After studying this chapter you should be able to:
Define: Goodwill.
Understand the nature and sources of goodwill.
Appreciate the need for valuing goodwill.
Understand the terms: future maintainable profit; normal rate of return; capital employed and average capital employed.
Determine average capital employed under different methods.
Value goodwill by average profits method; super profit method and capitalization method.
Appreciate the need for valuation of shares.
Value shares by intrinsic value method; yield method and fair value method.
Understand “minority” and “majority” holdings.
Explain the meaning of certain key terms associated with “Valuation of Goodwill and Shares”.
A firm’s reputation is generally assessed by goodwill. Despite its popular usage in business activities, its value is not yet properly understood in accounting language. As a student of corporate accounting, one should be able to define goodwill, and understand its nature and sources. They should also appreciate the need to value goodwill, and should be aware of the factors that affect the value of goodwill and the methods of valuing it. Similarly, the students should also know to determine the value of shares.
Questions like why the value of shares has to be ascertained, what are the factors that affect the value of shares, and what are the methods of valuation of shares are answered in detail in this chapter.
The term “goodwill” is most widely used in the business world. But no one will be able to explain it in crystal clear words. It is difficult to define. However, it is considered as an invaluable asset—intangible in nature. But it is not a fictitious asset. In simple words, a business firm which earns reputation over a period of time gets the credit of goodwill. It is a common notion that if a firm is a profitable one it is valued high and in turn attracts goodwill. Hence it may be said that the reputation of a firm coupled with its going
profitability represents “goodwill”. But goodwill can be realizable or quantified in money’s worth when the firm is disposed of. Though there are many definitions, the following are noteworthy to be quoted:
“The capacity of a business to earn profits in future is basically what is meant by the term Goodwill”. “Goodwill is the present value of a firm’s anticipated excess earnings”.
Generally, goodwill may be valued and realized only at the time of disposal of the business. Such being the inherent characteristic feature of goodwill, naturally a question arises as to the necessity of valuation of goodwill. The need for valuation of goodwill depends on the form of organization. In case of sole proprietorship, it is valued at the time of disposal of the business. Goodwill cannot be sold as a separate item. In case of a partnership firm, the need for valuation of goodwill arises on some important events such as, admission of a new partner, retirement or death of a partner, change in profit sharing ratio, dissolution or sale to a company.
In case of joint stock companies, the need for valuation of goodwill arises in the following circumstances:
The following are some of the factors that affect the value of goodwill:
Now, the most important components of goodwill namely (1) profitability; (2) yield expected by the investors (normal rate of return) and (3) capital employed are to be explained in detail which will facilitate the evaluation of goodwill.
According to the definition in Section 8.1, emphasis is on the future profits of a firm. It is natural that any buyer is keen to assess whether the firm will enhance the profitability in the coming years. This process of assessment whether the firm will maintain its profits in the future is otherwise called “future maintenance profit”. Profits earned in the past years, naturally, forms the basis for estimating future profits. As such, the following factors are to be considered while estimating the future maintainable profits:
It is natural that any investor is interested in getting a fair return (yield) on their investments. This is referred to as “rate of earnings”. It varies from industry to industry. It depends upon various factors such as bank rate, nature of industry, risk, etc. It consists of the following elements:
The normal rate of return is to be ascertained by taking into account the above factors. Apart from these, the following factors that affect the normal rate of return are also should be borne in mind:
The other most important element in the valuation of goodwill is “capital employed”. The quantum of profits earned with respect to the capital used is an important basis for the valuation of goodwill. Of late, capital employed represents the fixed assets plus_net working capital. This may also be said as an aggregation of share capital, reserves and long-term loans. In other words, this term represents the equity shareholders funds along with long-term borrowings. Care should be taken to exclude non-trading assets, fictitious assets and goodwill appearing in the balance sheet.
However, this is not suitable for evaluating goodwill of individual companies. In such individual companies, the benefit accrued to the shareholders has to be assessed. For this, the amount of debentures or loans should not be included in capital.
The items to be included in the determination of capital employed are as follows:
Items to be excluded in determining capital employed are:
At present, “average capital” employed is used instead of capital employed. Since the profit earning is a continuous process throughout the year, it is reasonable to use average capital employed. Average capital employed is nothing but the average of the capital employed at the end of the year and employed in the beginning of the year.
If the capital employed in the beginning of the year is not given in the question, average capital employed may be determined by deducting the half the profits of the year from the capital employed at the end of the year.
All these factors can best be understood in the illustrations provided in the chapter.
The following are the methods of valuation of goodwill:
Part A: In this part, simple problems are solved for valuation of goodwill. In the next part, i.e. Part B, advanced problems are discussed.
Under this method, the goodwill is valued
It is presumed that any new business will not be able to earn profits during the first few years. The person who purchases an already running business has to pay a sum (goodwill) which is equal to the profits that is likely to be earned in the first few years. Hence, the goodwill is to be calculated by multiplying the past average profits by the number of years during which the expected profits will accrue.
Goodwill is paid for obtaining a future advantage. After deciding the number of years for which the business will run in the market, the profits of these years expected will be paid by the buyer to the seller. For this reason, the average profit is to be multiplied by number of years.
Formula: Goodwill = Average profit × Number of years’ purchase
Illustration 8.1
Model: Average profits method
The profit for the last 5 years of a company were as follows:
2006: 5,00,000
2007: 2,00,000
2008: 7,00,000
2009: 1,00,000
2010: 5,00,000
Calculate the goodwill of the company on the basis of 3 years purchase of the average profits based on the last 5 years.
Solution
Step 1: Compare the Average Profit:
Step 2: Computation of Goodwill:
4,00,000 × 3 = 12,00,000
(Ref: Step 1) (Given)
This method is a modified version of average profit method. Under this method, weighted average has to be found out instead of simple average as in earlier method. For this, each year’s profit is multiplied by the respective number of weights, i.e. 1, 2, 3, 4, 5, etc., to determine the value of the product and it is totalled. This is divided by the total of weights to determine the weighted average profits. Finally, the weighted average profit is multiplied by the agreed number of years purchase to ascertain the value of goodwill.
Formula:
The value obtained under this method will be better than the simple average profit method.
Illustration 8.2
Model: Weighted average method
The profits of a company for the year ended 31 March for the last 5 years were as follows:
|
Year |
Profit |
|
2006 |
1,20,00,000 |
|
2007 |
15,00,000 |
|
2008 |
9,00,000 |
|
2009 |
7,00,000 |
|
2010 |
4,00,000 |
Calculate the value of goodwill on the basis of 2 years’ purchase of weighted average profits after weights 1, 2, 3, 4 and 5 respectively to the profits for the years 2006 to 2010.
Solution
Step 1: First, Total Value of the Product is Determined as:
Step 2: Weighted Average Profit
Step 3: Goodwill |
= |
Weighted Average Profits × Number of Years’ Purchase |
|
= |
15,00,000 × 2 |
|
= |
30,00,000. |
Illustration 8.3
Model: Weighted average method with adjustments
Calculate the goodwill of a company on the basis of 2 years’ purchase of weighted average profits for the last 3 years. Purchase of weighted average profits for the last 3 years. 2007: 1,00,000; 2008: 70,000; 2009: 50,000. The weights assigned to each year are: 2007: 1; 2008: 2; 2009: 3.
Further information:
Solution
1. Adjustments:
Year 2009 |
= |
Period → 1 year |
|
= |
[5,000 − 10% of 5,000(3 months)] × |
|
|
4,875 × |
|
= |
487.50 |
2. Calculation of adjusted profit:
3. Calculation of weighted average profits:
Weighted average profit
Goodwill = 62,881 × 2 years
= 1,25,762
In the earlier methods, goodwill is computed on the basis of average profits. It is based on the assumption that if any new business is set up, one may not be able to earn any profits during the first few years of running the business. As such, the person who buys an existing running business has to pay an amount equal to total profits he is likely to earn in the next “few years”. Hence, goodwill represents a valuation of future earnings.
