VALUATION

(Chapter – 9 of Study Module)

Valuation of Goodwill
Goodwill Means: Monetary Value of Advantage of Earning More Profits. Goodwill is based

on Normal Operating Future Profits after Tax.

Class Notes:

Methods of Valuing Goodwill:

Average Profit Method – FMP x No. of years purchased

Super Profit Method – (FMP – Normal Profit) x No. of years purchased

Capitalisation Method – Super Profit / Capitalisation Rate

Annuity Method – SP x Annuity Value (as per Present value factor)

NO. OF YEARS PURCHASE – It will always be given in the question, if not given we will

use capitalization rate.

NRR: It means normal rate of return expected in the same business. It is generally given

in question. If it is not given then it will be calculated as under:

NRR = Div/MPS *100

(Avg Dividends and Avg MPS is allowed) (NRR is considered Post Tax Always)

CALCULATION OF FMP is based on Projected profits method and past profits method.

While calculating Past profits approach following items will be adjusted:

1. Tax Expenses

2. Abnormal Items

1 D-FORTUNE CLASSES, 9589260560

 3. Rectification of Errors

4. Effects of Changes in A/c Policy

5. Revaluation of Current Assets and Liabilities

6. Non recurring items (eg. Loss/profit on sale of assets)

7. Non operating Incomes (eg. Interest on investments)

8. Goodwill w/off added back

9. Additional Depreciation due to revaluation of FAs

10. Future Incomes and Exp

11. Future Tax Rate

Note: When NRR is given after Tax for both SH then FMP after Tax is to be considered.

When NRR is given for ESH then FMP after Tax after Pref. Dividend is considered.

Average of FMP is not specified in Question

 Check Trend in NP ratios if these are available: Apply Weighted Avg if trend is

available otherwise Simple Avg.

 If NP ratios are not available then check trend in Adjusted Profits: Apply

Weighted Avg is trend is available otherwise Simple Avg.

 Trend line average will be used only when asked in the question.

Trend Line average – Y = a + bx, where Y is future profit, a is simple average, b is growth

and x is distance from centre point.

CAPITAL EMPLOYED: Capital employed means Shareholders fund (Eqt + Pref) applied in

the business for operating activities. It is calculated as under:

All Assets XXX

Less: All Liabilities XXX

 Assets are to be considered after – Revaluation, Rectification and Change in

Accounting Policy

 Non Operating Investment will be excluded in Capital employed. (if nothing is

2 D-FORTUNE CLASSES, 9589260560

 specified in question we always assume that Investments are Non Operating)

 If there is Purchased Goodwill in BS then it is considered otherwise it is will be

excluded.

 These are not Liabilities for the purpose of capital employed – Proposed Dividend

and Pref Share Capital. But if NRR given in question is for ESH then they are

deducted.

 Capital employed may be “Closing Capital Employed” or “Average Capital Employed”

 Tangible capital employed means Closing Capital employed excluding Intangible

Assets.

 Avg. Capital Employed may be –

½ (Opening CE + Closing CE)

Or

Closing CE – ½ Rectified PAT

 Which Capital Employed to Use ?

If Not Specified in the question, then we have to check the basis of FMP. If FMP is

based on Projected Profits, Trendline Avg. or Weighted Avg. then we may use

Closing Capital Emp. and if FMP is based on Simple Avg. then we may use Avg.

Capital Employed.

Note: Tangible Capital Employed means Closing Capital Employed excluding Intangible

Assets.

Some Important Key Points:

 Investment for Replacement of P&M/Building is Trade Investment.

 RPAT is the actual profit earned after rectifications since we take capital emp

after rectification also. Moreover RPAT also includes income on Non Trade

Investment assuming that it is utilized in business activities.

 Abnormal Year is not to be considered in the valuation until and unless the loss due

3 D-FORTUNE CLASSES, 9589260560

 to abnormal activity is mentioned and quantified separately.

 If the Goodwill is shown in balance sheet and nothing is given in question about

goodwill, then we will assume it as Self Generated and not to be considered.

 We need to consider the additional provision of Tax due to increase in Tax Rate.

 Rectification is required when there is any Error or Omission or any information is

given which shows that there is wrong treatment in books. (Eg. Some trade

receivables are bad – it is assumed as error and to be rectified)

Q1. (Study Material)

PPX Ltd. gives the following information about past profits:

Year Profits ('000)

1996 21,70

1997 22,50

1998 23,70

1999 24,50

2000 21,10

On scrutiny it is found (i) that upto 1998, PPX Ltd. followed FIFO method of finished

stock valuation thereafter adopted LIFO method, (ii) that upto 1999 it followed straight

line depreciation and thereafter adopted written down value method.

Given below the details of stock valuation:

(Figures in Rs. 000)

Year Opening Stock Closing Stock

FIFO LIFO FIFO LIFO

1996 40,00 39,80 46,00 41,20

1997 46,00 41,20 49,20 47,90

1998 49,20 47,90 38,90 39,10

1999 38,90 39,10 42,00 38,50

4 D-FORTUNE CLASSES, 9589260560

2000 42,00 38,50 45,00 43,10

Straight line and written down value depreciation were as follows:

Year Straight Line W. D.V..

('000 Rs.) ('000 Rs.)

1996 12,10 17,00

1997 14,15 18,10

1998 15,00 19,25

1999 16,70 19,60

2000 18,00 19,40

Determine future maintainable profit that can be used for valuation of goodwill.

Solution:

Past profits of PPX Ltd. showed an increasing trend excepting in year 2000. But the
effects of changes in accounting policies should be eliminated to ascertain the true nature
of trend. Since the company has adopted LIFO method of Inventory valuation and W.D.V
method of depreciation, profits may be recomputed applying these policies consistently in
all the past years. Recompilation of profits following uniform accounting policies are shown
below:
(Figures in Rs ‟000)
Year Books profit Effect of LIFO Profit after
effect of valuation elimination of the
of Inventory effect of change in
W.D.V. accounting policies
1996 2170 -460 -490 1220
1997 2250 +350 -395 2205
1998 2370 +150 -425 2095
1999 2450 -20 -290 2140
2000 2110 - - 2110
Profits were oscillating during the last four years excepting 1996. So a simple average may
be taken of the last 4 years profits to arrive at the future maintainable profits:
Future Maintainable Profit (‟000 Rs) = 22,05 + 20,95 + 21,40 + 21,10 / 4 = 21,37.50
Working Note:
Effect of LIFO Valuation:
1996: Increase in Inventory as per FIFO valuation 6,00
Less: Increase in Inventory per LIFO valuation (1,40)
Reduction in profit 4,60
1997: Increase in Inventory as per FIFO valuation 3,20
Increase in Inventory as per LIFO valuation 6,70

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 Increase in profit 3,50
1998: Decrease in Inventory as per FIFO valuation 10,30
Decrease in Inventory as per LIFO valuation 8,80
Increase in profit 1,50
1999: Opening Inventory as per FIFO valuation 38,90
Opening Inventory as per LIFO valuation 39,10
Reduction in profit 20

Trend Average Method

Q2. B K Ltd. gives the following profit figures for the last five years:

Year Profits ('000)

1996 37,20

1997 42,00

1998 47,50

1999 53,50

2000 57,20

Since past profits show increasing trend, time series trend may be used to determine

future maintainable profit. Applying Linear trend equation three to five years profit may

be predicated and average of such future profits may be taken as future maintainable

profit. Calculate FMP for next three years.

