CORPORATE FINANCING

PROJECT ON VALUATION ON SHARES

Prepared by:: Name Roll No. Shalini Ekka 40 Mary Shirine 52 Jaya Sinha 43 Prabhat Metiya 45

What are Shares???

The capital of the company is divided into small number of units called as shares. Share implies a unit having property rights. Shares of a company are generally quoted in the stock exchange. So the shares are quoted and the market quotations are often taken as the representing value of share on a particular date. But the price of share may not always be warranted by the financial position of the company because stock exchange prices are influenced by Bank rate Taxation Political influence etc

Types of shares

Preference shares: Carries 2 rights as per section 85 of Companies Act. They have a right to receive dividend at a fixed rate before any dividend is paid on equity shares. On winding up of the Company, they have a right on return on capital before anything is paid to equity shareholders.

Equity shares: Is a share which is not a preference share. They control the affairs of business hence have right to profits after all preference dividend is paid off.

Valuation Of Shares
The necessity of valuation arises out of following reasons: 1. When a block of share is to be purchased so as to acquire controlling interest on amalgamation or merger of companies. 2. When the company is nationalized and the shareholders of the company are compensated by the government. 3. When the shares are to be taken as a security against loan. 4. When a class of shares is converted to another class of share or debenture. 5. When the partners of a company jointly hold some shares of a company for ascertaining the amount to be distributed among the partners on dissolution. 6. Under the scheme of nationalization when the shares of the company are taken over by the government

Methods Of Valuation Of shares

Methods of valuation of shares depends on the purpose and factors affecting the valuation of shares.
1. Intrinsic Value Method 2. Yield method 3. Earning capacity method 4. Capitalization and earning capacity 5. Fair value

1.Intrinsic Value Method

This method involves estimation of current value of assets and liabilities and determination of the exact net worth or net asstes of the business so as to give the value of shares as under:
Value of shares = Net worth Or Net worth x face value (paid up) value of each share Share capital Number of shares

Net worth: All the credit balances appearing in the balance sheet should be carefully studied so for accumulated profits & reserves may not be considered . All ficticious assets should be excluded. Special care should be taken to include assets and liabilities that are not disclosed in the balance sheet. Goodwill: It comprises of a real asset in a sense that it may be sold for value n hence it is rational to include the value of goodwill.

Intrinsic Value Method

When there is both equity and preference shares the valuation will be made with reference to the provision contained in The Articles of Association of the company.
If both shares enjoy the same benefit: Net worth/Number of total shares = value per share

In other cases the amount payable to the preference share holder:

Intrinsic value of that class of shares = Total assets backing for equity shares X actual paid up of Total amount of paid up equity capital value of each share

Without separation of goodwill. Sundry assets 00 (Including goodwill and non trading assets like investments but excluding fictitious assets like misc expenses or P/L (DR.) ) Less : liabilities External liabilities 00 CONTINGENT LIABILITIES 00 00 Net worth 00 Less: preference shareholders claim 00 Add; notional calls partly paid shares 00 Net assets backing equity shares or available to equity shareholders 00 Intrinsic value of each fully paid shares = net assets available for eq shareholders No of equity shares Intrinsic value of each partly paid share= intrinsic value of each fully paid eq share notional call per share

With separate valuation goodwill

Step a Step b Step c calculation of capital employed 00 calculate goodwill trading capital employed 00 Add: value of goodwill computed 00 Add: non trading asset (at market price, if given , otherwise at cost) Less: preference shareholders claim Add: notional call on partly paid shares Less: goodwill at cost Less: proposed dividend (for valuation of shares ex- dividend) Net assets (including goodwill) available for equity shareholders

00 00 00 00 00

Intrinsic value of each fully paid equity share = net assets available for equtiy shareholders No of equity shares

2 .Yield method

Under this method profit determines the value of shares. 1. On the basis of expected return on capital employed. 2. On the basis of expected future dividends.

A. Return On Capital Basis: Rate of return on capital x paid up value per share Normal rate of return (Rate of return: profit earned /capital employed) x 100

Where,
Profit earned means: less debenture interest and preference dividend but after charging income tax. Capital employed includes share capital, long term loans, and reserves

B. Dividend basis: following steps:

Expected profit available for equity dividend is calculated by deducting from estimated future maintainable profits, income tax, preference dividends and transfer to reserves. (Expected rate of return: Expected profit available for equity dividend/paid up) x paid up value per share
Value of each equity share: (Expected rate of dividend/normal rate of return) x paid up value per share

The method to be used in valuation depends on the number of shares involved When large block of shares involved: return on capital employed When small number of shares involved : dividend basis

3 Earning Capacity Method

This method takes into account the earning potentials of a company rather then return of the shareholders. The earning capacity method takes into account total earning of the company before any appropriation.

This method involves the following steps.

1. 2. 3. 4. 5. Calculation of future maintainable profits. Calculation of capital employed. Ascertaining the rate of earnings. Determining the normal rate of return. Determination of value of shares.

How F.M.P. is calculated??

Particular Average profit Add: Expenses & losses incurred so far, but not likely to be incurred in future Add: Income & Gain not earned so far, but likely to be earned in the future xx xx Amount Amount xx

xxx Less: Expenses & losses not incurred so far, but likely to be incurred in future Less: : Income & Gain not earned so far, but likely to be earned in the future xx xx xx

xxx

Calculation of capital employed

The capital employed should mean Equity capital employed as i.e. Equity capital plus retained earning. The preference share capital, The Long term borrowing and debentures were to be excluded.

 Rate of earning
= Profits after interest, tax & preference dividend X 100 Equity capital

Value of Equity shares

Earning Rate X Paid up value Normal rate of return

IV. Capitalization of Earning Capacity Method

Under this method profits available for equity shareholders as calculated under capitalization of method, are capitalized on the basis of normal rate of return. Then the value of equity shares is ascertained by dividing the capitalized profits by the number of equity shares as shown under

Capitalized Value of profits = Future Maintainable Profits X100 Normal Rate of Return

Value of Equity shares = Capitalized value of Profits No. of equity shares

5. Fair value
Some authorities are of the view that neither the intrinsic value nor the yield value is correct but the proper method of valuation is to take average of both the methods.
Formula: (Intrinsic value + yield value)/2 Or Intrinsic value + Capitalized/Earning capacity 2

6.Valuation of Preference shares

A preference shareholder is particularly interested in the security of capital and consistency of returns. That is why he is anxious for a priority of repayment of his capital/dividend or both. The following points must be kept in the mind while calculating the value of preference shares.

continued In the case preference shares are cumulative and participating then besides arrears they will also be entitled to shares in the surplus of the company, left after returning equity capital. However, if the preference shares do not have any preference (priority) with regard to repayment of capital and dividend, the values of preference shares shall be calculated as if these are equity shares If preference shares are non-cumulative and nonparticipating the value of each preference shares shall be equal to its paid up value If preference shares are cumulative and non-participating the value will be determined after arrears of preference dividend are added back to their paid up capital

Thank you.