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Valuation of Shares

Value of an asset is the price which buyer & seller or the parties to the
transaction agree to. Once a particular figure is agreed upon as a price,
how it has been arrived at becomes insignificant. But as the parties
have to convince each other about the valuation of price they are
demanding, there are many methods which are used for valuation either
singly or in combination.
A.1 Purposes of valuation:
1) Assessments under the Wealth Tax, Income Tax or Gift Tax Acts.
2) Purchase of a block of shares which may or may not give the holder
thereof a controlling interest in the company.
3) Purchase of shares by employees of the company where the
retention of such shares is limited to the period of their employment
4) Formulation of schemes of amalgamation, absorption, etc.
5) Acquisition of interest of dissenting shareholders under a scheme of
reconstruction.
6) Compensating shareholders, on the acquisition of their shares, by the
Government under a scheme of nationalization.
7) Conversion of shares, say, preference into equity shares.
8) Advancing a loan on the security of shares.
9) Resolving a deadlock in the management of a private limited
company on the basis of the controlling block of shares given to
either of the parties.
A.2 Relevance of valuation:
Valuation by an expert is generally called for when parties involved in
the transaction/ deal/ scheme, etc. fail to arrive at a mutually
acceptable value or agreement or when the Articles of Association etc.
provide for valuation by experts. For transactions concerning relatively
small blocks of shares which are quoted on the stock exchange,
generally the ruling stock exchange price (average price) provides the
basis. But valuation, by a valuer becomes necessary when
1) Shares are not quoted;
2) Shares relate to private limited companies;
3) The court so directs;
4) Articles of association or relevant agreements so provide;
5) A large block of shares is under transfer; and
6) Statutes so require (like Wealth Tax, Gift Tax Acts)

A.3 Limitation of stock exchange price as a basis for valuation:


In a stock exchange numerous people collect-some to deal, some
to watch and some to rig.
Consequently, depending on the motivation they react and the
result of such reactions come out as the market price, which is
partly an outcome of reasoned investments or sales policy, partly
embodying the effect of speculative motives.
The stock exchange registers not its own actions and opinions, but
the actions and opinions of private and institutional investors all
over the country and, indeed the world.
These actions and opinions are the results of hope, fear,
guesswork, intelligence or otherwise, good or bad investment
policy and many other considerations.
The quotations that result definitely do not represent a valuation
of a company by reference to its assets and its earning potential.
Stock exchange price is basically determined on the inter-action of
demand and supply and may not reflect a true value of shares
(that based on fundamental factors like net assets, earnings yield,
etc.)
A.4 Factors for share valuation:
Two factors stand out to be basically important for equity share
valuation: Assets employed and the profit earned; mostly both are
considered. The following has general acceptance:
1. For a company destined to be liquidated, assets will constitute the
basis for valuing the shares of the company.
2. For organizations where assets play a relatively unimportant role, for
example in the case of professional practice of architects and
engineering consultants, valuation may depend wholly on the earning
capacity.
3. Earning power and assets both may be considered in valuation of the
shares of a going concern, earning power playing a major role while
assets are considered only to indicate safety margin i.e. asset
backing.

A.5 METHODS OF SHARE VALUATION:


A.5.1 Net Asset basis/ Breakup value/Intrinsic value of Equity
share
1. All assets at the proper value are added then deduct all liabilities
including preference capital the balance will be net worth. The net
worth is divided by the number of shares to get value per share.
2. If purchased goodwill appears in the books of account it should be
eliminated and new valuation should be taken into consideration. In
case goodwill was recently purchased then the same may be
considered.
3. Shares and securities which are quoted in the stock exchange and
traded on a regular basis, their market price should be used as
current value of investments. For other investments book value may
be taken after adjustments of known loss or gain.
4. The stock of finished goods may be taken at the market price. But
other stocks like raw material, stores and work-in-progress should be
taken at cost following conservative approach, Due allowance should
be made for any obsolete, unusable or unmarketable stocks held by
the company.
5. If the objective is to determine ex-dividend value of equity shares,
proposed equity dividend is also to be deducted.