Ans. (Study Material)

Year X Y XY X2

1996 –2 37,20 – 74,40 4

1997 –1 42,00 – 42,00 1

1998 0 47,50 0 0

1999 1 53,50 53,50 1

2000 2 57,20 114,40 4

0 237,40 51,50 10

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B=

Trend Equation given by:

Y = 4748 + 515 X

Ans.: FMP T6293, 6808, 7323.

Q3. From the following information prepare statements showing:

1. Capital employed

2. Average capital employed

3. Goodwill on the basis of 5 years purchase of the average super profit.

Equity & Liabilities Amount

Shareholders Fund

20,000 equity shares of Rs. 10 each 2,00,000

1,000 9% Preference Shares of Rs. 100 each 1,00,000

Reserve and Provision 2,00,000

(Provision for taxation Rs. 20,000)

Share-selling Commission -10,000

Discount on issue of Debentures -15,000

Non-Current Liabilities

10% Debentures 90,000

Current Liabilities

Creditors 60,000

6,25,000

Assets Amount

Non-Current Assets

Goodwill, 30,000

Fixed Assets 3,50,000

Investments (6% Government Loan) 45,000

Current Assets

Current Assets 2,00,000

7 D-FORTUNE CLASSES, 9589260560

 6,25,000

The current market value of the plant included in fixed assets is Rs. 15,000 more. The

average profit of the company (after deductions for interest on debentures and

Government taxes) is Rs. 68,000.

Expected rate of return is 10%, Rate of depreciation on fixed assets is 10%.

Ans.: Case – 1 If Tax rate is ignored - Average Capital Employed 3,61,000;

Goodwill 1,38,500 Closing CE 395000, FMP 63,800.

Case – 2 If Tax rate is to be calculated – Tax Rate 22.73%, FMP – 64752, Goodwill

- 143260

Q4. Goodwill and leverage effect (Home Work)

The following is the extract from the Balance Sheets of Popular Ltd.:
Liabilities As at As at Assets As at As at
31.3.2016 31.3.2017 31.3.2016 31.3.2017
Rs in lakhs Rs in lakhs Rs in lakhs Rs in lakhs
Share capital 500 500 Fixed assets 550 650
General reserve 400 425 10% 250 250
Investment
Profit and Loss 60 90 Inventory 260 300
account
18% Term loan 180 165 Trade 170 110
Receivables
Trade Payables 35 45 Cash at bank 46 45
Provision for 11 13 Fictitious 10 8
tax assets
Dividend 100 125
payable
1,286 1,363 1,286 1,363
Additional information:
(i) Replacement values of fixed assets were Rs 1,100 lakhs on 31.3.16 and Rs 1,250
lakhs on 31.3.2017 respectively.
(ii) Rate of depreciation adopted on fixed assets was 5% p.a.
(iii) 50% of the inventory is to be valued at 120% of its book value.
(iv) 50% of investments were trade investments.
(v) Trade Receivables on 31st March, 2017 included foreign trade receivables of $
35,000 recorded in the books at Rs 35 per U.S. Dollar. The closing exchange rate
was $ 1= Rs 39.
(vi) Trade Payables on 31st March, 2017 included foreign trade payables of $ 60,000
recorded in the books at $ 1 = Rs 33. The closing exchange rate was $ 1 = Rs 39.

8 D-FORTUNE CLASSES, 9589260560

(vii) Profits for the year 2016-2017 included Rs 60 lakhs of government subsidy which
was not likely to recur.
(viii) Rs 125 lakhs of Research and Development expenditure was written off to the
Profit and Loss Account in the current year. This expenditure was not likely to
recur.
(ix) Future maintainable profits (pre-tax) are likely to be higher by 10%.
(x) Tax rate during 2016-2017 was 50%, effective future tax rate will be 40%.
(xi) Normal rate of return expected is 15%.
One of the directors of the company Arvind, fears that the company does not enjoy
goodwill in the prevalent market circumstances.
Critically examine this and establish whether Popular Ltd. has or has not any goodwill.
If your answers were positive on the existence of goodwill, show the leverage effect it
has on the company‟s result.
Industry average return was 12% on long-term funds and 15% on equity funds.
Answer
1. Calculation of Capital employed (CE) Rs in lakhs
As on 31.3.16 As on 31.3.17
Replacement Cost of Fixed Assets 1,100.00 1,250.00
Trade Investment (50%) 125.00 125.00
Current cost of inventory
130 + 130 × 120 ÷ 100 286.00
150 + 150 × 120 ÷ 100 330.00
Trade Receivables 170.00 111.40
Cash at Bank 46.00 45.00
Total (A) 1,727.00 1,861.40
Less: Outside Liabilities
18% term loan 180.00 165.00
Trade Payables 35.00 48.60
Provision for tax 11.00 13.00
Total (B) 226.00 226.60
Capital employed (A-B) 1501.00 1634.80
Average Capital employed at current value
= Opening capital employed + closing capital employed / 2
=lakhs 1501 + 1634.80 /2 = 1567.90
2. Future Maintainable Profit Rs in lakhs
Increase in General Reserve 25
Increase in Profit and Loss Account 30
Dividends 125
Profit After Tax 180
Pre-tax Profit = 180÷1-0.5 360
Less: Non-Trading investment income (10% of Rs 125) 12.50
Subsidy 60.00

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 Exchange Loss on Trade Payables 3.60
[0.6 lakhs × (39-33)]
Additional Depreciation on increase in value of Fixed 30.00 (106.10)
Assets (current year) (1250-650)×5÷100 i.e.,
253.90
Add: Exchange Gain on trade receivables [0.35 lakhs × 1.40
(39-35)]
Research and development expenses written off 125.00
Inventory Adjustment (30-26) 4.00 130.40
384.30
Add: Expected increase of 10% 38.43
Future Maintainable Profit before Tax 422.73
Less: Tax @ 40% (40% of Rs 422.73) (169.09)
Future Maintainable Profit 253.64
3. Valuation of Goodwill Rs in lakhs
(i) According to Capitalisation of Future Maintainable 1,690.93
Profit Method Capitalised value of Future Maintainable
Profit = 253.64×100÷15
Less: Closing capital employed 1,634.80
Value of Goodwill 56.13
Or
(ii) According to Capitalization of Super Profit Method
Future Maintainable Profit 253.64
Less: Normal Profit @ 15% on average capital employed 235.19
(1,567.90 ×15%)
Super Profit 18.45
Capitalised value of super profit 18.45×100÷15 i.e. 123.00
Goodwill
Goodwill exists; hence director‟s fear is not valid.
Leverage Effect on Goodwill
Rs in lakhs
Future Maintainable Profit on equity fund 253.64
Future Maintainable Profit on Long-term Trading
Capital employed
Future Maintainable Profit After Tax 253.64
Add: Interest on Long-term Loan (Term Loan)
(After considering Tax) 165× 18% = 29.7 × (100 – 40) 19.602 273.242
÷ 100 = 17.82 Add: 10% Increase of FMP = 1.78
Average capital employed (Equity approach) 1,567.90
Add: 18% Term Loan (180+165)/2 172.50
Average capital employed (Long-term Fund approach) 1,740.40
Value of Goodwill

