ears are to be considered. Profits of last four years are
as under:
(vii) 2008-2009 Rs.16,00,000, 2009-2010 Rs.18,00,000, 2010-2011 Rs.21,00,000,
2011-2012 Rs.22,00,000
(viii) Additional depreciation provision at the rate of 10% on the additional value of
plant and Machinery alone may be considered for arriving t average profit.
Find out the intrinsic value of the equity Share. Income Tax and Dividend tax are not
to be considered.

Method I Net Assets Method Question

Practice Manual (Answer No.14) .
(1) Future maintainable profit

Profit Given

2008-2009
Rs.

2009-2010
Rs.

2010-2011
Rs.

2011-2012
Rs.

16,00,000

18,00000

21,00,000

22,00,000

Add: Capital expenditure of

machinery charged to revenue
Loss of sale of Furniture

2,00,000
40,000
16,00,000

Less:

Depreciation on
machinery
Income from nonTrade Investment
Reduction in value
of Stock
Bad debts

Adjusted Profit

20,000

21,40,000

22,00,000

(20,000)

(18,000)

(16,200)

(1,08,000)

(2,16,000)

(2,16,000)
(1,00,000)
(20,000)

16,00,000

18,72,000

19,06,000

18,47,800
Continued..

Method I Net Assets Method Question

Practice Manual (Answer No.14) . Continued..
Step 1 Continued.
Average Adjusted Profit = 16,00,000 + 18,72,000 + 19,06,000 + 18,47,800
4
= 18,06,450
- Depreciation at 10% on additional
value of Machine
FMP

70,374
--------------17,36,076

Method I Net Assets Method Question

Practice Manual (Answer No.14) . Continued..
(2) Closing Capital Employed
Fixed Assets

Rs.

Building
Machinery (Rs.22,00,000 + Rs.1,45,800)
Furniture
Vehicle

24,00,000
23,45,800
10,00,000
18,00,000

Add: 30% increase

75,45,800
22,63,740

Rs.

98,09,540
Trade investments (Rs.16,00,000 x 10% x90%)
Debtors (Rs.18,00,000 Rs.20,000)
Stock (Rs.11,00,000 Rs.1,00,000)
Bank balance
Less:

Outside liabilities
Bank Loan
Bills payable
Creditors

Closing Capital employed

1,4,000
17,80,000
10,00,000
3,20,000

1,30,53,540

12,00,000
6,00,000
31,00,000

(49,00,000)
81,53,540
Continued

Method I Net Assets Method Question

Practice Manual (Answer No.14) . Continued..
(3) Normal Rate of Return(NRR) / Expected Rate of Return (ERR) = 20%
(4) Normal Profits / Expected Profits = Step 2 x Step 3
= 81,53,540 x 20%
= 16,30,708
(5) Super Profits = Step 1 - 4
= 17,36,076 - 16,30,708
= 1,05,368
(6) Goodwill = 2 x 1,05,368
= 2,10,736

Continued

Method I Net Assets Method Question

Practice Manual (Answer No.14) . Continued..
(7) NA for ESH
Closing Capital Employed
+ Goodwill as per Valuation
+ Non Trade Investment

81,53,540
2,10,736
14,40,000
98,04,276

- Preference Share Capital 20,00,000

NA for ESH

78,04,276

(8) Value per Share (VPS)

NA for ESH
VPS =
---------------------------No. of Equity Share
= 78,04,276
4,00,000
= 19.51 per Share

Method II Yield Method

Use for valuation of small no. of shares

Optimistic and Positive Approach

Basic Logic is if Actual Yield is Double of Expected
Yield then VPS must be Double of Paid up Value

Continued.

Method II Yield Method

Continued
Basis of Yield Valuation
1. Expected Divided Basis
- Small lot of Equity Shares Purchased
2. Expected Earnings Basis
- Large No. of Equity Shares Purchased
Continued.

Method II Yield Method

Continued

Suitability of Yield Method

1. Investor More Interested in
Yield i.e. Dividends or Earnings
2. Data Available Earnings /
Dividend Data is readily available

Method II Yield Method

Continued

Steps to Solve the Question

1. FMP for Equity Share Holders
2. Expected Yield
3. Actual Yield / Capitalized Value of FMP
4.Value per Share
Continued.

Method II Yield Method

Steps Continued

(1) FMP for ESH

Average Profits
+ / - Future Adjustments

X
X
--------X

Less: Preference Dividends

X
---------Earnings for ESH X

Less : Transfer to Reserves

FMP for ESH

X
-----------X

(Expected Earnings Basis)

(Expected Divided Basis)

(2) Expected Yield = % (As given in the Question)

Continued.

Method II Yield Method

Steps Continued
(3) Actual Yield

FMP for ESH

= -------------------------------------- x 100
Paid up Equity Share Capital

OR
(3) Capitalized Value of FMP

100
= FMP for ESH x --------------------Expected Yield

Continued.