The other school of thought is that the buyer’s real benefit lies not in total profits but in excess profits. They do not advocate “moral” or “actual profits”. This method emphasises the valuation of goodwill on the basis of excess profits.
Super profit = Average profit – Normal profit
Goodwill = Super profit × Number of years
The following are the main requirements:
Step 1: |
Average Profit is Calculated. |
Step 2: |
Normal Profit on the Capital Employed on the Basis of the Normal Rate of Return is Calculated. |
Step 3: |
Normal Profit is Deducted from Average Profit Super Profit = Average Profit – Normal Profit[Step 2 – Step 1] |
Step 4: |
Goodwill = Super Profit × Number of Years’ Purchase [Step 3 × Number of Years] |
Illustration 8.4
Model: Super profits method
The books of the business showed that the capital employed on 31 March 2010, 6,00,000 and the profits for the last 5 years were:
Years |
|
2005–06: |
50,000 |
2006–07: |
60,000 |
2007–08: |
70,000 |
2008–09: |
80,000 |
2009–10: |
1,40,000 |
You are required to calculate the value of goodwill based on 3 years’ purchase of the super profits of the business, given that the normal rate of return is 10%.
Solution
Step 1: Average Profit is Calculated as:
|
Years |
Profit () |
|
2005–06: |
50,000 |
|
2006–07: |
60,000 |
|
2007–08: |
70,000 |
|
2008–09: |
80,000 |
|
2009–10: |
1,40,000 |
Total Profit = |
4,00,000 |
Step 2: |
Normal Profit is Calculated: |
|
Formula: Normal Profit = Capital Employed × Normal Rate of Return |
|
Substituting the Values We Get, |
= 6,00,000 × 10% = 6,00,000 ×
= 60,000
Step 3: Super Profit = Average Profit – Normal Profit
Step 4: Goodwill |
= |
Super Profit × Number of Years’ Purchase |
|
= |
20,000 × 3 years |
|
= |
60,000. |
Under this method, goodwill is determined by using the formula:
Goodwill = Super profit × Present value factor (PVF)
To put in other words, goodwill is determined as the present value of the future super profits.
Present value factor can be obtained either by using the formula:
or from annuity tables.
Goodwill is calculated as follows:
Step 1: |
Future Super Profits for Next 5 or 6 or 7 Years have to be Calculated. |
Step 2: |
Rate of Return has to be Fixed. |
Step 3: |
Present Value Factors Have to be Calculated Either by Using the Formula or From Annuity Table. |
Step 4: |
Present Value Factors Have to be Multiplied with Future Super Profits. |
Step 5: |
The Aggregate (Sum Total) of Product of Present Value Factors and Super Profits is the Value of Goodwill. |
Illustration 8.5
Model: Annuity method of super profit
A company has made a forecast of profit for the coming 5 years as follows:
The total assets of the firm are 6,00,000 and outside liabilities are 2,00,000. The present value factor @ 10% are as follows:
Calculate the value of goodwill.
Solution
Step 1: Profit on Capital Employed is Calculated as:
Capital: Assets − Liabilities (Outside)
= 6,00,000 − 2,00,000 = 4,00,000
Profit |
= |
Capital Employed × Required Rate of Return |
|
= |
4,00,000 × 10% = 40,000. |
Under this method, goodwill may be calculated in the following two ways:
Under this method, the value of goodwill is determined by deducting the actual capital employed in the business from the capitalized value of the average profits on the basis of normal rate of return.
Value of goodwill is determined as follows:
Step 1: |
The Average Profits are Ascertained on the Basis of Past Few Years’ Performance. |
Step 2: |
The Average Profits Thus Obtained are to be Capitalized on the Basis of Normal Rate of Return, by using the |
|
|
|
This is the Total Value of Business. |
Sept 3: |
Actual Capital Employed (Net Assets) is Calculated by Deducting Outside Liabilities from the Total Assets (Excluding Goodwill) |
|
Formula: |
|
Capital Employed = Total Assets (Excluding Goodwill) – Outside Liabilities |
Step 4: |
Goodwill is Obtained by Deducting the Actual Capital Employed (Net Assets) from the Total Value of Business (Step 2 – Step 3) |
Illustration 8.6
Model: Goodwill: Capitalization of average profit
A company has earned an average profit of 60,000 during the last 5 years. The normal rate of return in a similar type of business is 10%. The total assets of the business are 7,50,000 and outside liabilities are 2,50,000. Ascertain the value of goodwill by capitalization method.
Solution
Step 1: Average Profits = 60,000 (Given)
Step 2: Capitalization of Average Profits:
Step 3:
Capital Employed |
= |
Total Assets − Outside Liabilities |
(Net Assets) |
|
|
|
= |
7,50,000 − 2,50,000 |
|
= |
5,00,000 |
Step 4: Goodwill |
= |
Capitalized Value – Net Assets |
|
= |
6,00,000 − 5,00,000 |
|
= |
1,00,000 |
|
|
(Step 2 − Step 3) |
Under this method, valuation of goodwill is determined as follows:
Step 1: |
Capital Employed is Computed |
|
Capital Employed = Total Assets – Outside Liabilities |
Step 2: |
Required Profit on Capital Employed is Calculated by Using the Formula: |
|
Profit = Capital Employed × Required Rate of Return |
Step 3: |
Average Profit for the Last Few Years is Calculated. |
Step 4: |
Super Profits is Arrived at by Deducting Required Profits From Average Profits. |
Step 5: |
Super Profits is Multiplied by the Required Rate of Return to Find the Value of Goodwill. |
Illustration 8.7
Model: Capitalization of super profits
Compute goodwill in each of the following cases:
Solution
(i)
Step 1: |
Total Profit 20,000 + 25,000 + 55,000 + 60,000 |
|
= 1,60,000 − 10,000 (Loss) |
|
= 1,50,000 |
|
|
Step 3: |
Goodwill: Average Profit × Number of Years’ Purchase |
|
= 30,000 × 3 = 90,000 |
(ii)
Step 1: |
Average Profit = 50,000 |
Step 2: |
Normal 3,00,000 × 10% or 3,00,000 × = 30,000 |
Step 3: |
Super Profit = Average Profit − Normal Profit |
|
= 50,000 − 30,000 = 20,000 |
Step 4: |
Goodwill = Super Profits × Number of Years’ Purchase |
|
= 20,000 × 3 = 60,000 |
(iii)
Step 1: |
Normal Profit = 50,000 × 10% or 5,00,000 × |
Step 2: |
Super Profit = Average Profit − Normal Profit |
|
= 60,000 − 50,000 = 10,000 |
|
Goodwill = = 10,000 × = 1,00,000 |
Some of the important factors that should be considered for valuation of goodwill are as follows:
In the previous part, i.e., for the beginners in corporate accounting, the term “capital employed” was discussed in simple terms as:
Capital employed = Total assets – Outside liabilities
But in practice, in companies of large size, it is not easy to compute the value of capital employed by a simple equation. The following two different approaches are adopted to compute the value of capital employed:
Value of capital employed, under this approach, is calculated as follows:
Step 1: |
Assets at Market Value |
|
|
(Excluding Goodwill, All Deferred Expinditures Such as Preliminary Expenses, Discount, etc.) |
− |
Step 2: |
Less: Liabilities to Outside Parties (Including Credits, Bills Payable, Debentures, Outstanding Bills, Taxation, Dues, etc.) at Revised Value |
− |
Step 3: |
Capital Employed |
xxxxxxx |
Step 4: |
Less: 50 % of Profit Earned During The Year |
− |
Step 5: |
Average Capital Employed |
0000 |
“Average capital employed” is computed because of the assumption that profits have been earned evenly over the year. Further, if fresh, additional capital is not introduced in the business, the capital employed increases due to profits.