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 (A) Equity Approach
Capitalised value of Future Maintainable Profit = = 1,690.93
273.242×100÷15
Less: Average capital employed (1,567.90)
Value of Goodwill 123.03
(B) Long-Term Fund Approach
Capitalized value of Future Maintainable Profit = 2277.00
271.46×100÷12
Less: Average capital employed (1,740.40)
Value of Goodwill 536.62
Comments on Leverage effect of Goodwill: Adverse Leverage effect on goodwill is 413.59
lakhs (i.e., Rs 536.62 – 123.03). In other words, Leverage Ratio of Popular Ltd. is low for
which its goodwill value has been reduced when calculated with reference to equity fund as
compared to the value arrived at with reference to long term fund.
Working Notes:
Rs in lakhs
(1) Inventory adjustment
(i) Excess current cost of closing inventory over its 30.00
Historical cost (330 – 300)
(ii) Excess current cost of opening inventory over its 26.00
Historical cost (286-260)
(iii) Difference [(i– ii)] 4.00
(2) Trade Receivables‟ adjustment
(i) Value of foreign exchange Trade Receivables at the 13.65
closing exchange rate ($35,000×39)
ii) Value of foreign exchange Trade Receivables at the 12.25
original exchange rate ($35,000×35)
(iii) Difference [(i) – (ii)] 1.40
(3) Trade Payables‟ adjustment
(i) Value of foreign exchange Trade Payables at the 23.40
closing exchange rate ($ 60,000×39)
(ii) Value of foreign exchange Trade Payables at the 19.80
original exchange rate($60,000×33)
(iii) Difference [(i) – (ii)] 3.60

Q5. Given below the balance sheet of PPX Ltd. as on 31-12-2000.

Balance Sheet
Equity & Liabilities Rs. '000
Shareholders Fund 50,00
Reserve 32,00

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 P & L A/c 3,00
Current Liabilities
Sundry Creditors 8,20
Proposed Dividend 10,00
1,03,20
Assets Rs. in '000
Non-Current Assets
Sundry fixed assets 72,00
Non-trade investments 12,00
Current Assets
Stock 7.80
Debtors 6,20
Cash & Bank 5,20
1,03,20
Other Information:

(1) Profit before tax and other relevant information:

Year PBT (‘000 Rs.) Provision for Gratuity Paid Loss of

Gratuity (‘000 Rs.) Uninsured
Required Stock
96 4200 220 - -
97 3900 230 167 62
98 4400 250 32 -
99 4200 260 142 -
2000 3700 270 12 -

(2) Tax-rate 51%.

(3) Non-trade investment fetched 11%

(4) Expected tax-rate 45%.

(5) The company wants to switch over towards maintaining gratuity provision on actuarial
calculation rather than accounting on payment basis.

(6) Normal rate of return may be taken as 16%.

Find out value of goodwill. It may be assumed that super profit, if any, is maintainable for
5 years. 20% should be the appropriate discount factor.

12 D-FORTUNE CLASSES, 9589260560

Ans.: Goodwill 3105; FMP 2082; CCE 7423; ACE 6517.

Q6.
The Balance Sheet of D Ltd. on 31st March, 2017 is as under:
Liabilities Rs Assets Rs
1,25,000 shares of Rs 1,25,00,000 Goodwill 10,00,000
100 each fully paid up Building 80,00,000
Bank overdraft 46,50,000 Machinery 70,00,000
Trade Payables 52,75,000 Inventory 80,00,000
Provision for taxation 12,75,000 Trade receivables (all 50,00,000
considered good)
Profit and loss account 53,00,000
2,90,00,000 2,90,00,000

In 2000, when the company started its activities the paid up capital was the same. The
Profit/Loss for the last five years is as follows:
2012-2013: Loss (13,75,000), 2013-2014: Profit Rs 24,55,000, 2014-2015: Profit Rs
29,25,000, 2015-2016: Profit Rs 36,25,000, 2016-2017: Profit Rs 42,50,000.
Income-tax rate so far has been 40% and the above profits have been arrived at on the
basis of such tax rate. From 2016-2017, the rate of income-tax should be taken at 45%.
10% dividend in 2013-2014, 2014-2015 and 15% dividend in 2015-2016 and 2016-2017 has
been paid. Market price of this share on 31st March, 2017 is Rs 125. With effect from 1st
April, 2017, the Managing Directors remuneration will be Rs 20,00,000 instead of Rs
15,00,000. The company has secured a contract from which it can earn an additional Rs
10,00,000 per annum for the next five years.
Calculate the value of goodwill at 3 years purchase of super profit. (For calculation of
future maintainable profits weighted average is to be taken).
Answer
(i) Future Maintainable Profit
Year Profit (P) Rs Weight (W) Products (PW) Rs
2013-2014 24,55,000 1 24,55,000
2014-2015 29,25,000 2 58,50,000
2015-2016 36,25,000 3 1,08,75,000
2016-2017 42,50,000 4 1,70,00,000
10 3,61,80,000
Weighted average annual profit (after tax)= 3,61,80,00010/10 = Rs 36,18,000

Weighted average annual profit before tax is 60,30,000

36,18,000×100/60
Less: Increase in Managing Director‟s remuneration (5,00,000)
55,30,000
Add: Contract advantage 10,00,000

13 D-FORTUNE CLASSES, 9589260560

 65,30,000
Less: Tax @ 45% (29,38,500)
Future maintainable profit 35,91,500
(ii) Average Capital Employed
Rs.
Assets
Building 80,00,000
Machinery 70,00,000
Inventory 80,00,000
Trade Receivables 50,00,000
2,80,00,000
Liabilities
Bank Overdraft 46,50,000
Trade Payables 52,75,000
Provision for taxation 12,75,000
Additional provision for taxation** 3,54,167 (1,15,54,167)
Capital employed at the end of the year 1,64,45,833
Less: ½ profit after tax for the year [(42,50,000- (19,47,917)
3,54,167)/2]
Average capital employed 1,44,97,916
 Loss amounting Rs 13,75,000 for the year 2012-2013 has not been considered in calculation of
weighted average profit assuming that the loss was due to abnormal conditions.
 Additional provision for taxation 5% of Rs 70,83,333 (Rs 42,50,000/60%) has also been
created assuming that the necessary rectification is being done in the financial statements for
the year 2016-2017.
(iii) Normal Profit
Average dividend for the last four years
= 12.5 = 10+10+15+15 / 4
Market Price of share =Rs 125
Normal rate of return= 12.5/125×100=10%
Normal profit 10% of Rs 1,44,97,916 Rs 14,49,792
(iv) Valuation of Goodwill
Rs
Future maintainable profit 35,91,500
Less: Normal profit (14,49,792)
Super Profit 21,41,708
Goodwill at 3 years‟ purchase of super profits (Rs 21,41,708 x 3) 64,25,124

Q7. The following is the Balance Sheet (as at 31st December, 2006) of Sun Ltd:
Equity & Liabilities Rs.
Shareholders Fund

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80,000 Equity shares of Rs.10 each fully paid up 800,000
50,000 Equity shares of Rs.10 each Rs.8 paid up 400,000
36,000 Equity shares of Rs.5 each fully paid up 180,000
30,000. Equity shares of Rs.5 each Rs. 4 paid-up 120,000
3,000 10% Preference shares of Rs.100 each fully paid 300,000
General reserve 140,000
Profit and Loss account 210,000
Preliminary Expenses – 10,000
Non-Current Liabilities
Secured Loan: 12% debenture 200,000
Unsecured loan: 15% term loan 150,000
Deposits 100,000
Current Liabilities
Bank Loan 50,000
Creditors 150,000
Outstanding expenses 20,000
Provision for tax 200,000
Proposed Dividend:
Equity 150,000
Preference 30,000
3,190,000
Assets Rs.
Non-Current Assets
Goodwill 1,00,000
Plant and Machinery 8,00,000
Land and Building 10,00,000
Furniture and Fixtures 1,00,000
Vehicles 2,00,000
Investments 3,00,000
Current Assets
Stock 2,10,000
Debtors 1,95,000
Prepaid Expenses 40,000
Advance 45,000
Cash and Bank balance 2,00,000
31,90,000
Additional Information:

