VALUATION OF SHARES

1. Introduction

Shares of a company may be quoted or unquoted in the stock exchange. So long as shares are
quoted, the market quotations are often taken as representing the value of the shares on particular dates. But
the stock exchange price of a share may not always warranted by the financial position of the company,
because stock exchange prices are influenced by supply and demand, bank rate, taxation, political influence
and such other external factors. Hence not only the shares of private companies and the unquoted shares of
public companies need valuation, the quoted shares of public companies may also have to be valued.

2. Why Valuation Needed

The necessity for the valuation of shares of a company may arise in different circumstances some of
which are enumerated below:
(a) When a block of shares is to be purchased not so much as to acquire the controlling interest;
(b) When a block of shares are purchased so as to acquire controlling interest on amalgamation or
merger of companies;
(c) When a shareholder dies, for the purpose of assessing estate duty; or when some shares are
given as a gift, for the purpose of assessing gift tax;
(d) When shares are purchased by employees of company to be retained only during the tenure of
service;
(e) When the interests of shareholders who do not give consent to the scheme of reconstruction are
purchased;
(f) When a company is nationalized ad the shareholders are compensated by the Government;
(g) When shares are to be taken as a security against loan;
(h) When a class of shares is converted into another class;
(i) When partners in a firm jointly hold some shares of a company, for ascertaining the amount to
be distributed amongst the partners on dissolution, valuation of the shares becomes necessary.

3. Methods of Valuation

There are three methods of valuing shares, viz.: (i) Intrinsic Value Method or Asset Backing Method
or Balance Sheet Method, (ii) Yield Method or Earning Capacity Method and (iii) Fair Value Method.

3.1 Intrinsic Value Method or Asset Backing Method or Balance Sheet Method

The method involves estimation of the current values of assets and liabilities and determination of
the exact net worth or net assets (i.e., assets minus liabilities) of the business so as to give the value of shares
as
Net Worth
Value of shares = X face Value (or paid up value) of each shares
Share Capital

Intrinsic valuation may be either on a “going concern basis” or on a “break up basis”. In the former
case, utility of an asset to the business should be considered for the purpose of arriving at the valuation of
the asset, while in the latter case the realizable value of an asset should be taken into consideration.
In order to determine the net worth all credit balances appearing in the Statement of Financial
Position should be carefully studied so that accumulated profits and reserves may not be considered as
liability or provision. Similarly, all fictitious assets should be excluded. Special care should be taken to
include assets and liabilities not disclosed in the Statement of Financial Position. Some authorities are of the
opinion that goodwill is to be excluded. But Goodwill comprises a real asset in the sense that it may be sold
for value, and hence it is rational to include the value of goodwill for the purpose of finding out the intrinsic
value of shares.
Where there are both equity and preference shares, the valuation will be made with reference to the
provisions contained in the Articles of the Company. If both the types of shares enjoy same benefit and right
on liquidation, net worth when divide by the number of total shares (both equity and preference) will give
the value per share. In other cases, the amount payable to the preference shareholders (having a preferential
right as to the return of capital under section 85) should be deducted from the net worth and the balance
when divided by the number of equity shares will give the value per equity share.
Where there are both fully and partly paid equity shares, the amount uncalled on partly paid shares
should be added to the total net assets as notional call, thus notionally converting all partly paid shares not
fully paid shares, The asset backing for equity shares arrived at in this manner when divided by the total
number of equity shares (both partly paid and fully paid) will give the value of each fully paid share. The
value of each partly paid share can now be easily ascertained by deducting the uncalled amount from the
value of each fully paid share.
Where there are equity shares of different denominations (e.g., 1,000 shares of Tk. 10 each fully
paid and 1,000 shares of Tk. 8 each fully paid), the total asset backing for equity shares when divided by
total amount of paid up equity capital (and not by the total number shares) will give the value of each Tk. 1
of the paid up capital. When this is multiplied by the actual paid up value of each class of shares, the
intrinsic value of that class of shares will come out.

3.2 Yield Method

Under this method profits determine the value of shares. Valuation can be made either (a) on the
basis of expected return on capital employed or b) on the basis of expected future dividends.

3.2.1 Return on Capital

When this basis is adopted, return on capital employed is compared with the normal rate of return to
give the value of shares as follows:

Rate of Return on Capital

X Paid up Value per Share
Normal Rate of Return

Rate of return of capital is calculated as follows:

Profit Earned
X 100
Capital Employed

“Profit earned” means profit before deducting debenture interest and preference dividend but after
charging income-tax. “Capital employed” includes share capital (both equity and preference), long-term
loans and free reserves. Some authorities prefer to exclude non-trading assets like investments from capital
employed and their income from the profits earned.

3.2.2 Dividend

When this basis is adopted, the following steps will be taken to ascertain the value of shares:
(a) The expected profit available for equity dividend is calculated by deducting form estimated
future maintainable profits, income tax, preference dividend and transfer to reserves.

(b) Expected rates of dividend is calculated by the following formula-

Expected profit available for equity dividend
X 100
Paid up capital

Expected rate of dividend may also be calculated on the basis of dividend actually paid during
the last few years.