Average capital employed
In case the capital employed in the beginning of the year is not given in the question, average capital employed can be determined by deducting 50% profit of the year from the capital employed at the end of the year as shown in Step 4 above.
Capital employed may be determined as follows, under this approach:
Step 1: |
Share Capital |
|
Step 2: |
Add: |
|
|
(a) Profit |
− |
|
(b) Reserves |
− |
|
(c) Workmen Compensation Fund |
− |
|
(d) Gain on Revaluation of Assets and Liabilities |
− |
|
|
xxxx |
Step 3: |
Less: |
|
|
(a) Goodwill |
− |
|
(b) Loss on Revaluation of Assets and Liabilities |
− |
|
(c) All Losses |
− |
|
(d) Preliminary Expenses |
− |
|
(e) Investments |
− |
Step 4: |
Capital Employed |
000 |
Step 5: |
Less: 50% (1/2) of the Profit Earned During the Year |
− |
Step 6: |
Average Capital Employed |
xxx |
Illustration 8.8
Model employed and average capital employed—Computation of
You are required to calculate (a) capital employed and (b) average capital employed from the following balance sheet:
Solution
Method I: Assets Side Approach:
Method II: Liabilities Side Approach:
Note: Result will be same under both approaches; students may opt either of the two.
Illustration 8.9
Model: Capital employed—Computation of
The following is the balance sheet of Vasanth Ltd. as at 31 March 2010:
Buildings are now worth 5,00,000, and plant and machinery is worth 4,75,000.
You are required to compute the value of capital employed.
Solution
Method I: Assets side approach
NOTE:
Step 1: |
Assets: |
|
|
Add: (i) Buildings (Market Value) |
5,00,000 |
|
(ii) Plant & Machinery (Market Value) |
4,75,000 |
|
(iii) Furniture |
50,000 |
|
(iv) Trade Investments |
1,75,000 |
|
(v) Stock |
2,80,000 |
|
(vi) Debtors |
3,50,000 |
|
(vii) Cash at Bank |
90,000 |
|
|
19,20,00 |
Method II: Liabilities Side Approach
Illustration 8.10
Model: Capital employed and super profits
The following is the balance sheet of Raj Co Ltd. as on 31 March 2010:
You are asked to value the goodwill of Raj Co Ltd. on the basis of 5 years’ purchase of super profits, for which the following information is supplied:
[C.S. Modified]
Solution
(i) Computation of capital employed:
(Assets side approach is followed)
(ii) Profits After Providing Taxation: |
|
Provision for Taxation is 70,000 |
|
This is at 50% of the Profit |
|
Total Profit 100% will be 1,40,000 |
|
∴ Profit After Providing Taxation |
= 70,000 |
(iii) Computation of Normal Profit: |
|
Reasonable Return on Capital Employed: |
|
Capital Employed (Ref: Step 3 in (i)) |
= 5,30,000 |
Reasonable Return = 12% |
|
∴ Normal Profit = |
|
(iv) Calculation of Super Profits:
Super Profits |
= |
Current Profits − Normal Profit |
|
|
(ii) (iii) |
|
= |
( 70,000 − 63,600) |
|
= |
6,400 |
(v) Value of Goodwill:
Goodwill |
= |
Super Profits × Number of Years’ Purchase |
|
= |
6,400 × 5 |
|
= |
32,000. |
Illustration 8.11
Ascertain the value of goodwill of Sudarsan Ltd. carrying on business from the following:
The Company started operations in 2005 with paid-up capital as aforementioned of 20,00,000. Profits earned before providing for taxation have been as follows:
Year Ended 31 March | |
---|---|
2006 |
6,00,000 |
2007 |
7,00,000 |
2008 |
8,00,000 |
2009 |
5,00,000 |
2010 |
9,00,000 |
Income tax @ 50% has been payable on these profits. Dividends have been distributed from the profits of first 3 years @ 10% and from those of next 2 years @ 15% of the paid-up capital.
[I.C.W.A. (Final). Modified]
Solution
(i) Calculation of capital employed (Net assets):
(ii) Calculation of Average Profi ts:
Year Ended on 31 March |
|
|
2006 |
|
6,00,000 |
2007 |
|
7,00,000 |
2008 |
|
8,00,000 |
2009 |
|
5,00,000 |
2010 |
|
9,00,000 |
Total |
|
35,00,000 |
Average Profit |
|
|
|
= |
7,00,000 |
Less: Provision for Taxation @ 50% |
= |
3,50,000 |
Average Profits |
= |
3,50,000 |
(iii) Computation of Goodwill:
|
|
|
|
|
|
|
Fair Return of Capital |
= 12% |
Step 2: |
Capitalized Value of Business: |
|
|
|
|
Step 3: |
Less: Net Assets |
= 22,90,000.00 |
Step 4: |
Value of Goodwill |
= 6,26,666.67 |
As the purchaser pays goodwill on the firm belief that in the future good profits will be earned, proper estimation has to be made for such future profits. For evaluation of goodwill, estimation of future profits is a vital factor. The following factors should be considered for this:
Illustration 8.12
Model: Future maintainable profit
For the year ended 31 March 2010, a public limited company reported a profit of 14,00,00,000 after paying income tax @ 30%. It was found that the year’s income included 1,00,00,000 for a claim lodged in 2007–08 for which no entry had been passed then. The year 2008–09 was a normal year for trading concern. The company plans to launch a new product and the following are the estimates in respect of this
Sales | |
---|---|
Expenditure on raw material |
12,00,00,000 |
Wages |
5,00,00,000 |
Share of fixed expenses (including an expected increase of 1,50,00,000) |
4,50,00,000 |
[I.C.W.A. Modified]
Solution
Step1: |
Profit Before Tax for the Year Ended 31 March 2010 |
20,00,00,000 |
Step 2: |
Less: Income in Respect of 2007 − 08: |
1,00,00,000 |
Step 3: |
Normal Profit for 2009−10 |
19,00,00,000 |
|
(Step 1 – Step 2) |
|
Step 4: |
Add: Expected Profit of New Product: |
|
|
(i) Sale |
12,00,00,000 |
|
(ii) Less: Expenditure on Raw Material, Additional Fixed Expenses, etc. |
6,50,00,000 |
|
[ 5,00,00,000 + 1,50,00,000] |
5,50,00,000 |
Step 5: |
Expected Profit Before Tax = (19,00,000 − 5,50,000) 13,50,00,000 |
|
Step 6: |
Less: Income Tax @ 30% = |
4,05,00,000 |
Step 7: |
Future Maintainable Profit = |
9,45,00,000 |
|
(Step 5 – Step 6) |
|
Illustration 8.13
Model: Good will—Comprehensive
On 31 March 2010, X Ltd. proposes to purchase the business carried on by Y Ltd. Goodwill for this purpose is agreed to be valued as 3 years’ purchase of the weighted average profits for the last 4 years. The appropriate weights to be used were decided as follows:
Years | Weight | |
---|---|---|
2006–07 |
− |
1 |
2007–08 |
− |
2 |
2008–09 |
− |
3 |
2009–10 |
− |
4 |
The profits for these years are 2006-07: 6,20,000; 2008–09: 7,40,000; 2007–08: 5,80,000; 2009–10: 8,60,000.