15 D-FORTUNE CLASSES, 9589260560

 (1) In 2004 a new machinery costing Rs 50,000 was purchased, but wrongly charged to
revenue (no rectification has yet been made for the same).
(2) Stock is overvalued by Rs 10,000 in 2005. Debtors are to be reduced by Rs 5,000 in
2006, some old furniture (Book value Rs 10,000) was disposed of for Rs 6,000.
(3) Fixed assets are worth 5 percent more than their actual book value. Depreciation
on appreciated value of Fixed assets except machinery is not to be considered for
valuation of goodwill.
(4) Of the investment 20 per cent is trading and the balance is non-trading. All trade
investments are to be valued at 20 per cent below cost. Trade investment was
purchased on 1st January, 2006. 50 percent of the nontrade investments were
acquired on 1st January, 2005 and the rest on 1st January, 2004. A uniform rate of
dividend of 10 percent is earned on all investments.
(5) Expected increase in expenditure without commensurate increase in selling price is
Rs.20,000.
(6) Research and Development expenses anticipated in future Rs.30,000 per annum.
(7) In a similar business a normal return on capital employed is 10%.
(8) Profit (after tax) are as follows:
In 2004 - Rs. 2,10,000, in 2005 – Rs. 1,90,000 and in 2006 - Rs.2,00,000,

(9) Current income tax rate is 50%, expected income tax rate will be 40%.

From the above, ascertain the ex-dividend and cum-dividend intrinsic value for different
categories of Equity shares. For this purpose goodwill may be taken as 3 years purchase of
super profits, Depreciation is charged on machinery @ 10% on reducing system.

(Answer: FMP-202581; Goodwill – 5557; CCE – 2106273; ACE – 2007286; IV (Ex) –

1.23 Per Rupee) (May 2007; 16 Marks)

Q8. The summarized Balance Sheet of M/s Indus Ltd. as on 31.03.2013 is as follows:

Liabilities Amount Assets Amount

Equity Share Capital 10/- each 5,00,000 Goodwill 1,00,000
12% Pref. Shares 10/- each 4,00,000 Land & Building 4,50,000
Equity shares of 10/- each, 7/- 2,80,000 Plant & Machinery 5,45,000
paid Vehicle 3,50,000
Reserves and Surplus 2,20,000 Investment 5,00,000
Secured Loan (12%) 7,50,000 Inventory 4,25,000
Sundry creditors 2,50,000 Debtors 1,00,000

16 D-FORTUNE CLASSES, 9589260560

Provision for Expenses 1,50,000 Cash and Bank Balances
35,000
Prepaid Expenses 45,000
25,50,000 25,50,000
(1) Net profits of the company for the past four years (Before intt and tax) were as
under:
2012-13 5,50,000
2011-12 3,85,000
2010-11 5,25,000
2009-10 4,90,000
(2) The company has purchased a furniture in the year 2011-12 for Rs. 1,20,000 which
was wrongly charged to Revenue A/c. Furniture and fixture are depreciated at 15%
of the WDV.

(3) In the year 2012-13 asset having book value of Rs. 80000 was sold for Rs. 65,000
only.

(4) In the year 2010-11 company paid Rs. 25,000 against failure to comply with the
rules as per the environment pollution control board.

(5) 60% of the Investments are non-trade investments and market value of the trade
investments is 15% below the book value. The investments realize an interest of 8%
p.a. whether trade or not. The Non trade investments were purchase on 01.04.2012.

(6) The company has been paying managerial remuneration of Rs. 1,00,000 p.a. but as
per the companies Act, the amount eligible is Rs. 80,000 only for the past four
years.

(7) The goodwill in the books has been purchased in the year 2009-10.

(8) 60% of the Secured loan was availed from US which was recorded at a rate of $1 =
Rs. 50 where the closing rate was $1= Rs. 55.

(9) The company wishes to revalue Assets on the realizable value as under:
Land & Building 5,50,000
Plant & Machinery 5,00,000
Vehicles 2,50,000
Debtors 80,000
(ignore the change in depreciation due to change in value of Assets)
The rate of Tax on companies is 30% and the rate of return on capital employed is
15% p.a. Calculate Goodwill based on four years purchase of Super Profit. Make
appropriate assumption wherever required. (16 Mark, November 2013)

17 D-FORTUNE CLASSES, 9589260560

(Answer: FMP - 297903; Clo. Cap – 1046700; Avg Cap - 901695; Goodwill – 650596; ½
RPAT- 145005)

Hint: Managerial Remuneration is Rectification of Error and Exchange Difference &

Additional Interest on Ex. Diff assume as Rectification

Solution (as per suggested):

(i) Future Maintainable Profit
2009-10 2010-11 2011-12 2012-13
Rs Rs
Profit before interest and tax 4,90,000 5,25,000 3,85,000 5,50,000
Adjustment for:
1. Furniture purchased wrongly written 1,20,000
off as expenses (working note 1)
2. Depreciation of above furniture (18,000) (15,300)
3: Loss on sale of assets 15,000
4. Extraordinary claim –Penalty paid 25,000
5. Income from Non trade investment (24,000)
6. Managerial remuneration 20,000 20,000 20,000 20,000
7. Interest on loan (90,000) (90,000) (90,000) (90,000)
8. Exchange loss on secured Loans - - - (45,000)
(W.N. 3)
9. Exchange loss on interest of
secured Loans (W.N. 3) (5,400)
Adjusted profit 4,20,000 4,80,000 4,17,000 4,05,300
Average profits before tax Rs 4,30,575
Less: Tax @ 30% Rs 1,29,173
Rs 3,01,402
(ii) Average Capital employed
Rs Rs
Goodwill 1,00,000
Land and building (Revalued) 5,50,000
Furniture & fixture 86,700
Vehicle 2,50,000
Trade investment [2,00,000 (W.N.2) less 15%] 1,70,000
Inventory 4,25,000
Debtors 80,000
Cash and bank balances 35,000
Plant and Machinery 5,00,000
Total assets (A) 45,000
Less outside liabilities 22,41,700
Secured loan [7,50,000+45,000] 7,95,00
Sundry creditors 2,50,000

18 D-FORTUNE CLASSES, 9589260560

 Provision for expenses 1,50,000
Total liabilities (B) 11,95,000
Capital employed at the end of the year [C=A+B] 10,46,700
Less: 50% of profit (after tax) for the year
Rs 4,05,300+Rs 24,000-Rs 1,28,790/2 1,50,255
Average capital employed 8,96,445
(iii) Normal Profit:
Average capital employed Rs 8,96,445
Normal profits 15% of the capital employed] Rs 1,34,467
(iv) Valuation of Goodwill
Particulars Rs
Future maintainable profit 3,01,402
Less: normal profit 1,34,467
Super profit 1,66,935
Goodwill at 4year‟s purchase thereof 6,67,740
Working note:
1. Adjustment for Furniture:
Particulars Rs
Furniture purchased 1,20,000
Less: depreciation for year
2011-12 18,000
2012-13 15,300
86,300
2. Adjustment for non-trade investments:
Rs
Investment 5,00,000
40% trade investment 2,00,000
Non-trade investment 3,00,000
8% interest on the above 24,000
3. Adjustment for exchange loss on Secured loans:
Particulars Rs
Secured loan 7,50,000
60% of above loan is availed from USA 4,50,000
Exchange loss [US$9,000×(Rs 55-Rs 50)] 45,000
Impact of exchange rate on interest on loan
[US$1080×(Rs55-Rs 50)] 5,400
Note:
1. Goodwill given in Balance Sheet of M/s. Indus Ltd. has been considered in calculation of
Capital employed as it is purchased goodwill.
2. Average Capital employed has been taken for the valuation of goodwill.