(c) Now, the value of each equity share can be calculated by the following formula-

Expected rate of dividend

X Paid up value per share
Normal rate of return

Whether the valuation should be on the basis of return on capital or of expected dividend will
depend upon the number of shares involved. Return on Capital Basis is proper when a large block of shares
is involved because the shareholder in this case can exert influence on the working of the company.
Dividend basis is proper when the number of shares involved is small because the shareholder in this case
will have to content himself only with the dividend as recommended by the Board.

3.3 Fair Value Method

Some authorities are of the view that neither the intrinsic value nor the yield value is correct by the
proper method of valuation is to take a mean between the intrinsic and yield values. This is referred to as
“Fair Value’ which is considered to give a better indication of the value of a share than either its intrinsic or
yield value. The formula is-

Intrinsic value+Yield Value

2

For this purpose yield value may be taken either on the basis of return on capital or on the basis of
future maintainable dividend.

4. Valuation of Preference Shares

If the liquidation is anticipated and the preferential shareholders have a right to participate in surplus
assets, the intrinsic value method will e applied. The formula is-

Surplus assets attributable to preferece shareholders

Nominal value of each preference share +
Number of preference sharess

In all other cases preference shares will be valued on the basis of dividend. The formula is-

Rate of Preference dividend

X Paid up value of each preference shares
Normal yield on preference shares

Normal yield on preference shares will usually be lower than that on equity shares because of
greater safety. Where the preference shareholders have a right to participate in surplus profits the valuation
will be on the basis of expected dividend. Expected dividend will depend upon the volume of total profits of
the company and the conditions under which additional share is payable to preference shareholders. Other
factors like “assets cover” (i.e., ratio of net assets to preference capital) and “dividend cover” (i.e., ratio of
net profit to preference dividend) are also considered for determining the value under this method.
Problem # 1

The following information are obtained from the books of Sunrise Company Ltd. as on 31.12.2012:
Capital
- 10,000 equity shares of Tk. 10 each fully paid-up Tk. 100,000
- 10,000 equity shares of Tk. 10 each, Tk. 7.50 per share paid up 75,000
- 10,000 equity shares of Tk. 10 each, Tk. 5 per share paid up 50,000
Accumulated profit 134,000
Account Payable 55,000
Non-current Assets less depreciation 167,000
Commission on issue of shares 6,000
Preliminary Expenses 9,000
Floating assets 233,000

It is estimated that the normal average profit less tax of the company will be maintained at 34,000
and expected rate of return for capitalization purpose is 8%.

Required: Fair value of shares.

Problem # 2

The following is the Statement of Financial Position of AB Ltd. as on 31.12.2012.

AB Ltd.
Statement of Financial Position
As on 31.12.2012
Assets Taka Taka Taka
Land & Building 270,000
Plant & Machinery 100,000
Working Capital
A. Current Assets
- Closing Inventory 360,000
- Account Receivable 160,000 520,000
Less: B. Current Liabilities
- Bank Overdraft 10,000
- Account Payable 80,000
- Provision for Taxation 100,000
- Proposed Dividend 60,000 250,000 270,000
Total Assets less Current Liabilities 640,000
Capital & Liabilities Taka Taka Taka
Share Capital:
60,000 shares of Tk. 10 each fully paid-up 600,000
Accumulated Profit 40,000
Total Capital & Liabilities 640,000
The net profits of the company after deducting usual working expenses but before providing for
taxation were as under:
1st year Tk. 170,000
2nd year 210,000
3rd year 180,000
4th year 220,000
5th year 200,000
On the date of the Statement of Financial Position Land & Building were valued at Tk. 280,000; and
Plant & Machinery at Tk. 120,000. Account Receivable included tk. 4,000, which is irrecoverable. Having
regard to the nature of business, a 10% return on net capital invested is considered reasonable.

Required: value of the company’s shares ex-dividend. Goodwill may be based on five years
purchase of the annual super profits (assuming tax rate of 50%).
Problem # 3

The following is the extract from the Balance Sheet of Super Prospect Limited:
Share Capital:
3,000 5% Preference Shares of Tk. 10 fully paid Tk. 30,000
6,000 Equity Shares of Tk. 10 each fully paid 60,000
4,000 Equity Shares of Tk. 7.5 each fully paid 30,000
Reserve 30,000
Accumulated profit 12,000
16% Debentures 20,000
Accounts Payable 15,000
Find out the value of each type of equity share after taking into consideration the following
information:
(i) Average annual profit (before taxation) Tk. 49,000;
(ii) Rate of income tax to be assumed to be 50%;
(iii) Tk. 5,000 is being transferred to General Reserve every year;
(iv) Normal return on capital employed is 8%;
(v) Goodwill to be valued at 4 years’ purchase of super profit;
(vi) Dividend declared by companies doing similar business is 9%;
(vii) Market value of share being Tk. 10.2;
(viii) All assets worth book value subject to the following changes:
(a) Investment in 15% Securities- Taka
Cost price 12,000
Nominal Value 10,000
Market value 14,400
(b) Land & Building- Taka
Book value 30,000
Market Value 35,000

