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VALUATION MEANS
Option pricing models are used for certain types of financial assets (e.g.,
warrants, put options, call options, employee stock options, investments with
embedded options such as a callable bond) and are a complex present value
model. The most common option pricing models are the BlackScholesMerton models and lattice models.
GOODWILL
WHAT IS GOODWILL?
Goodwill is excess of purchase price over share of Net Assets (Fair Value)
Goodwill is Intangible Asset Goodwill is Reputation , higher earning of
income , etc Goodwill = Purchase price FV of Net Assets acquired as on
date of purchase
DEFINITION
An intangible asset that arises as a result of the acquisition of one company
by another for a premium value. The value of a companys brand name, solid
customer base, good customer relations, good employee relations and any
patents or proprietary technology represent goodwill. Goodwill is considered
an intangible asset because it is not a physical asset like buildings or
2008.....
20,000
2009.....
20,000
2010.....
35,000
Super Profits are the profits earned above the normal profits. Under this
method Goodwill is calculated on the basis of Super Profits i.e. the excess of
actual profits over the average profits. For example if the normal rate of
return in a particular type of business is 20% and your investment in the
business is $1,000,000 then your normal profits should be $ 200,000. But if
you earned a net profit of $ 230,000 then this excess of profits earned over
the normal profits i.e. $ 230,000 - $ 200,000= Rs.30,000 are your super
profits. For calculating Goodwill, Super Profits are multiplied by the agreed
number of years of purchase.
Steps for calculating Goodwill under this method are given below:
PROBLEM 1
The capital employed as shown by the books of ABC Ltd is $ 50,000,000.
And the normal rate of return is 10 %. Goodwill is to be calculated on the
basis of 3 years puchase of super profits of the last four years. Profits for the
last four years are:
10
10,000,000
2006
12,250,000
2007
7,450,000
2008
5,400,000
Total profits for the last four years = 10,000,000 + 12,250,000 + 7,450,000 +
5,400,000 = $35,100,000
Average Profits = 35,100,000 / 4 = $ 8,775,000
Normal Profits = 50,000,000 X 10/100 = $ 5,000,000
Super Profits = Average/ Actual Profits Normal Profits = 8,775,000
5,000,000 = $ 3,775,000
Goodwill = 3,775,000 3 = $ 11,325,000
PROBLEM 2
When the actual profit is more than the expected profit or normal profit of a
firm, it is called Super Profit. Under this method goodwill is to be calculate
of on the following
manner:
Goodwill = Super Profit x Number of Years Purchase
11
Product
2006-07
2,60,40,742.63
2007-08
77,77,726.00
2008-09
1,34,84,208.75
2009-10
2,83,01,883.14
TOTAL
7,56,04,560.00
(Rounded off)
SOLUTION:
Average Profit = Rs. 75604560 /4 = Rs. 1,89,01,140
Normal Profit = Rs. 7,30,49,249x 10/100 = Rs. 73,04,925
Super Profit = Actual/Average Profit - Normal Profit
Super Profit = Rs. 1,89,01,140-Rs. 73,04,925= Rs. 1,15,96,215
Goodwill = Rs. 1,15,96,215 x 3 = Rs. 3,47,88,645
Capital employed
12
Particulars
Assets (Fixed +current )
Less : External Liablities
Net TangibleAssets
Less : Non-Trading Assets
Trading Capital Employed
Less : of Net Profit Earned during year
Average Capital Employed during year.
NOTES:
Net Tangible Assets:
Net Tangible Assets = Fixed Assets + Current Assets - External
Liabilities
Amt
Xxx
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
13
2.
3.
4.
5.