Q9. (Home Work)

19 D-FORTUNE CLASSES, 9589260560

Balance Sheet of X Ltd.

Equity & Liabilities: Rs. (in lakhs)

Shareholders Fund:
Share Capital 80
Profit & Loss A/c - 20
Non Current Liabilities
13% Debentures 1,20
Current Liabilities
Sundry Creditors 40
2,60
Assets Rs. in lakhs
Non Current Assets
Sundry Fixed Assets 1,80
Current Assets
Stock 40
Debtors 20
Cash & Bank 20
2,60
Calculate Goodwill assuming normal return on shareholder funds 20% and long
terms funds 18%. Future maintainable profits before interest are 38.4 lakhs.
Calculate Leverage effect. (Study Material)
Hint:
Capital employed (Shareholders' fund approach)
Rs 260 lakhs - 160 lakhs outside liabilities = Rs. 100 lakhs.
Capital employed (long term fund approach):
Rs. 260 lakhs - Rs. 40 lakhs Sundry Creditors = Rs. 220 lakhs
Value of goodwill is:

- Rs. 220 lakhs

i.e. Rs. 213.33 lakhs – Rs. 220 lakhs
i.e., Rs. 6.67 lakhs, negative goodwill.
If shareholders' fund approach is followed, value of goodwill as per capitalization
method is:

- Rs. 100 lakhs

20 D-FORTUNE CLASSES, 9589260560

 i.e. Rs. 114 lakhs – Rs. 100 lakhs
i.e. Rs. 14 lakhs, positive goodwill.
Favaourable Leverage 20.67

Q10. Find out Leverage effect on Goodwill from the following information:
(i) Average capital employed (Equity Approach) Rs. 11,50,000
(ii) FMP on equity fund (After Tax) Rs. 1,80,000
(iii) 10% Long Term Loan Rs. 4,50,000
(iv) Tax Rate 40%
(v) Normal Rate of return
On equity capital employed 15%
On Long term capital employed 12%
(May18 & Nov15, 6 Marks)
Solution:

Determination of leverage effect on goodwill

Rs.
A Profit available for equity fund after tax 1,80,000
B Profit (as per long term fund approach)
Profit for equity fund 1,80,000
Add: Interest on long term loan (net of tax
4,50,000×{10%×(1-0.4)] 27,000 2,07,000
C Capital employed (by Equity approach) 11,50,000
D Capital employed as per long term fund approach
Capital employed (by Equity approach) 11,50,000
Add: 10% long term loan 4,50,000 16,00,000
E Value of goodwill
(a) By equity approach
Capitalized value of profit as per equity approach
(1,80,000/15×100) 12,00,000
Less: capital employed as per equity approach (11,50,000)
value of Goodwill 50,000
(b) By long term fund approach
Capitalized value of profit as per long-term fund
approach (2,07,000/12×100) 17,25,000
Less: capital employed as per long term fund
approach 16,00,000
Value of Goodwill 1,25,000
Leverage effect on Goodwill:
Adverse leverage effect on goodwill is Rs 75,000 (i.e. Rs 1,25,000 – Rs 50,000)

21 D-FORTUNE CLASSES, 9589260560

In other words, leverage ratio is low for which its goodwill value has been reduced when
calculated with reference to equity fund as compared to value arrived at with reference to
long term fund.

Q11: The summarised Balance Sheet of Domestic Ltd. as on 31st March, 2017 is as under:

Liabilities (Rs in Assets (Rs in

lakhs) lakhs)
Equity shares of Rs 10 each 3,000 Patent 744
Premises and Land at cost 400
Reserves (including provision for 1,000 Plant and Machinery 3,000
taxation of Rs 300 lakhs)
5% Debentures 2,000 Motor vehicles (purchased on 40
1.10.16)
Secured loans 200 Raw materials at cost 920
Trade Payables 300 Work-in-progress at cost 130
Profit & Loss A/c: Finished goods at cost 180
Balance from previous year 32 Trade Receivables 400
Profit for the year (after 1,100 Investment (meant for 1,600
taxation) replacement of plant and
machinery)
Cash at bank and cash in hand 192
Discount on debentures 10
Underwriting commission 16
7,632 7,632
1. The resale value of premises and land is Rs 1,200 lakhs and that of plant and machinery
is Rs 2,400 lakhs. Patent appearing in the balance sheet is of no use and should be
ignored for the valuation purpose.
2. Depreciation @ 20% is applicable to motor vehicles.
3. Applicable depreciation on premises and land is 2% and that on plant and machinery is
10%.
4. Market value of the investments is Rs 1,500 lakhs.
5. 10% of trade receivables are bad.
6. The company also revealed that the depreciation was not charged to Profit and Loss
account and the provision for taxation already made is sufficient.
7. In a similar company the market value of equity shares of the same denomination is Rs
25 per share and in such company dividend is consistently paid during last 5 years @
25%. Contrary to this, Domestic Ltd. is having a marked upward or downward trend in
the case of dividend payment.
8. In 2011-2012 and in 2012-2013, the normal business was hampered. The profit earned
during 2011-2012 is Rs 67 lakhs, but during 2012-2013 the company incurred a loss of
Rs 1,305 lakhs.

22 D-FORTUNE CLASSES, 9589260560

 Past 3 years' profits of the company were as under:
2013-2014 Rs 469 lakhs
2014-2015 Rs 546 lakhs
2015-2016 Rs 405 lakhs
The unusual negative profitability of the company during 2012-2013 was due to the lock
out in the major manufacturing unit of the company which happened in the beginning of the
second quarter of the year 2011-2012 and continued till the last quarter of 2012-2013.
Value the goodwill of the company on the basis of 4 years‟ purchase of the super profit.
Answer
1. Rectification of current year’s profit i.e. 2016-2017
Profit after Tax = Rs 1,100 lakhs
Provision for taxation = Rs 300 lakhs
Profit before Tax = PAT + Provision for taxation
= Rs 1,100 lakhs + Rs 300 lakhs = Rs 1,400 lakhs
Rate of tax = Provision for tax ×100 = 300÷1400×100 = 21.43% (approx.)
Profit before tax
Rs in lakhs
Profit for the year after tax 1,100
Less: Depreciation net of tax on motor vehicles (Rs 40 lakhs x 20% (3.1428)
x 6/12) x (100-21.43)%
Depreciation net of tax on Premises and Land (Rs 400 lakhs x 2%) x (6.2856)
(100-21.43)%
Depreciation net of tax on Plant and Machinery (Rs 3,000 lakhs x (235.71)
10%) x (100-21.43)%
Provision for doubtful receivables net of tax (Rs 400 lakh x 10%) x (31.428)
(100-21.43)%
Rectified profit of 2016-2017 823.43
2. Calculation of Capital Employed
(Rs in (Rs in
lakhs) lakhs)
Premises and land 1,200
Plant and machinery 2,400
Motor vehicles (book value less depreciation for ½ year) 36
Raw materials 920
Work-in-progress 130
Finished goods 180
Trade Receivables (400 x 90%) 360
Investments (market value) 1,500
Cash at bank and in hand 192
6,918
Less: Liabilities:
Provision for taxation 300