Problem # 4

The following figures are extracted from the books of S & C. ltd.
Share Capital: Taka
9% Preference shares of Tk. 10 each 300,000
10,000 Equity shares of Tk. 10 each, Tk. 5 called up 50,000
10,000 Equity shares of Tk. 10 each, Tk. 25 called up 25,000
10,000 Equity shares of Tk. 10 each full called & paid-up 100,000
Reserves and Surplus
General Reserve 200,000
Accumulated Profit 50,000
On a fair valuation of all the assets of the company, it is found that they have an appreciation of Tk.
75,000.
That Articles of Association provided that, in case of liquidation, the Preference shareholders will
have a further claim to the extent of 10 of the surplus assets.
Required: Ascertain the value of each Preference shares and Equity shares assuming liquidation
and avoiding liquidation expenses.

Problem # 5

From the following Statement of Financial Position of XYZ Ltd. as on 31.12.2012 find out the value
of each fully and partly paid equity shares:

XYZ Ltd.
Statement of Financial Position
As on 31.12.2012
Assets Taka Taka Taka
Non-current Assets:
Goodwill 40,000
Land & Building 184,000
 Plant & Machinery 288,000
Furniture & Fittings 20,000
Investments 100,000
Fictitious Assets:
Preliminary expenses 20,000
Working Capital
B. Current Assets
- Closing Inventory 160,000
- Account Receivable 288,000
- Cash at Bank 40,000 488,000
Less: B. Current Liabilities
- Bank Overdraft 80,000
- Account Payable 236,000 316,000 172,000
Total Assets less Current Liabilities 824,000
Capital & Liabilities Taka Taka Taka
Share Capital:
Equity shares of Tk. 10 each 400,000
Less: Calls-in-arrear (Tk. 2 per share) 8,000 392,000
11% preference shares of Tk. 10 each fully paid-up 160,000
Reserves & Surplus
General Reserve 162,000
Accumulated Profit 110,000
Total Capital & Liabilities 824,000

Additional information:
1. Non-current assets are worth 20% above their actual book value. Depreciation on appreciated
value of Non-current assets to be ignored for valuation of goodwill.

2. Of the investments 80% is non-trading and the balance is trading. All trade investments are to be
valued at 20% below cost. A uniform rate of dividend of 10% is earned on all investments.

3. Goodwill is to be valued at 4 years’ purchase of super profits based on average profits of the last
three years. Profits for the last three years (after charging tax @ 50%) were Tk. 148,000; Tk.
162,000; and Tk. 170,000 respectively.

4. In a Similar business return on capital employed is 15%.

5. In 2010 new furniture costing Tk. 10,000 was purchased but wrongly charged to revenue (No
effect has yet been given for rectifying the same.).

6. Depreciation charged on furniture at @ 10 on diminishing balance.

Problem # 6

The following is the Statement of Financial Statement of XY Ltd. as on 31.12.2012.

XY Ltd.
Statement of Financial Position
As on 31.12.2012
Assets Taka Taka Taka
Non-current Assets:
Goodwill 10,000
Land & Building 40,000
Plant & Machinery 30,000
Investments:
5% Govt. Securities (face value Tk. 20,000) 22,000
Preliminary expenses 4,000
Working Capital
 C. Current Assets
- Closing Inventory 80,000
- Account Receivable 40,000
- Cash at Bank 6,000 126,000
Less: B. Current Liabilities
- Provision for Taxation 5,000
- Account Payable 25,000 30,000 96,000
Total Assets less Current Liabilities 202,000
Capital & Liabilities Taka Taka Taka
Share Capital:
Equity shares of Tk. 10 each 100,000
6% preference shares of Tk. 10 each fully paid-up 50,000
Capital Redemption Reserve 5,000
General Reserve 6,000
Replacement Reserve 7,000
Accumulated Profit 14,000
6% Debentures 20,000
Total Capital & Liabilities 202,000

Additional information:

1. Assets to be revalued:
Land & building Tk. 60,000
Investments Tk. 25,000

2. Goodwill to be valued at 4 years’ purchase of super profits.

3. Average profits for last 3 years after charging income tax Tk. 30,000.

4. Fair return 10%.

Requirement: Fair value of each equity shares.

Solution # 5

Workings:

Book value of furniture:

2010 2011 2012
Purchase price/book 10,000 9,000 8,100
value
Less: depreciation @ 1,000 900 810
10%
Written down value 9,000 8,100 7,290

Capital employed:
Machinery Tk. 184,000
Land & Building 288,000
Furniture (20,000 + 7,290) 27,290
499,290
Add: 20% of increase 99,858
599,148
Trade investments 20,000
Less: 20% 4,000 16,000
Closing inventory 160,000
Accounts Receivable 288,000
Cash at Bank 40,000
Total Assets 1,103,148
Less: Current Liabilities:
Bank Overdraft 80,000
Account payable 236,000 316,000
Capital Employed 787,148

Super Profits: