Today I am going to talk about valuation of shares. Just be relax cause this is going to be interesting topic. this topic is not only useful for students but also for those people who wants to invest in the share market because this will help them to know how to value the shares they are investing on.
so get ready.
There are three methods of valuing equity shares.
1. Intrinsic value method.(net asset method)
2. Yield method.
3. Fair value method.
1. Intrinsic value method:
This method says that add all the assets of the company (excluding any fictitious asset) and from it deduct its outside liabilities. The value that you get should be divided by number of equity shares and that would be your intrinsic value per shares. what you have to remember is if you have any preference share capital in the given balance sheet you have to deduct it also from total assets.
yes you are understanding little bit but you need practical example: suppose the following balance sheet is given to you:
Liabilities: Amount
Share capital
1000 equity shares of $100 each fully paid up 100000
2000 preference shares of $10 each fully paid up 20000
10%debentures 15000
creditors 8000
Total liabilities 143000
Asset:
Machinery 50000
Furniture 40000
stock 30000
cash and cash equivalent 20000
preliminary expenses 3000
Total asset 143000
Now how to determine intrinsic value ?
first add all the assets excluding preliminary expenses so ( 50000+40000+ 30000+20000=140000).
second deduct 15000, 8000 and 20000 of preference share capital as well that is, 43000 from 140000 and we get (140000-43000=97000) this 97000 is the value of equity shareholder.
lastly, divide 97000 by number of equity shares(here we have 1000 as our number of equity share) and you get 97000/1000=97 as your intrinsic value per share.
There are lots of things to note down while calculating intrinsic value.
Take some tea or coffee and get ready again.
The next method is to value the shares on the basis of yield value.
Yield value Method :
First step is to determine "profit available for equity shareholder"
for this we need to determine average profit of the company and from the average profit deduct the amount that need to transfer to reserves. sometimes in the question it is given that 10% of profit must be transfer to reserves, in that case we have to compute 10% of average profit and then deduct it from average profit.
The second item that need to be deducted is the preference share dividend.
suppose the average after tax profit of the company is $10000.
company transfer 5% of the profit to the reserves.
and in the balance sheet it is given like that "10% 500preference shares of $10 each $5000"
" 1000 equity shares of $100 each (fully paid) $100000"
in the above case, profit available for equity shareholder would be:
Average profit 10000
less: transfer to reserves 10% of 10000 = 1000
less: preference shares dividend = 500
(10% of 5000)
total profit available for equity shares 8500
The second step is to determine Expected Return
The formula of expected return is:
profit available for equity shareholder *100
P
aid up Equity share capital
so, in the above example our equity share capital is 100000 therefore, our expected return would be
8500/100000*100=8.5%
The third and final step is to determine yield value
formula is :
expected return/normal return* paid up value
therefore in the above example, suppose the normal return is 5% and paid up value of each share is $100 each.
yield value of shares = 8.5%/5%*100=$170
one thing must be noted here that it is the paid up value which should be multiplied not the face value . in the be given example if paid up value had been 80$ each and face value had been 100 $ each, we would multiply with 80$ not with 100$. and in that case our yield value would be;
8.5%/5%*80=$136
Till now hope I have been successful in making you understand the concept so far. the final method remains is valuation on the basis of fair value which is nothing but the average of intrinsic value and yield value.
here comes your formula :
Fair value= intrinsic value+ yield value
2
Practical questions:
1. Balance sheet of x ltd as on 31.12.2016
liabilities:
share capital:
15000 equity shares of 10$ each, fully paid 150000
20000 equity shares of $10 each, $6 paid 120000
9% cumulative preference shares 60000
long term loan 140000
sundry creditors 80000
Total 550000
Assets:
Sundry fixed asset 220000
investments 40000
stock in trade 80000
sundry debtors 40000
cash and bank 40000
profit and loss account 130000
Total 550000
Other information:
1. current cost of sundry fixed asset is $370000 and that of stock is $100000
2. Investment could fetch only $10000.
3. 50% debtors are doubtful.
4. preference dividend is in arrears for the last five years.
Find out the intrinsic value per share of x ltd by net asset method.
For answer click here
Q2.
On the basis of the following information , calculate the intrinsic value of equity shares:
5000, 6% preference shares of $100 each , 500000
30000 equity shares of $10 each fully paid 300000
total tangible asset (other than goodwill) 949000
total outside liabilities 95000
average net profit after tax 62560
expected normal yield for equity shares is 7% of capital employed. Goodwill is to be taken at 5 years' purchase of super profit.
For Answer click here
Q3. From the following information, calculate the value per equity shares under yield method
2000, 9% preference shares of $100 each 200000
50000 equity shares of $10 each , $8 per share paid up. 400000
expected profit per year before tax 218000
rate of tax 50%
transfer to general reserve 20% of profit
normal earning rate 15%
Q4. From the following, information calculate fair value of shares:
share capital (fully paid up)
Equity 100000 shares of $10 each
12% preference shares of $50 each
Reserve and surplus $150000
preliminary expenses $30000
The valuation of asset revealed that assets as per accounts are under valued by $250000
The average pre-tax profit of past three years were $500000. tax rate 50%
it is anticipated that, due to favourable market condition, pre-tax profit will increase by 20%
Equity shareholder expect a return of 15%.
* **------------***
so get ready.