23 D-FORTUNE CLASSES, 9589260560

 5% Debentures 2,000
Secured loans 200
Trade Payables 300 (2,800)
Total capital employed on 31.3.2017 4,118
Less: Half of current year‟s rectified profit (823.43 x 1/2) (411.72)
Average Capital Employed 3,706.28
3. Calculation of Future Maintainable Profits
(Rs in lakhs)
2013-14 2014-15 2015-16 2016-17
Profit after tax 469 546 405 823.43
Less: Depreciation net of tax on (6.29) (6.29) (6.29)
Premises and Land (Rs 400 lakhs x 2%)
x (100-21.43)%
Depreciation net of tax on Plant and (235.71) (235.71) (235.71)
Machinery (Rs 3,000 lakhs x 10%) x
(100-21.43)%
Adjusted Profit 227 304 163 823.43
Average adjusted profit (227+304+163+823.43)/4 379.36
Less: Excess depreciation (net of tax) due to upward revaluation of (12.57)
premises and land [(1,200-400) x 2%] x (100 - 21.43)%
Depreciation on motor vehicle (net of tax) for remaining six months (in (3.14)
future depreciation on motor vehicle will be charged for full year) (Rs
40 lakhs x 20% x 6/12) x (100-21.43)%
Add: Short depreciation (net of tax) due to downward revaluation of 47.14
plant and machinery [(3,000 - 2,400) x 10%] x (100 - 21.43)%
Future Maintainable Profit 410.79
4. Calculation of General Expectation
Similar Company pays Rs 2.5 as dividend (25%) for each share of Rs 10.
Market value of an equity share of the same denomination is Rs 25 which fetches
dividend of 25%.
Therefore, share of Rs 10 (Face value of shares of Domestic Ltd.) is expected to fetch
(2.5/25) x 100 = 10% return.
A nominal rate of 1% or 2% may be added as Risk premium, to the normal rate of
return for uncertainty associated with dividend distribution.
Since, Domestic Ltd. is not having a stable record in payment of dividend, therefore,
the expectation from it may be assumed to be slightly higher, say 11% instead of 10%.
5. Calculation of value of goodwill of Domestic Ltd.
(Rs in lakhs)
Future maintainable profit 410.79
Less: Normal profit i.e. 11% of average capital employed (407.69)
(3,706.28x11%)
Super Profit 3.1

24 D-FORTUNE CLASSES, 9589260560

 Goodwill at 4 years‟ purchase of Super Profit (3.1 × 4) 12.4
Notes:
(1) It is assumed that „Provision for Taxation‟ included in reserves is made in the current
year only.
(2) It is assumed that plant and machinery given in the balance sheet is at cost.
(3) It is assumed that depreciation on „Premises and Land‟ and „Plant and Machinery‟ is
charged on Straight Line method.
(4) It is assumed that resale value of „Premises and Land‟ and „Plant and Machinery‟ given
in the question is for depreciated value of respective assets. Therefore, no
adjustment for depreciation has been made in such assets while calculating capital
employed.
(5) It is assumed that profit for the year 2013-2014, 2014-2015 and 2015-2016 given in
the questions is after tax and no depreciation was charged in the earlier years also.
(6) Average Capital employed has been taken for valuation of goodwill.
(7) While considering past profits for determining average profit, the years 2011-2012
and 2012-2013 have been left out, as during these years normal business was
hampered.

25 D-FORTUNE CLASSES, 9589260560

Important Notes:

26 D-FORTUNE CLASSES, 9589260560

 Valuation of Shares
Methods for Valuation of Shares:

 Intrinsic Value Method

 Total Earning Capitalization Method

 Dividend Capitalization Method

 Fair Value Method

Intrinsic Value Method: (also called Net Asset method, Book value method,

Breakup value method)

It shows the expected return or refund per share if the company is being liquidated.

It is calculated as under:

Closing Capital Employed XXX

(+) Goodwill (as per valuation) Xxx

(+) Non Trade Investment Xxx

(-) Pref. Share Capital (xxx)

(-) Pref. Dividend payable (xxx)

(-) Proposed Dividend on Equity (xxx)

Net Assets for ESH XXX

(+) Uncalled capital/Calls in arrears due Xxx

Total Net Assets available for ESH XXX

÷ No. of Equity Shares or Total ESC xx

Intrinsic Value per share or per Rupee(Ex- XX

Dividend)

Key Points:

- This method is only applicable for Equity Shares.

- If the equity shares are of different face values then we will use Total Equity

Share Capital in rupees instead of No. of Equity Shares.

27 D-FORTUNE CLASSES, 9589260560

 - To Calculate Cum-Dividend value per share, DPS is to be added to the Ex-dividend

value per share.

- Goodwill will be valued if required data is provided in question.

Capitalization Method (Earning and Dividend Capitalization):

Earning Capitalization Method (ECM) is calculated as under

Value per Share = Expected EPS÷Ke

Or Value per Share = Earning Rate ÷ Ke x Paid up Value per Share

Earning Rate means - Earnings available for ESH ÷Equity paid up capital x 100

Ke = NRR

Dividend Capitalization Method (DCM) is calculated as under:

Value per Share = Expected DPS ÷ Ke

Or Value per Share = Dividend Rate ÷ Ke x Paid up Value per Share

Dividend rate can be average of previous years dividend rates.

Key Points:

 ECM is generally used for large lot of shares and DCM is used for Small lot of

Shares.

 For DCM, future expected dividend rate will be given or prior years dividend rate

will be given.

 EAESH is calculated as under:

FMP after Tax XXX

(+) Non Operating Income (net of Tax) XXX

(-) Pref. Dividend XXX

(-) CDT on pref. dividend XXX

 For the calculation of Dividend rate in DCM, sometimes question mentions “transfer

to general reserve” which implies the balance profits as expected dividend to be

distributed and hence this is also the maximum possible dividend rate.

28 D-FORTUNE CLASSES, 9589260560

Normal Rate of Return (NRR):

NRR is to be calculated by any of the following two approaches:

1. CAPM = Rf + (Rm – Rf) β

2. Estimation of NRR – Here the NRR of a company is estimated by considering the

NRR of the industry for the similar class of shares in which the company operates.

It is to be calculated as under:

NRR of the Industry for specific class of

share

+ 0.5% for Poor dividend track record

+ 0.5% for Poor debt equity ratio or Capial

gearing ratio

+ 0.5% for Poor dividend coverage ratio

+ 0.5% for Poor Asset backing ratio

NRR of Company

Important Key Points:

(a) The above 0.5% is the risk premium which the shareholder expects from a company

for taking higher risk and these 0.5% are assumed figures, they might change

according to the quesiton‟s requirement. This may be 1% or 2% etc.

(b) Asset Backing Ratio – calculated for Equity Share valuation only. Higher the better.

Intrinsic Value Per Share ÷ Paid up value per share

(c) Debt Equity Ratio – Lower the Better

Long term debts ÷ Shareholders fund (for PSH)

(d) Capital Gearing Ratio – Lower the Better

(Long term debts + PSC) ÷ ESH Fund (for ESH)

(e) Dividend Coverage Ratio – Higher the better

Profit after Tax ÷ Pref. Dividend (for PSH)

29 D-FORTUNE CLASSES, 9589260560

 EAESH ÷ Eqt. Dividend (for ESH)

Fair Value Method:

This method is used when large quantities of Shares are to be acquired or when the

controlling interest is to be acquired.

