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 A+B
B
Apna Ghar, Apni Dono Ho Jayen
Kamai i.e.
Gaadi, Bank to Mazza aa
Regular Revenue
Balance, Jayen i.e.
Income i.e.
Investments etc. ASSETS +
ie. PROFITS
ASSETS PROFITS
Main Methods of Share
Valuation
1. Asset
based
Net Assets Method

2. Profit
based
Yield Method

3. Asset &
Profit based
Fair Value Method

Continued
Other Methods of Share
Valuation

Market Price Price Earnings Multiple

Approach Book Value Multiple
Method

DCF Approach
Others i.e. Discounted Cash
Flow Approach
Method I
Net Assets Method

Different Names
Balance Break Up Asset Intrinsic
Sheet Value 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
Unquoted
Equity Shares
Amalgamation Sick Company Lenders
forming part
of wealth
 Method I
Net Assets Method Continued

Steps to solve the question

1. Net Assets
for Equity 2. Value per
Share Holders Share

Conti.
 Method I
Net Assets Method Continued
Step 1. Net Assets for Equity Share Holders (NA for ESH)

Closing Capital Employed XX (Revised values of assets & Outside liabilities)

+ Goodwill as per Valuation XX
+ Investments XX
- Proposed Dividend XX (If Ex Dividend, Ignore if Cum Dividend)
-------------------
XXX
- Amount due to Preference Shareholders

Preference Share Capital X

Premium on Redemption (if any) X
Preference Dividend (If unpaid) X
---------------- XX
---------------------
X

Add : Notional Call X

(for Partly Paid up Shares) --------------------
NA for ESH 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 Rs. Assets Rs.

4,00,000 Equity shares of Rs.10 each fully paid 40,00,000 Goodwill 6,0,000
Building 24,00,000
13.5% Redeemable preference shares of 20,000
Machinery 22,00,000
Rs.100 each fully paid
Furniture 10,00,000
General Reserve 16,00,000 Vehicles 18,00,000
Profit and Loss Account 3,20,000 Investments 16,00,000
Bank Loan (Secured against fixed assets) 12,00,000 Stock 11,00,000
Bills Payable 6,0,000 Debtors 18,00,000
Creditors 31,00,000 Bank Balance 3,20,000
1,28,20,000 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. Non-
Trade 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

2008-2009 2009-2010 2010-2011 2011-2012

Rs. Rs. Rs. Rs.
Profit Given 16,00,000 18,00000 21,00,000 22,00,000

Add: Capital expenditure of 2,00,000

machinery charged to revenue
Loss of sale of Furniture 40,000
16,00,000 20,000 21,40,000 22,00,000
Less: Depreciation on
machinery (20,000) (18,000) (16,200)
Income from non-
Trade Investment (1,08,000) (2,16,000) (2,16,000)
Reduction in value
of Stock (1,00,000)
Bad debts (20,000)
Adjusted Profit 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 70,374
---------------
FMP 17,36,076
Method I Net Assets Method Question
Practice Manual (Answer No.14) . Continued..
(2) Closing Capital Employed
Fixed Assets Rs. Rs.
Building 24,00,000
Machinery (Rs.22,00,000 + Rs.1,45,800) 23,45,800
Furniture 10,00,000
Vehicle 18,00,000
75,45,800
Add: 30% increase 22,63,740
98,09,540
Trade investments (Rs.16,00,000 x 10% x90%) 1,4,000
Debtors (Rs.18,00,000 Rs.20,000) 17,80,000
Stock (Rs.11,00,000 Rs.1,00,000) 10,00,000
Bank balance 3,20,000 1,30,53,540
Less: Outside liabilities
Bank Loan 12,00,000
Bills payable 6,00,000
Creditors 31,00,000 (49,00,000)
Closing Capital employed 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 81,53,540

+ Goodwill as per Valuation 2,10,736
+ Non Trade Investment 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 X
+ / - Future Adjustments X
---------
X

Less: Preference Dividends X

----------
Earnings for ESH X (Expected Earnings Basis)

Less : Transfer to Reserves X

------------
FMP for ESH X (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

Actual EPS
If Earnings Basis = ------------------ 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 4,00,000

(-) Debenture Int.

12% x 4,00,000 (48,000)
P.B.T. 3,52,000

(-) Tax @45% 1,58,400

P. A. T 1,93,600

(-) Pref. Dividend

11% x 3,00,000 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 54,000

b) 5% of Profits undistributed
5% of [1,60,600 9,00,000]
5% x 70,600 3,530
57,530
57,530
Actual Yields = ----------- x 100
5,00,000
= 11.51%

5. V. P. S.
11.51
= --------- x 10 (assumed)
17
= 6.77 per share
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
Main Methods Yield Method
VPS = AY x Paid up Value
1 NA Method
EY
2 Yield Method
3 Fair Value Method

NA Method
Valuation of VPS = NA for ESH /
Equity Shares No. of Equity
Shares

NA Method Yield Method

Pessimistic, Optimistic ,
Liquidation Going Concern
Approach Approach
Large No. of Shares . Few No. of Shares
Controlling Interest Transfers, Dividend
Transfer NA Method Approach
Suitable When
Balance Sheet given in
Question
Thank You