VALUATION OF SHARES
Concept And Meaning Of Valuation Of Shares
Introduction
Every share has its value printed in its front. Such a value is called as par value or face value of shares. The face value is assigned by the promoters of joint stock company and is given in the memorandum of association.
Except the face value, it also has market value on stock exchange market which may be differ from face value.
Except the face value, it also has market value on stock exchange market which may be differ from face value.
The market value of a share is determined by the demand and supply. Such a value is affected by the action and opinions of investors and their fear, guess, investment policy etc. Hence, the market price does not reflect the true value of shares and requires a proper valuation of shares.
Specially, in the case of private limited company the shares of such a company are not freely purchased and sold to the public. In that case, the valuation becomes absolutely necessary.
The value of shares can be determined in different ways. It can be valued either by taking the earning of a company or net assets that comprise the company. The choice is governed by the reasons for investment.
Need For Valuation Of Shares
1. Where companies amalgamate or are similarly reconstructed, it may be necessary to arrive at the value of shares hold by the members of the company being absorbed or taken over.
2. Where shares are hold jointly by the partners in a company and partnership firm dissolved, it becomes necessary to value of shares.
3. Where a portion of the shares is to be given by a member of proprietary company to another member as the member cannot sell it in the open market, it becomes necessary to certify the fair price of these shares by an auditor.
2. Where shares are hold jointly by the partners in a company and partnership firm dissolved, it becomes necessary to value of shares.
3. Where a portion of the shares is to be given by a member of proprietary company to another member as the member cannot sell it in the open market, it becomes necessary to certify the fair price of these shares by an auditor.
4. When a loan advanced on the security of shares, it becomes necessary to know the value of shares on the basis of which loan has been advanced.
5. When shares are given in a company as gift it may be necessary for the purpose of assessing gift tax, to place a value on the shares.
6. When preference shares or debentures are converted into equity share it becomes necessary to value the equity shares for ascertaining the number of equity shares required to be issued for debentures or preference shares which are to be converted.
7. When equity shareholders are to be compensated on the acquisition of their shares by the government under a scheme of nationalization then it is necessary to value the equity shares.
5. When shares are given in a company as gift it may be necessary for the purpose of assessing gift tax, to place a value on the shares.
6. When preference shares or debentures are converted into equity share it becomes necessary to value the equity shares for ascertaining the number of equity shares required to be issued for debentures or preference shares which are to be converted.
7. When equity shareholders are to be compensated on the acquisition of their shares by the government under a scheme of nationalization then it is necessary to value the equity shares.
Factors Affecting The Value Of Shares
1. The nature of the business
2. The income yielding capacity of the company
3. The demand and supply of shares
4. The percentage of dividend declared on shares
5. The availability of sufficient assets over liabilities
6. General economic condition e.g. availability of raw materials, possibility of new competitions.
7. Financial, political and other factors affecting the business
8. Reserves of the company
2. The income yielding capacity of the company
3. The demand and supply of shares
4. The percentage of dividend declared on shares
5. The availability of sufficient assets over liabilities
6. General economic condition e.g. availability of raw materials, possibility of new competitions.
7. Financial, political and other factors affecting the business
8. Reserves of the company
Methods Of Valuation Of Shares
1. Net Assets Method Of Valuation Of Shares
Under this method, the net value of assets of the company are divided by the number of shares to arrive at the value of each share. For the determination of net value of assets, it is necessary to estimate the worth of the assets and liabilities. The goodwill as well as non-trading assets should also be included in total assets. The following points should be considered while valuing of shares according to this method:
* Goodwill must be properly valued
* The fictitious assets such as preliminary expenses, discount on issue of shares and debentures, accumulated losses etc. should be eliminated.
* The fixed assets should be taken at their realizable value.
* Provision for bad debts, depreciation etc. must be considered.
* All unrecorded assets and liabilities ( if any) should be considered.
* Floating assets should be taken at market value.
* The external liabilities such as sundry creditors, bills payable, loan, debentures etc. should be deducted from the value of assets for the determination of net value.
