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VALUATION MEANS
VALUTION OVERVIEW
Option pricing models are used for certain types of financial assets (e.g.,
warrants, put options, call options, employee stock options, investments with
embedded options such as a callable bond) and are a complex present value
model. The most common option pricing models are the BlackScholes-
Merton models and lattice models.
GOODWILL
WHAT IS GOODWILL?
Goodwill is excess of purchase price over share of Net Assets (Fair Value)
Goodwill is Intangible Asset Goodwill is Reputation , higher earning of
income , etc Goodwill = Purchase price FV of Net Assets acquired as on
date of purchase
DEFINITION
An intangible asset that arises as a result of the acquisition of one company
by another for a premium value. The value of a companys brand name, solid
customer base, good customer relations, good employee relations and any
patents or proprietary technology represent goodwill. Goodwill is considered
an intangible asset because it is not a physical asset like buildings or
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EXPLANATION OF GOODWILL
The value of goodwill typically arises in an acquisition when one company
is purchased by another company. The amount the acquiring company pays
for the target company over the targets book value usually accounts for the
value of the targets goodwill. If the acquiring company pays less than the
targets book value, it gains negative goodwill, meaning that it purchased
the company at a bargain in a distress sale.
CHARACTERISTIC OF GOODWILL
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If a business has been earning the same amount of profits over a few past
years with almost no fluctuations, we can take these past profits as Future
Maintainable Profits. But if there are considerable ups and downs in the
results of the business, the Future Maintainable Profits are calculated on the
basis of Average Profits of the few past years.
For example the profits of company X Ltd. for the last three years are:
2008..... 20,000
2009..... 20,000
2010..... 35,000
Super Profits are the profits earned above the normal profits. Under this
method Goodwill is calculated on the basis of Super Profits i.e. the excess of
actual profits over the average profits. For example if the normal rate of
return in a particular type of business is 20% and your investment in the
business is $1,000,000 then your normal profits should be $ 200,000. But if
you earned a net profit of $ 230,000 then this excess of profits earned over
the normal profits i.e. $ 230,000 - $ 200,000= Rs.30,000 are your super
profits. For calculating Goodwill, Super Profits are multiplied by the agreed
number of years of purchase.
Steps for calculating Goodwill under this method are given below:
PROBLEM 1
2005 10,000,000
2006 12,250,000
2007 7,450,000
2008 5,400,000
Total profits for the last four years = 10,000,000 + 12,250,000 + 7,450,000 +
5,400,000 = $35,100,000
PROBLEM 2
When the actual profit is more than the expected profit or normal profit of a
firm, it is called Super Profit. Under this method goodwill is to be calculate
of on the following
manner:
2006-07 2,60,40,742.63
2007-08 77,77,726.00
2008-09 1,34,84,208.75
2009-10 2,83,01,883.14
TOTAL 7,56,04,560.00
(Rounded off)
SOLUTION:
Capital employed
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NOTES:
Or
1. ACTUAL RATE
If the final accounts of all the concerns in an industry are available, the
Normal Rate of Return for that industry would be
2. ESTIMATE RATE
However, generally the profit & loss accounts (to find out the profits ) and
the balance sheet (to find out the capital employed) of all the concerns in a
particular industry may not be available. In such a case , the Normal Return
is estimated by the formula :
Return at zero risk + Addl. Return for business risk + Addl. Return for
financial risks
(1) Return at Zero Risk: This refers to the return from a safe investment
e.g., the interst on Bank Deposits, say 10%. This is the mimimum rate
expected on investment, by an investor.
rate above, to give the normal rate of 13%. this rate goes up or down with
changes in general business condition e.g. boom or depression. Businesmen
expect a higher rate for business involving more risk.
(3) Additional Return for Financial Risks: Financial Risks refer to the
risks due to large amounts borrowed or due to the Capital Gearing policies
adopted by concern. If the concern has huge loans it means that a part of the
future profits will be used to pay interest. Suppose the additional return to
cover such financial risks is estimated at 3%, the normal rate of return would
now be 15% (10 + 2 + 3).
