A.5.

2 Yield Basis valuation of Equity share

Yield based valuation may take the form of valuation based on rate of
return.
The rate of return may imply rate of earning or rate of dividend.
If a block of shares is sufficiently large, so as to warrant virtual control
over the company the rate of earning should be the basis; for small
blocks the rate of dividend basis will be appropriate.
It is necessary to determine:
o the (after tax) maintainable profit or dividend for the company in
the foreseeable future, and
o the normal rate of yield of earning or dividend, as the case may be
for the company.
After the rate of yield of earning or dividend has been determined the
capitalization factor, or the multiplier, should be determined for
applying the same to the adjusted maintainable profit of business to
arrive at the total value.
Total value of the undertaking divided by the number of equity shares
gives the value for each equity shares.
Valuation of Equity Shares by Earning Yield Basis
Question A.6:
If the yield expected in the market is 8%, value the shares of an
undertaking earning Rs. 4,00,000 p.a. and having 1,00,000 equity
shares.
Valuation by Dividend Yield Basis if Equity Shares have different
paid-up values
Question A.7:
If the dividend yield expected in the market is 8%, value the shares of
an undertaking paying a dividend at a rate of 20% and having 1,00,000
equity shares of Rs.10 each, out of which 30,000 shares are Rs. 5 paidup.
(i) In asset basis and in earning basis, notional call will be taken for
partly paid shares but in dividend basis valuation, paid up value as it is
will be taken.
(ii) The expected rate is the normal expectation rate of equity
shareholders. It can also be called as cost of equity or capitalization rate.

Valuation of Equity Shares under two approaches buying

small lot and buying controlling interest
Question A.8:
From the following information, calculate the value of a share of face
value of Rs. 100 if you want to
(i) buy a small lot of shares;
(ii) buy a controlling interest in the company.
Capital
Profit
Dividend
Employed
Year
%
(Rs.)
(Rs.)
2009
55,00,000 3,43,75,000
12
2010
1,60,00,000 8,00,00,000
15
2011
2,20,00,000 10,00,00,000
18
2012
2,50,00,000 10,00,00,000
20
The market expectation is 12%.
Gordons Dividend Growth Model
Value per share =

Expected Dividend
Expected rate Growth rate

Growth rate (is growth in earning and dividend) =

Return on net worth rate x Retention ratio
Price Earning Model
Value per share = P/E Ratio x Earning Per Share

A.5.3 Fair Value: Average of asset and yield based valuation

This is, in fact, no valuation, but a compromise formula for bringing
the parties to an agreement.
This presents averaging two results obtained on quite different bases.
It is argued that average of book value and yield based value
incorporates the advantages of both the methods. That is why such
average is called the fair value of share.

Share Valuation under Fair Value Method

Question A.9:
Following is the Balance Sheet of Rampal Ltd as on 31st March, 2009:
Liabilities
Rs. Assets
Rs.
1,00,000 equity shares of
10,00,000 Goodwill
5,00,000
Rs. 10 each
Buildings
15,00,000
10,000, 12% preference
10,00,000 Plant
10,00,000
shares of Rs. 100 each
6,00,000 Investment in 10%
4,80,000
General reserve
4,00,000 stock
Profit and Loss account
10,00,000 Stock-in-trade
6,00,000
15% Debentures
8,00,000 Debtors
4,00,000
Creditors
Cash
1,00,000
Preliminary expenses
2,20,000
48,00,000
48,00,000
Additional information is given below:
a) Nominal value of investment is Rs. 5,00,000 and its market value is
Rs. 5,20,000.
b) Following assets are revalued:
(i) Building
Rs. 32,00,000
(ii) Plant
Rs. 18,00,000
(iii) Stock-in-trade
Rs. 4,50,000
(iv) Debtors
Rs. 3,60,000
c) Profit before tax of the company is Rs. 12,00,000 and 12.50% of the
profit is transferred to general reserve, rate of taxation being 50%.
The balance profit is distributed as dividend.
d) Normal dividend expected on equity shares is 8%.
e) Goodwill is valued at Rs. 4,92,000.
Ascertain the value of each equity share under fair value method.

A.6 Valuation of Preference Shares/Debentures:

The value of each preference share can be derived as
=

Preference dividend rate

100 (Paid up value)
Market expectation rate

Similarly value of debenture can be worked out as

Debenture interest rate
=
100 Paid up value
Market expectation rate
Valuation of Preference Share
Question A.10:
XYZ Ltd. has 10,000 8% Cumulative Preference shares of Rs. 100 each.
The market expectation rate is 10%. Calculate the value of preference
shares.
Alternatively,
The above formulae are basically suitable for perpetual preference
share/ debenture. In reality both are redeemable, hence the value
arrived by discounting the future cash flows in the form of
dividend/interest & principal is considered.
Discounting Future Cash Flows
Value of share can also be determined by discounting at normal
expectation rate, the future after tax cash flows generated for equity
shareholders.
Valuation by Discounting Future Cash Flows
Question A.11:
You are to purchase 1,000 cumulative preference shares of face value of
Rs. 10 each on which you are going to receive dividend at 8% per
annum. The remaining life of the shares is 4 years after which it will be
redeemed. Calculate the value that you can pay for these preference
shares assuming that the normal expectation rate of return is 10%.