Method II Yield Method

Steps Continued
(4) VPS
Actual Dividend
If Dividend Basis = --------------------------- x Paid up Value
Expected Dividend

If Earnings Basis

Actual EPS
= ------------------ x Paid up Value
Expected EPS

Capitalized Value of FMP

If Capitalized Value of FMP = ---------------------------------No. of Equity Shares

Yield Method Question Solving

The Capital structure of a company, on 31st March, 2005 was as under:
Rs.
Equity Share Capital

5,00,000

11% Preference Capital

3,00,000

12% Secured Debentures

4,00,000

Reserves

3,00,000

The company, on an average, earns a profit of Rs.4 Lakhs annually before deduction of interest on debentures and
income tax, which works out to 45%
The normal return on equity shares of companies similarly placed is 15% provided:
a) The profit after tax covers the fixed interest and fixed dividends at least four time.
b) Equity capital and reserves are 15% of debentures and preference capital.
c) Yield on shares calculated at 60% of profits distributed and 5% on undistributed profits:
The company has been paying regularly an equity dividend of 18%. Ascertain the vale of each equity shares of the
company.

Yield Method Answer

(1.) F.M.P. for ESH
Average Profits
(-) Debenture Int.
12% x 4,00,000
(-) Tax @45%
P. A. T
(-) Pref. Dividend
11% x 3,00,000

4,00,000

P.B.T.

(48,000)
3,52,000
1,58,400
1,93,600
33,000
1,60,600

Continued.

Yield Method Answer

Continued.
(2) Expected Yield = 15% provided
a) P. A. T. > 4 [ Fixed Int. + Fixed Div.]
1,93,600 + 48,000 > 4 [ 48,000 + 33,000]
Balance 2,41,600 > 3,24,000

(it is not)

b) Eq. Capital & Reserves > 1.5 [Debentures + Pref. Cap.]

5,00,000 + 3,00,000 > 1.5 [4,00,000 + 3,00,000]
Balance 8,00,000

> 10,50,000 (it is not)

Continued.

Yield Method Answer

Continued.
Hence both the conditions failed. Hence there is additional risk involved while
investing in this Co. The additional risk must be justified by additional gain. The
additional expected return may depend upon the perception of risk on the part of
decision maker which is very subjective. Hence say 1% per condition not satisfied
is a additional return expected. Hence expected yield would be worked out as
follows:Expected Yield
a) Normal Yield for Co. Satisfying the norms

15%

b) Additional Return expected per condition

not satisfied say 1% 2 x 1%

2%
17%
Continued.

Yield Method Answer

Continued.
3. Actual Yield
a) 60% of Profits distributed
60% of [18% x 5,00,000]
60% x 90000

b) 5% of Profits undistributed
5% of [1,60,600 9,00,000]
5% x 70,600
Actual Yields

5. V. P. S.

57,530
= ----------- x 100
5,00,000
= 11.51%

11.51
= --------- x 10 (assumed)
17
= 6.77 per share

54,000

3,530
57,530

Method III - Fair Value

Actually not a Method

Compromised Formula Fixing the value of the Shares
as Average of NA Method and Yield Method
Fair Value = NA Method Value + Yield Method Value
2

Valuation of Preference Shares

Normally Value is Par Value +
Premium Discount on Redemption
So Separate Valuation of Preference
Shares is not Required
Special Cases - When Separate
Valuation is Required - Next Slide

Continued.

Valuation of Preference Shares

Special Cases - When Separate
Valuation is Required
1. In case of Participating Preference Shares
2. When Actual Yield is different from
Expected Yield

Continued.

Valuation of Preference Shares

Special Cases
1. In case of Participating Preference Shares
VPS = NA for PSH + Surplus for PSH
No. of Preference Share
Example:
Nominal Value of 3,000 Preference Share = 3,00,000
Share of Participating Preference Share = 32,500
VPS = 3,00,000 + 32,500
3,000
= 110.833 per share

Continued.

Valuation of Preference Shares

Special Cases
2. When Actual Yield is different from
Expected Yield
VPS = Actual Yield x Paid up Value
Expected Yield
Example:
10% Preference Share Capital 3,00,000
Actual Yield 16%, Paid up value Rs.10 each
16
VPS = ------ x 10 = 16 per share
10

Lesson Summary
Yield Method
VPS = AY x Paid up Value
EY

Main Methods
1 NA Method
2 Yield Method
3 Fair Value Method

Large No. of Shares .

Controlling Interest
Transfer NA Method
Suitable When
Balance Sheet given in
Question

NA Method

Valuation of
Equity Shares

VPS = NA for ESH /

No. of Equity
Shares

NA Method
Pessimistic,
Liquidation
Approach

Yield Method
Optimistic ,
Going Concern
Approach

Few No. of Shares

Transfers, Dividend
Approach

Thank You