The normal rate of return in the case of limited company can also be
estimated on the basis of the Dividend paid by the company, the normal rate
of dividend expected and the market price of the shares of the company. The
formula is :
SOLVED PROBLEMS
278500 278500
The Companys average profits of the last five years after making
provisions for taxation at 50% amounted to Rs 47500.
Solution:
Capital Employed
Assets 110000
Land 60000
Machinery 57500
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Stock 49000
Less: Liabilities
Creditors 63000
(Assets Liabilities)
Working Notes:
3. Capitalisation Method:
Under this method first of all we calculate the Super Profits and then
calculate the capital needed for earning such super profits on the basis of
normal rate of return. This Capital is the value of our Goodwill . The
formula is:-
Valuation of shares
Normally , the value of shares is ascertained from the market price quoted
on the stock exchange. Sometimes, however, share valuation has to be done
by an independent valuer. Shares of a limited company are required to be
valued on many occasions such as
Methods of valuation
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:
Example-
Capital :
1,000, 5% Preference Shares of Rs. 100 each fully paid Rs. 1,00,000
2,000 Equity Shares of Rs. 100 each fully paid Rs. 2,00,000
6% Debentures Rs.1,00,000
For the purpose of valuation of shares, fixed assets and current assets are to
be depreciated by 10% ; Interest on debentures is due for six months;
preference dividend is also due for the year. Neither of these has been
provided for in the balance sheet.
Calculate the value of each equity share under Net Asset Method.
Solution:
Yield value per share = Expected rate of dividend * Paid up value of shares
PREFERENCE SHARE
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Capitalisation of earnings
This is not a method, but a compromise formula which arbitrarily fixes the
value of shares as the Average of the values obtained by the Net Assets
Method and the Yield Method.
Liabilities Rs Assets Rs
Equity Shares of Rs 10 5,00,000 Building 5,00,000
each 1,000,00 Machinery 3,00,000
10% Preference Shares of Stock 60,000
Rs 100 each 1,00,000 Debtors 50,000
General Reserve 50,000 Bank 50,000
Profit & Loss Account 1,10,000
Creditors 40,000
Provision for Income tax 60,000
Proposed Dividend 9,60,000 9,60,000
The profits of the company after charging depreciation but before income -
tax @ 40% were as follows for last five years;
1991 - Rs 1,00,000
2000 - Rs 1,40,000
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2001 - Rs 1,60,000
2002 - Rs 1,70,000
2003 - Rs 1,80,000
Find out the value of equity share under the Net Asset or Intrinsic
Method after valuing goodwill on the basis of five years purchase of
annual super profits.
Also , ascertain the share value on the basis of profit earning capacity
in relation to
Average dividend rate which was 8%, 9% ,7% for the last three
years.
Solution :
Computation of Goodwill
Capital Employed Rs Rs
Buildings 6,00,000
Machinery 2,50,000
Stock 60,000
Debtors 50,000
Bank 50,000
10,10,000
Less: Liabilities
Creditors 1,10,000
2 = 1,50,000
= Rs 10,000 x 5
= Rs 50,000
7,50,000 / 50,000
= Rs 15 per share
= 8%
= 8 x 10 / 10
= Rs 8 per share
CONCLUSION:
Goodwill arises when one company acquires another, but pays more than the
fair market value of the net assets (total assets - total liabilities). It is
classified as an intangible asset on the balance sheet. However, according to
International Financial Reporting Standards, goodwill is never amortized.
Instead, management is responsible to value goodwill every year and to
determine if impairment is required. If the fair market value goes below
historical cost (what goodwill was purchased for), impairment must be
recorded to bring it down to its fair market value. However, an increase in
the fair market value would not be accounted for in the financial statements.
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