Valuation of Shares

Valuation of Shares

Valuation of shares is essential for various financial transactions, including mergers, acquisitions, and private share transfers. The method of valuation depends on whether the shares are publicly traded or privately held, as well as the context of the valuation.

Need for Valuation of Shares

• Amalgamation Schemes: Valuation helps in determining the exchange ratio of shares in mergers or amalgamations.
• Purchase or Sale of Controlling Shares: For transactions involving large or controlling blocks of shares, stock exchange prices may not apply.
• Investment and Finance Companies: Valuation is necessary to assess the value of assets.
• Security Purposes: Used to evaluate the worth of shares when raising loans.
• Company Reconstruction: To determine fair compensation for dissentient shareholders.
• Acquisition of Shares: When acquiring shares of dissenting shareholders under certain sections of company law.

Factors Affecting Share Value

• Restrictions on Transfer: Shares with transfer restrictions generally have a higher required return.
• Disabilities Attached to Shares: Partly paid shares usually require a higher return.
• Dividend Performance: Consistent dividends can lead to a lower required return.
• Financial Prudence: Companies that distribute only part of their profits can attract investors with lower yields.
• Net Asset Backing: Higher tangible assets per share generally lead to a lower required return.

Methods of Share Valuation

• Net Asset Method (Intrinsic or Break-up Value Method)
  • Definition: This method focuses on the safety of investment by assessing the company's net assets.
  • Steps:
    • Determine Goodwill: Value of goodwill is added to the net assets.
    • Revalue Fixed Assets: Adjust to their realizable values.
    • Market Value of Floating Assets: Consider current market values.
    • Exclude Fictitious Assets: Remove items like Preliminary Expenses.
    • Consider Liabilities: Deduct external liabilities, including contingent liabilities.
  • Calculation:
  • Net Assets = Total Realizable Value of Assets−Total External Liabilities
  •  Value of Equity Shares = 

$\frac{Net Assets-Preference Share Capital}{Number of Equity Shares}$

• Yield Method
  • Definition: This method values shares based on the expected rate of return compared to the normal rate of return.
  • Formula: Value of Share = 

$\frac{Expected Rate of Return}{Normal Rate of Return}\times Paid-Up Value$

• Value of Rights Shares
  • Definition: Determines the value of rights offered to existing shareholders.
  • Calculation: Value of Right = 

$\frac{Number of Rights Shares}{Total Holding\mathrm{s }}\times$

$<br>$

$(Market\; Value\; -\; Issue\; Price)$

• Earning Capacity Method
  • Definition: Evaluates shares based on the company's earnings capacity and profit.
  • Calculation: Rate of Earning = 

$\frac{Profit Earned}{Capital Employed}\times 100$

• Fair Value Method
• Definition: Averages the intrinsic value and yield value to provide a balanced estimate.
• Calculation: Fair Value = 

$\frac{Intrinsic Value+Yield Value}{2}$

Conclusion

Valuation of shares is a crucial process for various financial and business decisions. Different methods offer insights into different aspects of share value, from safety and asset backing to potential return and earnings capacity. Each method has its context and application, making it essential to choose the right approach based on the specific circumstances and objectives of the valuation.