On scrutinizing the accounts, the following facts are revealed:
Solution
Step 6: Calculation of Weighted Average:
|
Weighted Average: |
|
Step 8: |
Less: Management Cost = |
2,00,000 |
|
|
4,03,000 |
Step 9: |
Goodwill |
= |
4,03,000 × Number of Year’s Purchase |
|
|
= |
4,03,000 × 3 = 12,09,000 |
Illustration 8.14
Model: Goodwill—Valuation of—Comprehensive
The following particulars are available in respect of the business of X Ltd:
2006–07 |
9,00,000 |
2008–09 |
11,00,000 |
2009–10 |
10,00,000 |
You are required to calculate the value of goodwill:
Solution
STAGE I: Calculation of Super Profits:
Step 1: |
Average Profits for the Last 3 Years: |
|
|
2006–07: |
9,00,000 |
|
2007–08: |
11,00,000 |
|
2008–09: |
10,00,000 |
|
Total |
30,00,000 |
|
|
|
|
|
10,00,000 |
Step 2: |
Less: Non-Recurring Profits (Given) = |
50,000 |
Step 3: |
Recurring Profits = |
9,50,000 |
Step 4: |
Less: Normal Profits: |
|
|
Capital Employed × Normal Rate of Return = 50,000,000 × 10% = |
5,00,000 |
Step 5: |
Super Profits (Average Profits − Normal Profits) = |
4,50,000 |
|
(Step 3 − Step 4) |
|
STAGE II: Valuation of Goodwill:
Formula = Goodwill |
= |
Super Profits × Number of Years’ Purchase |
|
= |
4,50,000 × 5 = 22,50,000 |
Formula = Goodwill
Formula = Goodwill |
= |
Super Profit × Annuity Factor |
|
= |
4,50,000 × 3.78 (Given) |
|
= |
17,01,000. |
Illustration 8.15
Model: Computation of expected rate of return
X Ltd’s financial position is as follows:
|
|
(a) Sundry assets |
40,00,000 |
(b) Current liabilities |
4,50,000 |
(c) Average net profit of the last 4 years |
4,82,000 |
(d) Average capital employed |
36,00,000 |
(e) Managers’ average annual remuneration |
72,000 |
(f) The goodwill valued at 4 year’s purchase |
2,00,000 |
Price of super profits |
|
Compute the expected rate of return. |
|
Solution
|
|
|
Step 1: |
Goodwill (4 Year’s Purchase Price of Super Profits:) |
2,00,000 |
Step 2: |
So, Super Profits Per Year (Average) |
50,000 |
|
( 2,00,000/4 years) | |
Step 3: |
Average Net Profit for the Last 4 Years (Given) |
4,82,000 |
Step 4: |
Less: Average Remuneration: |
72,000 |
Step 5: |
Net Profit (After Adjustment): |
4,10,000 |
Step 6: |
Formula: |
|
Illustration 8.16
The summarized balance sheet of Riddhima Vasanth Ltd. as on 31 December 2010 is as follows
Profit after the tax for the three years 2008, 2009 and 2010 after charging debentures interest were 2,00,000; 3,00,000 and 2,25,000, respectively.
Further information:
[I.C.W.A. Modified]
Solution
STAGE I: Computation of capital employed as on 31 December 2010 (Net assets).
STAGE II: Computation of Future Maintainable Profit:
STAGE III: Calculation of Valuation of Goodwill:
Valuation of shares of a company is not an easy task. A number of factors are associated with it. All such factors may not be taken into account for ascertaining the exact value of shares. For example, if the shares of a company are not quoted on the stock exchange, their value cannot be determined precisely. Some shares, especially private company shares possess no market value as their transferability is restricted.
Notwithstanding such inherent features, the necessity to ascertain the value of these shares has become utmost important.
Valuation of shares is essential for the following purposes:
The methods of valuation of shares may be categorized as follows:
There are so many alternative names to this method such as intrinsic value method, net worth method, equity method, asset backing method, break-up value method, real value method, asset basis method.
Under this method, value of the net assets of the company is measured against each share. Here, the emphasis is on the value of net assets. Further, the shares are valued on the basis of internal value of the assets.
Step 1: |
Add: All the Assets at Market Value |
Step 2: |
Deduct: All Liabilities (Including Debentures and Preference Shares) |
Step 3: |
Result = Net Assets |
Step 4: |
Divide Net Assets (As Arrived at Step 3) by Number of Equity Shares. The Formula to Ascertain the Value of a Share, |
|
Formula: |
While Evaluating the Assets, the Factors that Should be Considered are as Follows
Factors that should be considered for valuation of liabilities are as follows:
Illustration 8.17
Model: Intrinsic value—Pref. shareholders not having preference
The following is the balance sheet of VRS Ltd. as on 31 March 2010:
The market value of 70% of the assets is estimated to be 20% more than the book value and that of the remaining 30% at 10% less than the book value. There is an unrecorded liability of 10,000.
Find the value of each equity share assuming that preference shares have no prior claim as to payment of dividend or as to payment of capital.
Solution
Note: Preference shareholders not having preference will not make any difference.
Illustration 8.18
Model: Valuation of goodwill and valuation of share—intrinsic method
The following is the balance sheet of UVR Ltd. as on 31 March 2010:
2006: 25,000; 2007: 35,000; 2008: 50,000;
2009: 60,000; 2010: 80,000
Find the intrinsic value of each share.
Solution
Illustration 8.19
Model: Rate of return; Average capital employed and Intrinsic value of share
The following is the balance sheet of VRV Ltd. as on 31 December 2009:
The net profit of the company, after deducting all working charges and providing for depreciation and taxation were:
2005: 2,00,000; 2006: 2,25,000; 2007: 2,50,000;
2008: 2,75,000; 2009: 3,00,000
On 31 December 2009, land and buildings were valued at 6,25,000 and plant and machinery at 3,75,000.
In view of the nature of business, it is considered that 10% is reasonable on capital.
You are required to calculate the value of the company’s share after taking into account the revised values on fixed assets and your own valuation of goodwill based on 3 years’ purchase of annual super profits.
Solution
Illustration 8.20
Model: Valuation of shares—Treatment of non-trading assets
On 31 March 2010, the balance sheet of RBS Ltd. was as follows:
The assets were revalued as follows |
|
Land & Building |
2,80,000 |
Machinery |
2,20,000 |
Furniture |
30,000 |
The normal return on capital employed for valuation of goodwill is 10%, the basis of valuation being 4 years’ purchase of super profits.
50% of investment in building is treated as non-trading asset because a sum of 12,000 is collected annually as rent from building.
You are required to calculate the value of each equity share assuming that the average annual profit after tax at 50% is 1,32,500
Solution
Illustration 8.21
Model: Valuation of fully paid and partly paid shares
Following is an extract of the balance sheet of SR Ltd. as on 31 March 2010:
Share capital: |
|
5,000, 10% Preference shares of 100 each |
5,00,000 |
10,000 Equity shares of 10 each, 5 paid up |
50,000 |
10,000 Equity shares of 10 each, 2.50 paid up |
25,000 |
10,000 Equity shares of 10 each, fully paid up |
1,00,000 |
|
6,75,000 |
Reserves and surplus |
2,00,000 |
P&L A/c |
1,25,000 |
|
10,00,000 |
On revaluation of assets, on 31 March 2010, it was found that they had appreciated by 1,00,000 over their value in the aggregate.
The Articles of Association of the Company state that in case of liquidation, the preference shareholders would have a further claim of the surplus assets, if any.
You are required to ascertain the value of each equity share assuming that liquidation of the company has to take place on 31 March 2010 and that the expenses of winding up are NIL.
Solution
Methods of Valuation of Shares—Preference Shares
Illustration 8.22
Model: Treatment of preference shares
The following is the balance sheet of RBS Ltd. as on 31 December 2008:
The debenture interest is outstanding for one year and dividends and preference shares are in arrears for 2 years.
The sundry assets are worth their book values.
