Valuation of Shares

CA. Mandar JoshiValuation of SharesCircumstances where Valuation of Shares is essential for decision makingSale of shares by one person to anotherMergers, acquisitions & capital restructuringPurchase & sale of shares in private companies and other unquoted sharesValuation of shares for tax purpose e.g. gift tax, wealth taxWhen shares are pledged as collateral for a loanDetermining the amount payable to the dissenting shareholders under section 494 of the companies act, 1956Compensating the shareholders when the undertaking is nationalisedValuation of shares by an investment companyNeed for Valuation of SharesMethods of Valuation of SharesNet Assets Method - SuitabilityNet Assets Method Steps to solve the questionNet Assets MethodStep 1 Calculation of Net Assets for Equity Share Holders (NA for ESH)

Step 2 Value Per Share (VPS)NA for ESH / Total no. of Equity Share

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 valuationXXXTotal (A)XXXLess: Amount due to Preference Share HoldersPreference Share CapitalXXXPremium on redemption of Pref CapitalXXXUnpaid Preference DividendXXXTotal (B)XXX(A - B)XXXAdd: Notional Calls for Partly Paid up CapitalXXXNA for ESHXXXNet Assets MethodValuation of GoodwillValuation of goodwill is an essential and integrated part of the valuation of sharesGoodwill 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 goodwillStep 1Adusted Profits for the past years (Future Maintainable Profit)Step 2Average Adjusted Future Maintainable ProfitsStep 3Calculation of normal profitsNormal Profits = Capital Employed X Normal Rate of ReturnStep 4Super Profits = Adjusted Average Profits - Normal Profits(Step 2 - Step 3)Step 5Goodwill = Super Profits X No. of years considered for goodwillSolution:Step 1: Calculation of Net Assets for Equity Shareholdersa) Calculation fo Goodwilli) Future Maintainable ProfitsParticulars2010-112011-122012-132013-14Rs.Rs.Rs.Rs.Profit as per books 18,00,000 20,50,000 23,00,000 24,50,000 Add: Capital Expenditure of machinery charged to revenue 2,00,000 Less:Depreciation on Machinery for 3 years on reducing balance method 20,000 18,000 16,200 Adjusted for overvaluation of stock 1,00,000 Adjusted for Bad Debts 20,000 Adjusted Future Maintainable Profits 18,00,000 22,30,000 22,82,000 23,13,800 ii) Average Adjusted Future Maintainable Profits = 18,00,000 + 22,30,000 + 22,82,000 + 23,13,800 4 = 21,56,450 iii) Calculation of Normal ProfitNormal Profit = Capital Employed X Return on capitaliv) Calculation of Capital EmployedParticulars Rs Rs AssetsFixed AssetsBuilding 24,00,000 Machinery 22,00,000 (Consider machinery newly included)WDV of Machinery newly includedGross Value 2,00,000 Less: Accumulated Depreciation for 3 years 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 Current AssetsInvestment 16,00,000 Stock 11,00,000 Less: Overvauation 1,00,000 10,00,000 Debtors 18,00,000 Less: Bad Debts 20,000 17,80,000 Bank Balance 3,20,000 Total Revalued Current Assets 47,00,000 Total Assets(A) 1,45,09,540 Less: Outside LiabilitiesBank Loan - Secured Against Fixed Assets 12,00,000 Bills Payable 6,00,000 Creditors 31,00,000 Total Liabilities(B) 49,00,000 Capital Employed/ Net Worth 96,09,540 v) Calculation of Normal ProfitCapital Employed/ Net Worth 96,09,540 Rate of return on capital20%Normal Profit 19,21,908 vi) Calculation of Super Profit=Average Adjusted Future Maintainable Profit - Normal Profit =2156450 - 1921908 Super Profit = 2,34,542 vii) Goodwill (Two years purchase of Super Profit) =2,34,542 X 2 Goodwill = 4,69,084 Step 2: Net Assets for Equity Share HoldersParticularsRsRsClosing Capital Employed 96,09,540 Goodwill (As revalued) 4,69,084 1,00,78,624 Less:Preference Share Capital 20,00,000 Net Assets for Equity Share Holders 80,78,624 Step 3: Value per shareValue per share = NA for ESH / No. of equity shares= 80,78,624 / 4,00,000Value per ShareRs. 20.20 Yield MethodYield Method Steps to Solve the QuestionFuture 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 sharesFair Value MethodPurely 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