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Valuation of Shares

CA. Mandar Joshi

Circumstances where Valuation of Shares is essential


for decision making
Sale of shares by one person to another
Mergers, acquisitions & capital restructuring
Purchase & sale of shares in private companies and other

unquoted shares
Valuation of shares for tax purpose e.g. gift tax, wealth tax
When shares are pledged as collateral for a loan
Determining the amount payable to the dissenting shareholders
under section 494 of the companies act, 1956
Compensating the shareholders when the undertaking is
nationalised
Valuation of shares by an investment company

Need for Valuation of Shares


For the shares not listed on stock exchange
That is, where ready made market value of shares is not available

For the listed shares where there is no transaction


No takers for the shares of the company

Market quotation of shares may not show true valuation


Artificially Inflated market value of share
Volatile capital market conditions showing inaccurate market price

Valuation Statutorily required


Valuation of Shares required in instance of liquidation of company

Methods of Valuation of Shares


Asset Based
Valuation

Net Asset Method/ Intrinsic Value method/


Balance Sheet Method

Profit Based
Method

Yield Method

Asset & Profit


Based Method
Market Price
Approach Method
Other Method

Fair Value Method


Price Earning Multiple
Book Value Multiple
Discounted Cash Flow Method

Net Assets Method - Suitability


SUITABILITY OF NET ASSETS
METHOD

Amalgamation

Sick
Companies
(Revivals or
liquidation)

Unquoted
Equity Shares Lenders (when
forming part of
shares are
wealth (Where
pledged as
market value
security
is not readily
against loan)
available)

Net Assets Method Steps to solve the


question
Step 1
Net Assets for Equity Share Holders (Total Assets
Outside Liabilities)

Step 2
Calculate total number of shares outstanding in the
market

Step 3
Calculate value per share: Step 1/ Step 2

Net Assets Method


Step 1 Calculation of Net Assets for Equity Share Holders (NA

for ESH)
Closing Capital Employed (Assets excluding Goodwill
Outside Liabilities excluding Preference Capital)

XXX

(Based on revised value of assets and liabilities)


Less: Proposed Dividend

(XXX)

Add: Goodwill as per valuation

XXX
Total (A)

XXX

Less: Amount due to Preference Share Holders


Preference Share Capital

XXX

Step 2 Value Per Share (VPS)

Premium
on redemption of Pref Capital

NA for ESH / Total no. of Equity Share

Unpaid Preference
Dividend

Add: Notional Calls for Partly Paid up Capital

XXX
XXX

Total (B)

XXX

(A - B)

XXX
XXX

Net Assets Method


Valuation of Goodwill
Valuation of goodwill is an essential and integrated part of the
valuation of shares
Goodwill valuation implies that how much potential value
company is holding at the time of valuation of shares
(Always start the solution with calculation of goodwill)
Steps to calculate goodwill

Step 1

Adusted Profits for the past years (Future


Maintainable Profit)

Step 2

Average Adjusted Future Maintainable Profits

Step 3

Calculation of normal profits


Normal Profits = Capital Employed X Normal Rate of Return

Step 4

Super Profits = Adjusted Average Profits - Normal Profits

Step 5

(Step 2 - Step 3)
Goodwill = Super Profits X No. of years considered for goodwill

Solution:
Step 1: Calculation of Net Assets for Equity Shareholders
a) Calculation fo Goodwill
i) Future Maintainable Profits
Particulars

Profit as per books

2010-11

2011-12

2012-13

2013-14

Rs.

Rs.

Rs.

Rs.

18,00,000

Add: Capital Expenditure of machinery charged to


revenue

20,50,000

23,00,000

24,50,000

2,00,000

Less:
Depreciation on Machinery for 3 years on reducing
balance method

20,000

18,000

Adjusted for overvaluation of stock

16,200
1,00,000

Adjusted for Bad Debts

20,000

Adjusted Future Maintainable Profits

18,00,000

ii) Average Adjusted Future Maintainable Profits =

22,30,000

22,82,000

23,13,800

18,00,000 + 22,30,000 + 22,82,000 + 23,13,800


4
=

21,56,450

iii) Calculation of Normal Profit


Normal Profit = Capital Employed X Return on capital

iv) Calculation of Capital Employed


Particulars

Rs

Rs

Assets
Fixed Assets
Building
Machinery

24,00,000
22,00,000

(Consider machinery newly included)


WDV of Machinery newly included
Gross Value
Less: Accumulated Depreciation for 3 years

2,00,000
54,200
1,45,800

23,45,800

Furniture

10,00,000

Vehicle

18,00,000

Total Fixed Assets

75,45,800

Add: 30% Increase in the value of FA

22,63,740

Total Revalued FA

98,09,540

v) Calculation of Normal Profit


Capital Employed/ Net Worth

96,09,540

Rate of return on capital

20%

Normal Profit

vi) Calculation of Super Profit

19,21,908

=Average Adjusted Future Maintainable Profit - Normal Profit


=2156450 - 1921908

Super Profit =

vii) Goodwill (Two years purchase of Super Profit)

2,34,542

=2,34,542 X 2

Goodwill =

4,69,084

Step 2: Net Assets for Equity Share Holders


Particulars
Closing Capital Employed
Goodwill (As revalued)

Rs

Rs
96,09,540
4,69,084
1,00,78,624

Less:
Preference Share Capital

20,00,000

Yield Method

SUITABILITY OF YIELD
METHOD
Use for
valuation of
small
companies

Investors
More interested
in Yield, i.e.,
Dividend or
Earnings

Yield Method Steps to Solve the


Question
Future Maintainable Profits for Equity Shareholders
Expected Yield (Percentage given in the question)
Capitalised Value of FMP

=FMP for ESH X 100/ Expected Yield


Value Per Share

= Capitalised Value of FMP / No. of equity shares

Fair Value Method


Purely theoretical method of valuation
Compromised formula fixing the value of the

shares as average of Net Assets Method and


Yield Method
Fair Value = NA Method Value + Yield Method

Value
2

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