You are required to ascertain the value of preference shares and equity shares in each of the following alternative cases: if,
Solution
First, value of net assets has to be calculated as:
Illustration 8.23
Model: Fair value of shares—on the basis of majority and minority holdings
Determine the fair value of 200 shares held by Mr. Ram in Goodluck Ltd. to be transferred to Mr. Mehta on the basis of majority and minority holdings. The balance sheet of Goodluck Ltd. as on 31 March 2010 is as follows:
Debtors are estimated to be 10% below book value and goodwill is valued at its book value. Profit and loss account shows the net profit of the year after transfer to general reserve and payment of income tax.
Dividend was paid for the last 3 years at the rate of 14%, 18% and 16%, respectively. Normal expected return is 10%.
[C.A. Modified]
Solution
While determining the value of shares, there will be no difficulty if only one category (class) of shares is available. In such a case,
and value per share is determined without much difficulty.
But in case there are difference categories (classes) of equity shares, the amount paid up varying for each category, the valuation of shares must be pro-rated. This is explained in the following illustration:
Illustration 8.24
Model: Different classes of shares
X Ltd. equity capital comprises:
A: 2,00,000 equity shares of 10 each fully paid
B: 2,00,000 equity shares of 10 each, 7.50 fully paid
C: 1,00,000 equity shares of 10 each, 5 fully paid
The net assets available to equity shareholders are of the value of 80,00,000. Compare the intrinsic value of the equity share of each category.
Solution
There are three categories of equity shares—A, B and C.
All the shares shall be converted into shares of one denomination. Here, it is 10 fully paid.
Net assets basis or, intrinsic value: Intrinsic value of equity shares will be ascertained as follows:
Illustration 8.25
Model: Net assets method
The Following is the Balance Sheet of Raj Ltd. as on 31 March 2010:
The current value of land and buildings is 27,00,000 and that of furniture, fixture and fittings is 60,000. Stock is valued at 7,00,000. Debtors are expected to realize only 80% of their book value. You are informed that the preference dividend has not been paid for the last 5 years. Calculate the intrinsic value of equity share by the net assets method.
Solution
Yield denotes the income that the investors get for their investments. Naturally, the price of share depends on the quantum of dividends.
Here, yield may represent (i) the entire earnings or the (ii) dividend paid by the company. The normal procedure is that dividend is taken as a basis for calculating the yield and not the entire earnings.
Valuation of shares on the basis of yield is determined as follows:
Step 1: Future Maintainable Profits are Ascertained.
Step 2: The Normal Rate of Return is Computed.
Step 3: The Multiplier or the Capitalization Factor is to Be Ascertained
Step 4: Capitalized Value of Maintainable Profits is Determined by Multiplying Maintainable Profit by the Multiplier (i.e., Step 1 × Step 3)
Step 5: Finally, the Yield Value of Shae is Compared by dividing the Capitalized Value of Maintainable Profits (Compared in Step 4) By the Number of Equity Shares.
This Method is Described by the Following Illustration.
Illustration 8.26
Model: Valuation of shares-yield basis
From the following information, calculate the value of an equity share:
Solution
Step 1: Future Maintainable profits are Ascertained:
This can be calculated in another way as follows:
Earnings per share is determined by dividing the earnings with the number of equity shares.
After determining the EPS of the company, value of share on EPS is calculated by using the formula:
By using the same figures as in the above illustration,
Thus, we can see that the yield value of shares, under various methods, is the same, i.e., 8 only.
Illustration 8.27
Model: Value of two classes of shares intrinsic method
X Ltd. started its business on 1 April 2007. On 31 March 2010, its balance sheet in a summarized form was as follows:
The company is yet to declare its maiden dividend. A revaluation reveals that the fixed assets as on 31 March 2010 are really worth 30,00,000. Calculate the intrinsic value of two classes of shares.
Solution
Illustration 8.28
Model: Fair value of equity shares
From the following particulars, calculate the fair value of an equity share assuming that out of the total assets, those amounting to 19,00,000 are fictitious.
2,00,000 15% Preference shares of 100 each, fully paid
20,00,000 Equity shares of 10 each, fully paid
[C.S. Modified]
Solution
Illustration 8.29
Liabilities: |
|
Share Capital: |
5,00,000 |
5,000 Shares of 100 each |
1,00,000 |
General Reserve |
70,000 |
Profit and Loss Account |
1,45,000 |
Sundry Creditors |
|
Income Tax Reserve |
8,50,000 |
Assets: |
|
Land & Buildings |
2,00,000 |
Plant & Machinery |
3,00,000 |
Patents & Trade Marks |
25,000 |
Stocks |
75,000 |
Debtors |
2,00,000 |
Bank balance |
35,000 |
Preliminary expenses |
15,000 |
|
The expert valuer valued the land and buildings at 2,50,000; plant and machinery at 2,80,000 and Goodwill at 2,00,000. Out of the total debtors, it is found that debtors of 20,000 are bad. The profits of the company were as follows:
|
|
|
2007–08 |
: |
1,00,000 |
2008–09 |
: |
1,30,000 |
2009–10 |
: |
1,50,000 |
The Company follows the practice of transferring 25% to general reserve. Similar types of companies earn at 10% of the value of their shares.
You are required to ascertain the value of the shares of the company as follows:
Solution
1. Intrinsic value method
2. Yield Value Method:
Illustration 8.30
Model: Valuation of two classes of shares
From the following balance sheet, you are required to compare the value of (i) one preference share and (ii) one equity share:
The market value of 50% of the assets is considered at 10% more than the book value and that of remaining assets at 5% less than the book value. There was a liability of 20,000 which remain unrecorded. Assume that the preference shares have no priority as to repayment of capital or dividend.
Solution
Net assets available for equity and preference shareholders have to be calculated by using net assets
In case shares are valued on the basis of dividend declared and expected normal rate of return,
In this case, shares are valued on the basis of weighted average profits of the business and expected normal earnings of similar companies in the same industry.
Illustration 8.31
Model: Value of few shares are to be sold and majority are to be sold
From the data given below, you are required to compare the value of each share when (a) only a few shares are to be sold and if (b) majority shares are to be sold:
Year |
Profits |
Dividends |
|
|
|
2008 |
3,00,000 |
12% |
2009 |
4,00,000 |
16% |
2010 |
5,00,000 |
20% |
Solution
Illustration 8.32
Model: Market value of share—Calculations
The profit of a company, limited by shares, for the year ended 31 March 2010 was 50,00,000. After setting apart amounts for interest on borrowings, taxation and other provisions, the net surplus available capital base consisted of:
Enquiries in the stock market reveal that shares of companies engaged in similar business and declaring dividend of 15% on equity shares are quoted at a premium of 20%.
Based on your working on the yield method, what do you expect the market value of the company’s share to be?
[C.S. (Inter). Modified]
Solution
Price–earnings ratio is the ratio of market price to earnings per share, where earnings per share (EPS) is the earnings available to equity shareholders dividend by number of shares. It may also be said that it is the multiple of earnings which an investor paid for a share. This ratio is an important yardstick to measure whether a share is over-priced or under-priced. Price-earnings ratio of comparable firms may also be used as an important tool to measure the value of share of a firm.
Formula for computing price-earnings ratio is:
The same formula can be rearranged as:
We know that the normal rate of return is the earning rate of a company, which is determined by using the formula:
Studying these two formulae, we can understand that PE ratio is the reciprocal of normal rate of return.
Hence, PE ratio may be expressed as:
As normal rate of return is expressed in percentage
There is much similarly between capitalization factor and PE ratio. Even we may go to the extent that PE ratio = Capitalization factor.
Illustration 8.33
Model; PE ratio
The share of Shree Ltd. is quoted in the market at 120. Its earnings per share (EPS) is 15. Compute its normal rate of return, PE ratio and capitalization factor. If the future maintainable profits are 15,00,000 and there are 1,00,000 equity shareholders, determine the value of share on yield basis.