Valuation of Shares by Net Assets Basis


Question A.1:
The following is the balance sheet of M/s ABC Ltd as on 31/03/2012.
Calculate the value per equity share by Net Asset basis.
Amount
Amount
Liabilities
Assets
(Rs.)
(Rs.)
Capital
10,000 8% Preference Shares
1,00,000 Machine
3,00,000
of Rs. 10 each fully paid
30,000 Equity Shares of Rs. 10
5,00,000
3,00,000 Building
each fully paid
Reserve and Surplus
4,00,000 Goodwill
1,00,000
7% Debentures
4,00,000 Investments
2,00,000
Long Term Loan from Bank
1,30,000 Debtors
2,00,000
Sundry Creditors
40,000 Stock
1,00,000
Short Term Loan
30,000
Total
14,00,000
Total
14,00,000
Additional Notes:
1. The value of Goodwill appearing in the balance sheet represents
value of goodwill purchased 5 years back. The current valuation of
goodwill of the company is Rs. 3,00,000.
2. The Investments represent 5000 equity shares purchased of another
company XYZ Ltd. @ Rs. 40 per share. However the current quoted
value of share in the stock exchange is Rs. 35.
3. 10% of the debtors are doubtful and stock is to be valued at 5%
above Book value.
4. Interest on debentures is due for six months; preference dividend is
also due for the year. Neither of these has been provided for in the
balance sheet.
5. Depreciate the value of Machine & Building by 5% and 10%
respectively.

Valuation if Equity Shares are of different types that is having


different face values:
Valuation will be done considering the fact that the net assets available
will be distributed in proportion to the face value of shares.
Valuation if Equity Shares have different face values
Question A.2:
Equity: A type: 5 lacs shares of Rs. 10 each fully paid up i.e Rs.50 lacs;
& B type; 5 lacs shares of Rs. 5 each fully paid up i.e Rs.25 lacs. If the
Net worth is Rs.150/- lacs then calculate value of shares.

Equity shares having different paid up value:


If some shares are partly paid up, a notional call equivalent to the calls
unpaid added with the net assets. And value of shares is determined
taking partly paid up shares as notionally fully paid up. Thereafter value
of partly paid up shares is arrived at after deducting unpaid call or
uncalled amount from value of fully paid up shares.
Valuation by Net Asset Basis if Equity Shares have different
paid-up values
Question A.3:
Suppose in above Question A.2, B type shares are Rs.10 face value
share, having Rs.5 paid up, then value the shares.

Share Valuation by Net Asset basis and Goodwill Valuation by


Super Profit Method
Question A.4:
The following is the Balance Sheet of N Ltd. as on 31st March, 2011
Balance Sheet
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

Rs.
4,00,000

20,00,000 Building

24,00,000

16,00,000 Machinery
3,20,000 Furniture
12,00,000 Vehicles

22,00,000
10,00,000
18,00,000

6,00,000 Investments
31,00,000 Stock
Debtors
Bank Balance
Preliminary
Expenses
1,28,20,000

16,00,000
11,00,000
18,00,000
3,20,000
2,00,000
1,28,20,000

Further information:
(i) Fixed assets are worth 30% more than book value.
(ii) Stock is overvalued by Rs.1,00,000
(iii) Debtors are to be reduced by Rs.20,000.
(iv) Trade investments, which constitute 10% of the total investments
are to be valued at 10% below cost.
(v) In 2008-2009 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.
(vi) Goodwill is currently valued at Rs. 5,80,000
Find out the intrinsic value of the equity share.

Computation of Net Assets value of differently paid up


categories of Equity Shares
Question A.5:
From the following data, compute the Net Assets value of each category
of equity shares of Smith Ltd.:
Shareholders funds
10,000 A Equity shares of Rs. 100 each, fully paid
10,000 B Equity shares of Rs. 100 each, Rs. 80 paid
10,000 C Equity shares of Rs. 100 each, Rs. 50 paid
Retained Earnings
Rs. 9,00,000