Particulars
Share Capital (Equity + preference)
Add : Reserves & Surplus
Capital Reserve (Gain on Revaluation of Net Assets)
Less : Profit & Loss a/c (Dr) balance , if any
Misc. Exp. Not w/o, if any
Loss on revaluation , if any
Net Assets
Less : Goodwill (if appearing in balance sheet)
Tangible Capital Employed
Less : non-trading Assets
Trading Capital Employed
Less : of profit earned during the year
Average Capital Employed
Amt
xxx
xxx
xxx
xxx
(xxx)
(xxx)
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
14
2. ESTIMATE RATE
However, generally the profit & loss accounts (to find out the profits ) and
the balance sheet (to find out the capital employed) of all the concerns in a
particular industry may not be available. In such a case , the Normal Return
is estimated by the formula :
Return at zero risk + Addl. Return for business risk + Addl. Return for
financial risks
(1) Return at Zero Risk: This refers to the return from a safe investment
e.g., the interst on Bank Deposits, say 10%. This is the mimimum rate
expected on investment, by an investor.
(2) Additional Return for Business Risks: A businessman, however,
expects to earn more than the Bank rate, to cover the risk of busines. Such
extra return or 'premium' to cover business risk, say 2%, is added to the bank
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rate above, to give the normal rate of 13%. this rate goes up or down with
changes in general business condition e.g. boom or depression. Businesmen
expect a higher rate for business involving more risk.
(3) Additional Return for Financial Risks: Financial Risks refer to the
risks due to large amounts borrowed or due to the Capital Gearing policies
adopted by concern. If the concern has huge loans it means that a part of the
future profits will be used to pay interest. Suppose the additional return to
cover such financial risks is estimated at 3%, the normal rate of return would
now be 15% (10 + 2 + 3).
NRR for Company
The normal rate of return in the case of limited company can also be
estimated on the basis of the Dividend paid by the company, the normal rate
of dividend expected and the market price of the shares of the company. The
formula is :
Normal Rate of Return = Dividend (in Rs)_____ * 100
Market Price of the share
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SOLVED PROBLEMS
The Balance Sheet of Vishnu Limited, is as follows:
Purchase of Super Profits
Balance Sheet As on 31-12-2001
Liabilities
Amt(Rs)
Assets
Amt(Rs)
Share Capital
150000
Goodwill
15000
Capital Reserve
30000
Land
95000
Profit or Loss
13000
Machinery
60000
Creditors
63000
Stock
57500
Depreciation
Debtors 49000
Fund
RDD
Land
7500
Machinery
15000
(1500)
47500
3500
17
278500
278500
18
Solution:
Step
Particulars
Amt(Rs)
95000
10000
Adjusted Profit
85000
Less: Tax@50%
42500
Amt(Rs)
42500
Capital Employed
Assets
110000
Land
60000
Machinery
57500
19
Stock
49000
Debtors
3500
280000
63000
Depreciation Fund
22500
R.D.D
1500
Capital Employed
87000
193000
(Assets Liabilities)
23160
19340
20
77360
19340*4
Working Notes:
3. Capitalisation Method:
There are two ways of calculating Goodwill under this method:
(i) Capitalisation of Future Maintainable Profit
(ii) Capitalisation of Super Profits Method
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22
Valuation of shares
Normally , the value of shares is ascertained from the market price quoted
on the stock exchange. Sometimes, however, share valuation has to be done
by an independent valuer. Shares of a limited company are required to be
valued on many occasions such as
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Methods of valuation
Under this method, the net value of assets of the company are divided by the
number of shares to arrive at the value of each share. For the determination
of net value of assets, it is necessary to estimate the worth of the assets and
liabilities. The goodwill as well as non-trading assets should also be
included in total assets. The following points should be considered while
valuing
of
shares
according
to
this
method:
24
Calculation
Tangible, Real Gross Assets
Amt
XXX
(XXX)
Net assets
XXX
(XXX)
Surplus on liquidation
XXX
(XXX)
XXX
25
by
using
the
following
formula:
Rs. 1,00,000
Rs. 2,00,000
Rs. 2,00,000
6% Debentures
Rs.1,00,000
Current Liabilities
Rs. 1,00,000
Rs. 4,00,000
Current Assets
Rs. 3,00,000
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For the purpose of valuation of shares, fixed assets and current assets are to
be depreciated by 10% ; 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.