Solution
Formula:
Formula:
PE ratio can also be determined dividend 100 by normal rate of return as:
Formula = Future maintainable Profits × Capitalization Factor
= 15,00,00 × 8
Illustration 8.34
Model: PE ratio–Valuation of other firm’s share
‘X’ Ltd. has earning per share of 25 and is quoted at 225. Y Ltd., a similar firm, has earnings per share of 20. Determine the value of the share of ‘Y’ Ltd.
Solution
Illustration 8.35
Model: Value of shares—Net assets and PE ratio methods)
Dev Ltd. is a going concern and its directors who are also owners have decided to sell their business. They have approached you to make an assessment of the price per equity share a purchaser might offer. The relevant information is as follows:
Net profits after tax and interest but before payment of dividends were: 2005–06: 1,50,000; 2006–07: 1,60,000; 2007-08: 1,20,000; 2008–09: 1,50,000; 2009–10: 1,70,000.
The fixed assets of the company have been valued by independent experts as follows:
|
|
Land & Buildings |
17,40,000 |
Plant & Equipment |
8,60,000 |
Motor vehicle |
1,00,000 |
The applicable price earnings PE ratio is 10. You are required to compute the value per equity share of the company based on:
[I.C.W.A. Modified]
Solution
PE Ratio Method:
Note:
Assumptions:
Goodwill is the present value of a firm’s anticipated excess earnings. The need for valuation of goodwill arises under certain circumstances such as amalgamation, reconstruction, acquisition and sale of companies.
The vital components of goodwill are profitability, yield and the capital employed.
Methods of valuation of goodwill are: (i) average profits methods, (ii) super profits method, (iii) capitalization method and (iv) annuity method.
Formulae for calculating goodwill under these methods are as follows:
Average profits method
Super profits method
Goodwill = Super Profit × Present Value Factor, where present value factor is ascertained by using the formula:
Vector capitalization method
Goodwill is determined by capitalizing the average profits and capitalizing the super profits. Value of capital employed can be computed under two different approaches: (i) assets side approach and (ii) liabilities side approach.
Estimation of future profit—Ref: Illustration 8.12.
Valuation of shares:
1. Net assets method: Value of a share is ascertained under this method by using the formula:
Net assets value of a share or intrinsic value of a share
Fair value of shares is determined on the basis of majority and minority holdings. For details refer Illustration 8.23.
2. Yield basis or market value method is explained in detail in Illustration 8.26.
Earnings per Share Basis:
Valuation when only a few shares are to be sold and when majority shares are to be sold are explained in detail in Illustration 8.31.
Price-earnings ratio: Formula for computing PE ratio is
Goodwill: The capacity of a business to earn profits in future.
Normal Rate of Return: The rate of earnings which the investors expect on their investments.
Capital Employed: Equity shareholders’ funds in the company (with long-term borrowing) (or) Fixed assets + Net working capital.
Intrinsic Value of a Share: Valuation of share on the basis of internal value of the assets of a company.
Yield Value per Share: Valuation of share on the basis of yield, i.e., the effective rate of return on investment made in shares by shareholders.
Fair Value per Share: The average of the net assets value and yield value.
Average Capital Employed: Represents the closing capital employed (after deducting of the current year from it)
I: State whether the following statements are true or false
Answers:
II: Fill in the blanks with apt word(s)
Answers:
III: Multiple choice questions—Choose the correct answer
Answers:
1. (a) |
2. (b) |
3. (c) |
4. (d) |
5. (d) |
6. (c) |
7. (a) |
8. (b) |
9. (d) |
10. (a) |
1. Vasanth & Co. decided to purchase a business for 7,20,000. Its profits for the last 4 were 2006: 2,00,000; 2007: 1,28,000; 2008: 2,20,000; 2009: 2,80,000. The owner of the business was personally managing this. A manager to replace him has to be paid 27,000 p.a.
You are required to calculate the value of goodwill which is valued on the basis of three year’s purchase of the average net profit for the last 4 years.
[Ans: Goodwill: 5,40,000]
[Model: Average profit method]
2. The following particulars are available in respect of the business carried on by Sathyan Ltd:
You are required to calculate the value of goodwill on the basis of 2 year’s purchase of average profits for the last 3 years.
[Ans: Goodwill: 3,16,000; future maintainable profit: 1,58,000]
3. Parul Ltd. proposed to purchase the business carried on by M/s Kashyap. Goodwill for this purpose is agreed to be valued at 3 year’s purchase of the average profit of the past four years. The appropriate weights to be used are as follows:
2006: 1; 2007: 2; 2008: 3; 2009: 4.
Profit for these years were:
2006: 50,000; 2007: 55,000;
2008: 60,000; 2009: 75,000
Compute the value of the goodwill of the firm.
[Ans: Goodwill: 1,92,000]
[Model: Super profit method (years of purchase of super profit method)]
4. From the following information, calculate the value of goodwill on the basis of 3 years’ purchase of the super profit:
[Ans: Super profit: 38,000; Goodwill: 1,14,000]
5. The following particulars are available in respect of the business carried on by Mr. Devan.
2006— Profit— 2,44,000
2007— Profit— 3,00,000
2008— Loss — 40,000
2009— Profit— 4,20,000
You are required to compute the value of goodwill of the business on the basis of 3 year’s purchase of super profit taking average of last 4 years.
[Ans: Goodwill: 1,77,000]
6. Govind runs an automobile repair shop from rented premises. He pays a rent of 45,000 per month. Apart from non-skilled workers, he employs a skilled engineer at a salary of 36,000 per month. Govind made a profit of 19,50,000 before taxes for the year 2009-10 (year ended on 31 March 2010), on which date his net asset were worth 90,00,000. The owner of the premises plans to acquire the business from Govind.
The premises are worth 15,00,000, of which 15% were to be a reasonable return on capital employed in this line of business, how much goodwill can Govind expect on the basis of 3 years’ purchase of super profits?
[Ans: Goodwill: 27,45,000]
7. The balance sheet of ABC Ltd. on 31 March 2010 is as follows:
The average profit of the company (after deducting interest on debentures and taxes) is 90,000. The market value of the machinery included in fixed assets is 15,000 more. Expected rate of return is 10%. Evaluate the goodwill of the company at 5 times of the super profit.
[Ans: Goodwill: 1,56,750]
[Model: Super profit method (Capitalization of super profit method)]
8. From the following information, compute the value of goodwill by capitalizing super profit:
[Ans: Goodwill: 5,50,000]
9. Mr. Vasudevan has invested a sum of 3,00,000 on his own business which is a very profitable one. The annual profit earned from his business is 67,500, which includes a sum of 15,000 received as compensation for a part of his business premises.
As an alternative to his engagement in his business, he could have invested the money in long-term deposit with bank earning a normal rate of interest of 10% and also could engage himself in employment thereby getting an annual salary income of 10,800.
Considering 2% as fair compensation for risk involved in the business, calculate the value of goodwill of his business on capitalization of super profit at the normal rate of interest. Ignore taxation.
[Ans: Goodwill: 47,500]
10. From the following information, you are required to calculate the value of goodwill as per capitalization of super profit method:
2006: 1,44,000; 2007: 1,54,000;
2008: 1,69,000; 2009: 1,74,000;
2010: 1,79,000
The profit included non-recurring profit on an average basis of 10,000, out of which it was deemed that non-recurring profit had a tendency of appearing at the rate of 7,000 p.a.
[Ans: Goodwill: 1,10,000]
[Model: Annuity method]
11. The net profit of a company after providing for taxation for the past 5 years are 1,60,000; 1,68,000; 1,80,000; 1,84,000 and 1,88,000. The capital employed in the business is 16,00,000, on which a reasonable rate of return of 10% is expected. It is expected that the company will be able to maintain its super profit for the next 5 years. Calculate the value of goodwill of the business on the basis of an annuity of super profit, taking the present value of annuity of 1 for 5 years @ 10% interest at 3.78.