The net value of assets, determined so has to be divided by number of equity shares for finding out the value of share. Thus the value per share can be determined by using the following formula:
Value Per Share=(Net Assets-Preference Share Capital)/Number Of Equity Shares
2. Yield Or Market Value Method Of Valuation Of Shares
The expected rate of return in investment is denoted by yield. The term "rate of return" refers to the return which a shareholder earns on his investment. Further it can be classified as (a) Rate of earning and (b) Rate of dividend. In other words, yield may be earning yield and dividend yield.
a. Earning Yield
Under this method, shares are valued on the basis of expected earning and normal rate of return. The value per share is calculated by applying following formula:
Value Per Share = (Expected rate of earning/Normal rate of return) X Paid up value of equity share
Expected rate of earning = (Profit after tax/paid up value of equity share) X 100
b. Dividend Yield
Under this method, shares are valued on the basis of expected dividend and normal rate of return. The value per share is calculated by applying following formula:
Expected rate of dividend = (profit available for dividend/paid up equity share capital) X 100
Value per share = (Expected rate of dividend/normal rate of return) X 100
3. Earning Capacity Method Of Valuation Of Shares
Under this method, the value per share is calculated on the basis of disposable profit of the company. The disposable profit is found out by deducting reserves and taxes from net profit. The following steps are applied for the determination of value per share under earning capacity:
Step 1: To find out the profit available for dividend
Step 2: To find out the capitalized value
Capitalized Value =( Profit available for equity dividend/Normal rate of return) X 100
Step 3: To find out value per share
Value per share = Capitalized Value/Number of Shares
Under this method, the net value of assets of the company are divided by the number of shares to arrive at the value of each share. For the determination of net value of assets, it is necessary to estimate the worth of the assets and liabilities. The goodwill as well as non-trading assets should also be included in total assets. The following points should be considered while valuing of shares according to this method:
* Goodwill must be properly valued
* The fictitious assets such as preliminary expenses, discount on issue of shares and debentures, accumulated losses etc. should be eliminated.
* The fixed assets should be taken at their realizable value.
* Provision for bad debts, depreciation etc. must be considered.
* All unrecorded assets and liabilities ( if any) should be considered.
* Floating assets should be taken at market value.
* The external liabilities such as sundry creditors, bills payable, loan, debentures etc. should be deducted from the value of assets for the determination of net value.
The net value of assets, determined so has to be divided by number of equity shares for finding out the value of share. Thus the value per share can be determined by using the following formula:
Value Per Share=(Net Assets-Preference Share Capital)/Number Of Equity Shares
2. Yield Or Market Value Method Of Valuation Of Shares
The expected rate of return in investment is denoted by yield. The term "rate of return" refers to the return which a shareholder earns on his investment. Further it can be classified as (a) Rate of earning and (b) Rate of dividend. In other words, yield may be earning yield and dividend yield.
a. Earning Yield
Under this method, shares are valued on the basis of expected earning and normal rate of return. The value per share is calculated by applying following formula:
Value Per Share = (Expected rate of earning/Normal rate of return) X Paid up value of equity share
Expected rate of earning = (Profit after tax/paid up value of equity share) X 100
b. Dividend Yield
Under this method, shares are valued on the basis of expected dividend and normal rate of return. The value per share is calculated by applying following formula:
Expected rate of dividend = (profit available for dividend/paid up equity share capital) X 100
Value per share = (Expected rate of dividend/normal rate of return) X 100
3. Earning Capacity Method Of Valuation Of Shares
Under this method, the value per share is calculated on the basis of disposable profit of the company. The disposable profit is found out by deducting reserves and taxes from net profit. The following steps are applied for the determination of value per share under earning capacity:
Step 1: To find out the profit available for dividend
Step 2: To find out the capitalized value
Capitalized Value =( Profit available for equity dividend/Normal rate of return) X 100
Step 3: To find out value per share
Value per share = Capitalized Value/Number of Shares
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