Calculate the value of each equity share under Net Asset Method.
Solution:
Net Assets Available To Equity Shareholders:
Rs
Asstes
Fixed asstes (400000 10% of 400000)
360000
270000
Value of Asstes
630000
Less: Liabilities
Current Liabilities
100000
6% Debentures
100000
3000
203000
100000
5000
105000
308000
27
322000
2000
28
Yield value per share = Expected rate of dividend * Paid up value of shares
Normal rate of dividend
Expected rate of Dividend = Profit available for equity dividends * 100
Paid up equity capital
Particulars
1. Future maintainable profits
Amt
XXX
XXX
XXX
XXX
XXX
XXX (XXX)
PREFERENCE SHARE
XXX
29
30
Steps
Particulars
1. Future maintainable profits
Amt
XXX
XXX
XXX
XXX
Capitalisation of earnings
Another way to compute value of large block of shares is by capitalising the
earnings at the yield rate. This gives the capitalised Value of the earnings of
the company. Capitalised value shows the value of shares, which at the
normal rate of return, will yield the amount of the expected future earnings.
The expected Earnings are capitalised in the following manner.
31
This is not a method, but a compromise formula which arbitrarily fixes the
value of shares as the Average of the values obtained by the Net Assets
Method and the Yield Method.
Rs
Rs 10 5,00,000
each
1,000,00
Assets
Building
Rs
5,00,000
Machinery
3,00,000
Stock
60,000
Rs 100 each
1,00,000
Debtors
50,000
General Reserve
50,000
Bank
50,000
1,10,000
Creditors
40,000
60,000
Proposed Dividend
9,60,000
9,60,000
The profits of the company after charging depreciation but before income tax @ 40% were as follows for last five years;
1991 - Rs 1,00,000
2000 - Rs 1,40,000
32
2001 - Rs 1,60,000
2002 - Rs 1,70,000
2003 - Rs 1,80,000
Reasonable Return on Equity funds in this line of business is considered to
be 10%.
Find out the value of equity share under the Net Asset or Intrinsic
Method after valuing goodwill on the basis of five years purchase of
annual super profits.
Also , ascertain the share value on the basis of profit earning capacity
in relation to
Average maintainable profits.
Average dividend rate which was 8%, 9% ,7% for the last three
years.
Further calculate the number of shares to be purchased by an
individual investor with an amount of Rs 20,000 available for
investment on the basis of appropriate fair value of the relevant equity
shares.
33
Solution :
Computation of Goodwill
Capital Employed
Rs
Rs
Buildings
6,00,000
Machinery
2,50,000
Stock
60,000
Debtors
50,000
Bank
50,000
10,10,000
Less: Liabilities
Creditors
1,10,000
40,000
Proposed Dividend
60,000
Capital Employed
2,10,000
8,00,000
34
1,50,000
60,000
90,000
80,000
Super profit
10,000
Goodwill
= Super Profit x 5
= Rs 10,000 x 5
= Rs 50,000
8,00,000
50,000
8,50,000
1,00,000
7, 50,000
35
36
CONCLUSION:
CONCLUSION ON VALUATION OF GOODWIL
Goodwill exists in every business earning good profits. It is inseparably
linked with the business. It is the attractive force which brings in
customers . It distinguishes an old established business from a new
business at its first start.
Goodwill arises when one company acquires another, but pays more than the
fair market value of the net assets (total assets - total liabilities). It is
classified as an intangible asset on the balance sheet. However, according to
International Financial Reporting Standards, goodwill is never amortized.
Instead, management is responsible to value goodwill every year and to
determine if impairment is required. If the fair market value goes below
historical cost (what goodwill was purchased for), impairment must be
recorded to bring it down to its fair market value. However, an increase in
the fair market value would not be accounted for in the financial statements.
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38
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