There are three methods of valuing equity shares.1. Intrinsic value method.(net asset method)
2. Yield method.
3. Fair value method.
1. Intrinsic value method:
This method says that add all the assets of the company (excluding any fictitious asset) and from it deduct its outside liabilities. The value that you get should be divided by number of equity shares and that would be your intrinsic value per shares. what you have to remember is if you have any preference share capital in the given balance sheet you have to deduct it also from total assets.
yes you are understanding little bit but you need practical example: suppose the following balance sheet is given to you:
Liabilities: Amount
Share capital
1000 equity shares of $100 each fully paid up 100000
2000 preference shares of $10 each fully paid up 20000
10%debentures 15000
creditors 8000
Total liabilities 143000
Asset:
Machinery 50000
Furniture 40000
stock 30000
cash and cash equivalent 20000
preliminary expenses 3000
Total asset 143000
Now how to determine intrinsic value ?
first add all the assets excluding preliminary expenses so ( 50000+40000+ 30000+20000=140000).
second deduct 15000, 8000 and 20000 of preference share capital as well that is, 43000 from 140000 and we get (140000-43000=97000) this 97000 is the value of equity shareholder.
lastly, divide 97000 by number of equity shares(here we have 1000 as our number of equity share) and you get 97000/1000=97 as your intrinsic value per share.
There are lots of things to note down while calculating intrinsic value.
- if in your questions revaluation of any asset is given, then you should take revalued amount.
- in the above example Reserve and Surplus was not there but in your questions there will always be some Reserve and Surplus. If you find it, you don't have to deduct it because reserves and surplus are the value of equity shareholders so that should not be deducted from total assets.
- we are deducting preference capital because our aim is to determine intrinsic value of equity shares not preference shares so their value should be deducted from the total asset. apart from preference share capital, Arrear preference share dividend must also be deducted from total assets. Here in the above question, preference dividend was not there so we have not taken it in the calculation but if you find it, please deduct it also.
- Goodwill is to be added as per valuation. we know goodwill has its own method of valuation so we have to determine it on that basis.
- fictitious assets are not included in total assets because they don't have any value of their own. we can not sell it and get some money from that.
- and if you are learning intrinsic value of shares, I expect you to know the meaning of equity and preference shares.
Take some tea or coffee and get ready again.
The next method is to value the shares on the basis of yield value.
Yield value Method :
First step is to determine "profit available for equity shareholder"
for this we need to determine average profit of the company and from the average profit deduct the amount that need to transfer to reserves. sometimes in the question it is given that 10% of profit must be transfer to reserves, in that case we have to compute 10% of average profit and then deduct it from average profit.
The second item that need to be deducted is the preference share dividend.
suppose the average after tax profit of the company is $10000.
company transfer 5% of the profit to the reserves.
and in the balance sheet it is given like that "10% 500preference shares of $10 each $5000"
" 1000 equity shares of $100 each (fully paid) $100000"
in the above case, profit available for equity shareholder would be:
Average profit 10000
less: transfer to reserves 10% of 10000 = 1000
less: preference shares dividend = 500
(10% of 5000)
total profit available for equity shares 8500
The second step is to determine Expected Return
The formula of expected return is:
profit available for equity shareholder *100
P
aid up Equity share capital
so, in the above example our equity share capital is 100000 therefore, our expected return would be
8500/100000*100=8.5%
The third and final step is to determine yield value
formula is :
expected return/normal return* paid up value
therefore in the above example, suppose the normal return is 5% and paid up value of each share is $100 each.
yield value of shares = 8.5%/5%*100=$170
one thing must be noted here that it is the paid up value which should be multiplied not the face value . in the be given example if paid up value had been 80$ each and face value had been 100 $ each, we would multiply with 80$ not with 100$. and in that case our yield value would be;
8.5%/5%*80=$136
Till now hope I have been successful in making you understand the concept so far. the final method remains is valuation on the basis of fair value which is nothing but the average of intrinsic value and yield value.
here comes your formula :
Fair value= intrinsic value+ yield value
2
Practical questions:
1. Balance sheet of x ltd as on 31.12.2016
liabilities:
share capital:
15000 equity shares of 10$ each, fully paid 150000
20000 equity shares of $10 each, $6 paid 120000
9% cumulative preference shares 60000
long term loan 140000
sundry creditors 80000
Total 550000
Assets:
Sundry fixed asset 220000
investments 40000
stock in trade 80000
sundry debtors 40000
cash and bank 40000
profit and loss account 130000
Total 550000
Other information:
1. current cost of sundry fixed asset is $370000 and that of stock is $100000
2. Investment could fetch only $10000.
3. 50% debtors are doubtful.
4. preference dividend is in arrears for the last five years.
Find out the intrinsic value per share of x ltd by net asset method.
For answer click here
Q2.
On the basis of the following information , calculate the intrinsic value of equity shares:
5000, 6% preference shares of $100 each , 500000
30000 equity shares of $10 each fully paid 300000
total tangible asset (other than goodwill) 949000
total outside liabilities 95000
average net profit after tax 62560
expected normal yield for equity shares is 7% of capital employed. Goodwill is to be taken at 5 years' purchase of super profit.
For Answer click here
Q3. From the following information, calculate the value per equity shares under yield method
2000, 9% preference shares of $100 each 200000
50000 equity shares of $10 each , $8 per share paid up. 400000
expected profit per year before tax 218000
rate of tax 50%
transfer to general reserve 20% of profit
normal earning rate 15%
Q4. From the following, information calculate fair value of shares:
share capital (fully paid up)
Equity 100000 shares of $10 each
12% preference shares of $50 each
Reserve and surplus $150000
preliminary expenses $30000
The valuation of asset revealed that assets as per accounts are under valued by $250000
The average pre-tax profit of past three years were $500000. tax rate 50%
it is anticipated that, due to favourable market condition, pre-tax profit will increase by 20%
Equity shareholder expect a return of 15%.
* **------------***
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