[Ans: Goodwill: 60,480]
12. From the following particulars, compute the value of goodwill as per annuity method:
2005: 1,50,000; 2006; 1,60,000;
2007: 1,70,000; 2008: 1,80,000;
2009: 1,90,000
Non-recurring income: 8,000
Non-recurring expenses: 5,000
[Ans: Goodwill: 64,260]
[Model: Super profit method—all the three (Comprehensive)]
13. The following particular are available in respect of a business carried on by a trader:
2007: 2,00,000; 2008: 2,40,000;
2009: 2,20,000
You are required to calculate goodwill:
[Ans: (i) 4,40,000; (ii) 8,80,000; (iii) 3,32,640]
[Model: Capitalization method]
14. Mr. Thomas runs a textile business. His net assets as on 31 March 2010 amounted to 40,00,000. After paying a rent of 90,000 a year and a salary of 60,000 to the manager, he earns a profit of 4,20,000. His landlord, who happens to be an expert in textile business, is very much interested in purchasing the business. 8% is considered to be a reasonable return on capital employed. What can Mr. Thomas expect as payment for goodwill?
[Ans: Goodwill: 23,75,000]
15. The balance sheet of Good Luck Co. Ltd. discloses the following financial position as on 31 March 2010:
You are required to value the goodwill of the company with the additional information as following:
[Ans: Goodwill; 1,53,500]
[Valuation of shares: Model: Net assets or intrinsic value method (Preference shares having no priority]
16. From the following balance sheet, you are required to value the equity shares:
The market value of 50% of the assets is considered at 10% more than the book values and that remaining 50% at 5% less than the book values. There was a liability of 12,500, which remained unrecorded. Assume preference shares have no priority as to the repayment of capital or dividend.
[Ans: Value of each equity share: 10.33]
[Model: Two classes of shares]
17. VRS Ltd. started its business on 1 April 2007. On 31 March 2010, its balance sheet in a summarized from was as follows:
The company is yet to declare its main dividend on 31 March 2010. The fixed assets are revalued at 9,60,000. You are required to calculate the value of two classes of shares.
[Ans: Value of one preference share: 100; Value of one equity share: 12.42]
[Model: Intrinsic value method with goodwill]
18. From the following information, you are required to compute the value of each share:
For the valuation of shares, goodwill shall be taken at 2 years’ purchase of the average profit of the last 5 years. The profits for the last 5 years were: 3,00,000; 3,50,000; 2,00,000; 2,50,000 and 2,50,000.
[Ans: Goodwill: 5,40,000; Value of each share: 19.40]
[Model: Goodwill value remains the same]
19. From the following balance sheet of ABC Ltd as on 31 March 2007, calculate the value per equity share under asset backing material:
Preference dividend are in arrears for 3 years. There is a disputed liability of 15,000 not shown in the above balance sheet and 12,000 is likely to materialize. There is also liability of 3,000 which remains unrecorded. Goodwill is worth the same figure and 5% debtors are considered doubtful.
[Ans: Intrinsic value per equity share 0.775]
[Model: Yield method]
20. Mrs. Laxmi holds 20,000 equity shares in Excellent Ltd. The paid-up capital is 1,20,000 equity shares of 1 each. It is ascertained that:
Mrs. Laxmi requests you to value her shares based on the above figures.
[Ans: Yield value per equity share: 2.08
Mrs. Laxmi’s holding: 41,600]
21. Nirula & Co. Ltd has 10,000 equity shares of 10 each, 8 paid and 1,00,000 6% preference shares of 10 each fully paid. The company has a practice of transferring 20% of the profit to general reserve every year. If the expected profit (based on past year’s performance) before tax is 2,00,000 and the rate of tax is 50%, you are required to calculate the value of equity share assuming that normal rate of dividend is 20%.
[Madras University]
[Ans: Value of each equity share: 10]
[Model: Yield method—Majority and minority holdings]
22. From the following particulars, calculate the value of equity shares from the viewpoint of (i) majority holdings and (ii) minority holdings
[Ans: Value of each equity share:
[Model: Comprehensive—all methods]
23. The following particulars are available relating to a company:
Calculate the fair value of share assuming that out of the total assets, 7,000 are fictitious.
[Ans: Intrinsic value: 10.70; Yield value: 12.22; Fair value: 11.46]
24. On 31 March 2010, the balance sheet of a limited company disclosed the following position:
On 31 March 2010, the fixed assets were independently valued at 17,50,000 and the goodwill at 2,50,000.
The net profits for the three years were 2,58,000; 2,60,000 and 2,58,250, of which 20% was placed to reserve, the proportion being considered reasonable in the industry in which the company is engaged and where a fair investment return may be taken at 10%.
Compute the fair value of each share.
[Ans:
25. The balance sheet of Krishan Ltd as on 31 March 2010 was as follows:
Additional information:
You are required to calculate the fair value of the equity share.
[Ans:
26. The net profits of a company after providing for taxation for the past years are 2006: 37 lakh; 2007: 42 lakh; 2008: 44 lakh; 2009: 47 lakh and 2010: 50 lakh.
The capital employed in the business is 4 crore, on which a reasonable rate of return of 10% is expected. It is expected that the company will be able to maintain its super profits for the next 5 years.
[C.S. Modified; C.A. Modified]
[Ans: (i) 15,12,000; (ii) 40,00,000]
27. The following particulars are available in respect of the business carried on by Rukh & Co:
You are required to compute the value of goodwill on the basis of 3 years’ purchase of super profits of the business calculated on the average profits of the last 4 years.
[C.A. (Inter). Modified]
[Ans: Goodwill: 53,100]
28. Ascertain the value of goodwill of Rainbow Ltd. carrying on business from the following:
The company started operations in 2005 with a paid-up capital as aforementioned of 50,00,000. Profits earned before providing for taxation have been as follows:
Year ended 31 March |
|
2006 |
12,50,000 |
2007 |
13,00,000 |
2008 |
17,00,000 |
2009 |
20,00,000 |
2010 |
17,50,000 |
Income tax @ 50% has been payable on these profits. Dividends have been distributed from the profit of the first 3 years @ 10% and from those of next 2 years @ 15% of the paid-up capital.
[I.C.W.A. (Final)]
[Ans: Goodwill: 9,66,666.67]
29. The summarized balance sheet of Six Stars Ltd as on 31 December 2009:
Profits after tax for 3 years 2007, 2008 and 2009 are after charging debentures interest were 8,82,000; 12,90,000 and 9,60,000, respectively. Mr. Manu is interested in buying all the equity shares and requests you to let him know the proper price. You get the following information:
Ascertain the value of goodwill of the company by taking the capital employed as on 31 December 2009.
[I.C.W.A. Modified]
[Ans: Goodwill: 12,63,000]
30. From the following information supplied to you, ascertain the value of goodwill of XYZ Ltd. which is carrying on business as a retail trader, under super profits method:
The company commenced operations in 1990 with a paid-up capital of 25,00,000. Profits for recent years (after taxation) have been as follows:
Year Ended 31 March |
|
2006 |
(2,00,000) |
2007 |
4,40,000 |
2008 |
5,15,000 |
2009 |
5,80,000 |
2010 |
6,50,000 |
The loss in 2005-06 occurred due to a prolonged strike. The income tax paid so far has been at the average rate of 40% but it is likely to be 50% from 2010-11 onwards. Dividends were distributed at the rate of 10% on the paid-up capital in 2006-07 and 2007-08 at the rate of 15% in 2008-09 and 2009-10. The price of shares is ruling at 125 at the end of the year ended 31 March 2010. Profits till 2009-10 have been ascertained after debiting 2,00,000 as remuneration to the managing director. The government has approved a remuneration of 3,00,000 with effect from 1 April 2010. The company has been able to secure a contract for supply of materials at advantageous prices. The advantage has been valued at 2,00,000 p.a. for the next 5 years.