Fair value of share = (Intrinsic Value per Share + ECM) ÷ 2

INTRINSIC VALUE METHOD

Q12. The Balance Sheet of Mulyan Ltd. as on 31st December, 2016 is as follows:
Liabilities Rs Rs Assets Rs
Share Capital:
Equity shares of Rs 10 each 5,00,000 4,90,000 Fixed Assets:
less, calls in arrear (Rs 2 10,000 Machinery 2,30,000
for final call) Factory shed 3,00,000
8% Preference shares of 2,00,000 Vehicles 60,000
Rs 10 each fully paid Furniture 25,000
Reserve and Surplus: Investments 1,00,000
General Reserve 1,50,000 Current
Assets:
Profit & Loss A/c 1,40,000 Inventory 2,10,000
Current Liabilities: Trade 3,50,000
Receivables
Trade Payables 2,70,000 Cash at bank 75,000
Bank Loan 1,00,000
13,50,000 13,50,000
Additional Information:
(i) Fixed assets are worth 20% above their actual book value, depreciation on
appreciated portion of fixed assets is to be ignored for valuation of goodwill.
(ii) Of the investments, 80%, is non-trading and the Balance is trading. All trade
investments are to be valued at 20% below cost. A uniform rate of dividend of
10% is earned on all investments.
(iii) For the purpose of valuation of shares, Goodwill is to be considered on the basis
of 6 year‟s purchase of the super profits based on simple average profit of the
last 3 years. Profits after tax @ 50%, are as follows:
Year Rs

30 D-FORTUNE CLASSES, 9589260560

 2014 1,90,000
2015 2,00,000
2016 2,50,000
(iv) In a similar business, return on capital employed is 20%. In 2014, a new
furniture costing Rs 10,000 was purchased but wrongly charged to revenue. No
effect has yet been given for rectifying the same. Depreciation is charged on
furniture @ 10% p.a. (Diminishing Balance Method).
Find out the value of each fully paid and partly paid equity share.
Answer
Valuation of an equity share-
Value of an equity share = Net assets available to equity shareholders (W.N. 6) / Number
of equity shares
= 9,47,746/50,000 = Rs. 18.95492
Value of a Rs 10 fully paid up share = Rs 18.95492 per share
Value of Rs 10 share, Rs 8 per share paid up = (Rs 18.95492 – Rs 2) per share
= Rs. 16.95492 per share
Working Notes:
1. Capital employed
Rs
Fixed Assets:
Machinery 2,30,000
Factory shed 3,00,000
Furniture (Rs 25,000 + Rs 7,290) 32,290
Vehicles 60,000
6,22,290
Add: 20% increase 1,24,458
7,46,748
Trade investments (Rs 1,00,000 × 20% ×80%) 16,000
Inventory in trade 2,10,000
Trade Receivables 3,50,000
Cash at bank 75,000 13,97,748
Less: Outside liabilities:
Bank Loan 1,00,000
Trade Payables 2,70,000 (3,70,000)
Capital employed 10,27,748
2. Calculation of average adjusted profit
2014 Rs 2015 Rs 2016 Rs
Profit after tax 1,90,000 2,00,000 2,50,000
Add: Tax @ 50% 1,90,000 2,00,000 2,50,000
Profit before tax 3,80,000 4,00,000 5,00,000
Add: Capital expenditure on 10,000
furniture

31 D-FORTUNE CLASSES, 9589260560

 Less: Depreciation on furniture∗ (1,000) (900) (810)
Income from non-trade (8,000) (8,000) (8,000)
investments
3,81,000 3,91,100 4,91,190
Less: Tax @ 50% (1,90,500) (1,95,550) (2,45,595)
Adjusted profit 1,90,500 1,95,550 2,45,595

Rs
Total adjusted profit for three years (1,90,500 + 1,95,550 + 6,31,645
2,45,595)
Adjusted Average profit (Rs 6,31,645/3) 2,10,548
3. Normal Profit: 20% on capital employed i.e. 20% on Rs 10,27,748 = Rs 2,05,550

∗ Furniture is assumed to be purchased at the beginning of the year and therefore,

depreciation is charged for the whole year in 2014.

4. Super profit: Average Adjusted profit – Normal profit

= Rs 2,10,548 – Rs 2,05,550 = Rs 4,998
5. Goodwill: 6 years‟ purchase of super profit
= Rs 4,998 × 6 = Rs 29,988
6. Net assets available to equity shareholders
Rs
Capital employed (W.N.1) 10,27,748
Goodwill (W.N.5) 29,998
Add: Non-trade investments 80,000
11,37,746
Less: Preference share capital (2,00,000)
9,37,746
Add: Notional calls received for calls in arrears 10,000
Net assets for equity shareholders 9,47,746

Q13. (Homework)
From the following data, compute the „Net Assets‟ value of each category of equity shares
of Smith Ltd.:
Shareholders’ funds-
10,000 „A‟ Equity shares of Rs 100 each, fully paid
10,000 „B‟ Equity shares of Rs 100 each, Rs 80 paid
10,000 „C‟ Equity shares of Rs 100 each, Rs 50 paid
Retained Earnings Rs 9,00,000
Answer
(i) Computation of Net assets

32 D-FORTUNE CLASSES, 9589260560

Worth of net assets is equal to shareholders‟ fund, i.e.
Rs
Paid up value of „A‟ equity shares 10,000 x Rs 100 10,00,000
Paid up value of „B‟ equity shares 10,000 x Rs 80 8,00,000
Paid up value of „C‟ equity shares 10,000 x Rs 50 5,00,000
Retained earnings 9,00,000
Net assets 32,00,000
(ii) Net asset value of equity share of Rs 100 paid up
Notional calls of Rs 20 and Rs 50 per share on „B‟ and „C‟ equity shares respectively
will make all the 30,000 equity shares fully paid up at Rs 100 each. In that case,
Rs
Net assets 32,00,000
Add: Notional calls (10,000 x Rs 20 + 10,000 x Rs 50) 7,00,000
39,00,000
Value of each equity share of Rs 100 fully paid up = Rs 39,00,000 / 30,000=Rs 130
(iii) Net asset values of each category of equity shares
Value of „A‟ equity shares of Rs 100 fully paid up 130
Value of „B‟ equity shares of Rs 100 each, out of which Rs 80 paid 110
up (130-20)
Value of „C‟ Equity shares of Rs 100 each, out of which Rs 50 paid 80
up (130-50)
Alternatively value of an equity share may also be calculated as follows:
Total paid-up capital Rs.
„A‟ equity shares (10,000 x Rs 100) 10,00,000
„B‟ equity shares (10,000 x Rs 80) 8,00,000
„C‟ equity shares (10,000 x Rs 50) 5,00,000
23,00,000
Retained earnings 9,00,000
Net assets value of all shares 32,00,000
Value per rupee of paid up capital == Net assets value of all 32,00,000
sharesPaid up capital 23,00,000
= Rs 1.391
Therefore,
Net assets value of Rs 100 paid up share Rs 1.391 x 100 Rs 139.10
Net assets value of Rs 80 paid up share Rs 1.391 x 80 Rs 111.28
Net assets value of Rs 50 paid up share Rs 1.391 x 50 Rs 69.55

Q14. The following is the summarized Balance Sheet of N Ltd. as on 31st March, 2017:
Balance Sheet
Liabilities Rs Assets Rs
4,00,000 Equity shares of Rs 10 40,00,000 Building 24,00,000