[C.A. Modified]
[Ans: Goodwill: 7,42,560]
31. The following is the balance sheet of Good Morning Ltd. as at 31 March 2010:
Additional information:
|
|
2007–08 |
8,00,000 |
2008–09 |
8,60,000 |
2009–10 |
9,00,000 |
In a similar business, return on capital employed is 15% (after tax).
Depreciation on machinery is charged @ 10% on reducing balance method.
Find out the value of each fully paid and partly paid equity share on net assets basis
[C.A. Modified]
[Ans:
32. The balance sheet of Ever Fine Ltd as at 31 March 2010 is given as follows:
The net profits of the company, after deducting usual working expenses but before providing for taxation, were as under:
Year |
|
2007–08 |
6,00,000 |
2008–09 |
7,20,000 |
2009–10 |
6,60,000 |
On 31 March 2010, building was revalued at 6,00,000 and machinery at 7,50,000, Sundry debtors on the same date included 30,000 as irrecoverable. Having regard to the nature of the business, a 10% return on net tangible capital invested is considered reasonable. You are required to calculate the company’s share ex-dividend. Valuation of goodwill may be based on 3 years’ purchase of annual super profits. Depreciation on building is 2% and machinery 10%. The income tax rate is assumed to be at 50%. All workings should form part of your answer.
[C.A. Modified]
[Ans: Value per equity share (ex-dividend): 134.17]
33. Balance sheet of XY Ltd as on 31 March 2010 was as follows:
Profit and dividend in last several years were as follows:
Year |
Profit |
Equity Dividend |
|
|
% |
2007–08 |
8,80,000 |
12 |
2008–09 |
10,00,000 |
15 |
2009–10 |
12,80,000 |
18 |
Land & Buildings are worth 16,00,000. Managerial remuneration is likely to go up by 80,000 p.a. Income tax may be provided at 50%. Equity shares of companies in the same industry with dividend rate of 10% are quoted at par. Find out the most appropriate value of an equity share assuming that: (a) Controlling interest is to be transferred and (b) only a few shares are to be transferred. Ignore goodwill value, depreciation adjustment for revaluation and the need of transfer to general reserve.
[C.A. Modified]
[Ans: (a) Valuation of equity shares when controlling interest is to be transferred:
(b) Valuation of equity shares when only a few shares are to be transferred: Value of fully paid-up equity share: 15]
34. The following details are available in respect of LM Ltd
|
( in lakhs) |
PBIT for the year ended 31 December 2009 |
40.00 |
13% Secured loans as on 31 December2009 |
20.00 |
12% Preference shares of 100 each fully paid as on 31 December 2009 |
20.00 |
20,000 Equity shares of 100 each 80 paid-up as on 31 December 2009 |
16.00 |
80,000 Equity shares of 100 each fully paid as on 31 December 2009 |
80.00 |
Reserves and surplus as on 1 January 2009 |
20.00 |
Preliminary expenses as on 31 December 2009. |
15.830 |
Other information:
You are required to compute the value of different classes of equity shares on the basis of:
[Working required: (i) balance of P&L A/c as on 31 December 2009 & (ii) earning percentage]
[I.C.W.A. Modified]
[Ans: Balance of P&L A/c: 0.968 lakh; Earnings percentage: 22.57%
35. The balance sheet of ABC Ltd. as at 31 March 2010 was as follows:
What value would you place on equity share based on (i) Net assets (excluding realizable goodwill) and (ii) Capitalised value of maintainable profits which is agreed to be the weighted average net profits (weightage being 1, 2 & 3) of past three years, capitalization rate being 8½%. Confine your result on the data given.
[I.C.W.A. Modified]
[Ans: Gross assets excluding goodwill: 39,50,000; Net assess available to equity shares holders: 20,50,000; Value of share net assets: 20.50; Capitalized value of maintainable profit value: 45.80]
36. Company A wishes to takeover company B. The financial details of the two companies are as follows:
What offer do you think Company A could make to Company B in terms of exchange ratio, based on (i) net asset value; (ii) earning per share and (iii) market price per share? Which method would you prefer from Company A’s point of view?
[C.S. Material]
[Ans: Value of share: Net asset value method:
(Company A) 13.80
Company B: 11.20.
Exchange Ratio:
37. The capital structure of a company is as follows:
|
|
12% Preference shares of 10 each |
2,50,000 |
Equity shares of 10 each |
4,00,000 |
Reserves & Surplus |
2,00,000 |
10% Debentures |
3,00,000 |
11% Term loan |
3,50,000 |
|
_________ |
The average annual profit before payment of tax and interest is 3,00,000. The income tax rate is 45%.
You are required to state what valuation should be put upon the equity shares of the company if the applicable price earnings ratio is 9?
[I.C.W.A. (Final). Modified]
[Ans: Earnings per share 2.43; Value of equity shares: 21.87 if P/E ratio is 9]
38. The following particulars relate to a company:
|
|
Total assets |
37,00,000 |
External liabilities |
5,00,000 |
Share capital: |
|
14% Preference shares of 10 each, fully paid |
10,00,000 |
80,000 Equity shares of 10 each, fully paid |
8,00,000 |
1,20,000 Equity shares of 10 each, 7.50 paid |
9,00,000 |
You are required to calculate the value of each category of equity shares of the company based on a deemed liquidation.
[I.C.W.A. (Final). Modified]
[Ans: Value of equity share (fully paid): 12.50; Value of equity share (partly paid up): 10]
39. Following is the information of two companies for the year ended 31 March 2010:
|
Company |
Company |
|
X |
Y |
|
||
Equity shares of 10 each |
16,00,000 |
20,00,000 |
10% Preference shares of 10 each |
12,00,000 |
8,00,000 |
Profit after tax |
6,00,000 |
6,00,000 |
Assume that the market expectation is 18% and 80% of the profits are distributed.
[C.A. (Final). Modified]
[Ans: |
Company |
Company |
|
X |
Y |
EPS |
3.00 |
2.60 |
Dividend per share |
2.40 |
2.08 |
If small lot bought value per share |
13.33 |
11.56 |
If controlling interest is bought: value |
16.67 |
14.44 |
Preference dividend coverage ratio |
5 times |
7.5 times] |
40. Shiva & Vas Co. Ltd. has an issued, subscribed and paid-up share capital comprising 20,000 equity shares of 100 each and 6,000 9% preference shares of 100 each. The following information is supplied:
Year Ended |
Average Net Worth |
Adjusted Taxed |
31 March |
(Excluding Investments) |
Profits |
|
||
2008 |
37,20,000 |
3,80,000 |
2009 |
43,00,000 |
4,20,000 |
2010 |
43,80,000 |
5,00,000 |
As at the valuation date, the company has investments of the market value of 5,60,000 the yield in respect of which has been excluded in arriving at adjusted taxed profit figures.
The company sets apart 25% of taxed profits as rehabita and replacement reserve.
On the valuation date, the net worth (excluding investments) amounts to 45,00,000. The expected rate of return in the market is 9%. The company has consistently maintained dividend levels of 8–10% in the past and is known for its consistency.
You are required to ascertain the value of each equity share on the basis of productivity, applying suitable weighted averages.
[I.C.W.A. (Final). Modified]
[Ans: Weighted average earning: Profit: 3,06,000; Capitalized value of profit: 3,96,000; Value of each equity share: 198]
[I.C.W.A. (Final). Modified]
3.145.74.63