33 D-FORTUNE CLASSES, 9589260560

 each fully paid
13.5% Redeemable preference 20,00,000 Machinery 22,00,000
shares of Rs 100 each fully paid Furniture 10,00,000
General Reserve 10,00,000 Vehicles 18,00,000
Profit and Loss Account 3,20,000 Investments 16,00,000
Bank Loan (Secured against fixed 12,00,000 Inventory 11,00,000
assets)
Trade Payables 37,00,000 Trade 18,00,000
Receivables
Bank Balance 3,20,000
1,22,20,000 1,22,20,000
Further information:
(i) Return on capital employed is 20% in similar businesses.
(ii) Fixed assets are worth 30% more than book value. Inventory is overvalued by Rs
1,00,000, Trade Receivables are to be reduced by Rs 20,000. Trade investments,
which constitute 10% of the total investment are to be valued at 10% below cost.
(iii) Trade investments were purchased on 1.4.2016. 50% of Non-Trade Investments
were purchased on 1.4.2014 and the rest on 1.4.2015. Non-Trade Investments
yielded 15% return on cost.
(iv) In 2014-2015 new machinery costing Rs 2,00,000 was purchased, but wrongly
charged to revenue. This amount should be adjusted taking depreciation at 10% on
reducing value method.
(v) In 2015-2016 furniture with a book value of Rs 1,00,000 was sold for Rs 60,000.
(vi) For calculating goodwill two years purchase of super profits based on simple
average profits of last four years are to be considered. Profits of last four years
are as under:
2013-2014 Rs 16,00,000, 2014-2015 Rs 18,00,000, 2015-2016 Rs 21,00,000, 2016-
2017 Rs 22,00,000.
(vii) Additional depreciation provision at the rate of 10% on the additional value of Plant
and Machinery alone may be considered for arriving at average profit.
Find out the intrinsic value of the equity share. Income-tax and Dividend tax are not to be
considered.
Answer
Calculation of intrinsic value of equity shares of N Ltd.
1. Calculation of Goodwill
(i) Capital employed
Fixed Assets Rs Rs
Building 24,00,000
Machinery (Rs 22,00,000 + Rs 1,45,800) 23,45,800
Furniture 10,00,000
Vehicles 18,00,000
75,45,800

34 D-FORTUNE CLASSES, 9589260560

 Add: 30% increase 22,63,740
98,09,540
Trade investments (Rs 16,00,000 × 10% × 90%) 1,44,000
Trade Receivables (Rs 18,00,000 – Rs 20,000) 17,80,000
Inventory (Rs 11,00,000 – Rs 1,00,000) 10,00,000
Bank balance 3,20,000 1,30,53,540
Less: Outside liabilities
Bank Loan 12,00,000
Trade Payables 37,00,000 (49,00,000)
Capital employed 81,53,540
(ii) Future maintainable profit
Calculation of average profit
2013-2014 2014-2015 2015-2016 2016-2017
Rs Rs Rs Rs
Profit given 16,00,000 18,00,000 21,00,000 22,00,000
Add: Capital expenditure 2,00,000
of machinery charged to
revenue
Loss on sale of furniture _______ ________ 40,000 ________
16,00,000 20,00,000 21,40,000 22,00,000
Less: Depreciation on (20,000) (18,000) (16,200)
machinery
Income from non-trade (1,08,000) (2,16,000) (2,16,000)
investments
Reduction in value of (1,00,000)
inventory
Bad debts ________ ________ ________ (20,000)
Adjusted profit 16,00,000 18,72,000 19,06,000 18,47,800
(Rs.)
Total adjusted profit for four years (2013-2014 to 2016-2017) 72,25,800
Average profit (Rs 72,25,800/4) 18,06,450
Less: Depreciation at 10% on additional value of machinery (70,374)
(22,00,000 + 1,45,800) × 30/100 i.e. Rs 7,03,740
Adjusted average profit 17,36,076
(iii) Normal Profit: 20% on capital employed i.e. 20% on Rs 81,53,540 = Rs 16,30,708
(iv) Super profit: Expected profit – normal profit
Rs 17,36,076 - Rs 16,30,708 = Rs 1,05,368
(v) Goodwill: 2 years‟ purchase of super profit
Rs 1,05,368 × 2 = Rs. 2,10,736
2. Net assets available to equity shareholders
Rs
Goodwill as calculated in 1(v) above 2,10,736

35 D-FORTUNE CLASSES, 9589260560

 Sundry fixed assets 98,09,540
Trade and Non-trade investments 15,84,000
Trade Receivables 17,80,000
Inventory 10,00,000
Bank balance 3,20,000

1,47,04,276
Less: Outside liabilities
Bank loan 12,00,000
Trade Payables 37,00,000
(49,00,000)
Preference share capital (20,00,000)
Net assets for equity shareholders 78,04,276
3. Valuation of equity shares
Value of equity share = Net assets available to equity shareholders / Number of equity
shares
= Rs 78,04,276 / 4,00,000 = Rs 19.51
Note:
1. Depreciation on the overall increased value of assets (worth 30% more than book value)
has not been considered. Depreciation on the additional value of only plant and
machinery has been considered taking depreciation at 10% on reducing value method
while calculating average adjusted profit.
2. Loss on sale of furniture has been taken as non-recurring or extraordinary item.
3. It has been assumed that preference dividend has been paid till date.

Q15.
The directors of a public limited company are considering the acquisition of the entire
share capital of an existing company X Ltd engaged in a line of business suited to them.
The directors feel that acquisition of X will not create any further risk to their business
interest.
The following is the summarized Balance Sheet of X Ltd., as at 31st December, 2016:
Liabilities Rs Assets Rs
Share Capital: Fixed assets 6,00,000
4,000 equity shares of Rs 100 4,00,000 Current assets: 2,00,000
each fully paid-up Inventory
General reserve 3,00,000 Trade Receivables 3,40,000
Bank overdraft 2,40,000 Cash and bank 1,00,000
balances
Trade Payables 3,00,000
12,40,000 12,40,000
X‟s financial records for the past five years were as under:
2016 Rs 2015 Rs 2014 Rs 2013 Rs 2012 Rs

36 D-FORTUNE CLASSES, 9589260560

 Profits 80,000 74,000 70,000 60,000 62,000
Extra-ordinary item(s) 3,500 4,000 (6,000) (8,000) (1,000)
83,500 78,000 64,000 52,000 61,000
Less: Dividends 48,000 40,000 40,000 32,000 32,000
35,500 38,000 24,000 20,000 29,000
Additional information:
(i) There were no changes in the issued capital of X during this period.
(ii) The estimated values of X Ltd.‟s assets on 31.12.2016 are:
Replacement cost Rs Realizable value Rs

Fixed assets 8,00,000 5,40,000

Inventory 3,00,000 3,20,000
(iii) It is anticipated that 1% of the Trade Receivables may prove to be difficult to be
realized.
(iv) The cost of capital to the acquiring company is 10%.
(v) The current return of an investment of the acquiring company is 10%. Quoted
companies with similar businesses and activities as X have a P/E ratio approximating
to 8, although these companies tend to be larger than X.
Required:
Estimate the value of the total equity capital of X Ltd., on 31.12.2016 using each of the
following bases:
(a) Balance sheet value
(b) Replacement cost
(c) Realizable value
(d) P/E ratio model.
Answer
Rs.
(a) Balance Sheet Value
Capital 4,00,000
Reserve 3,00,000 7,00,000
(b) Replacement cost value
Capital 4,00,000
Reserve 3,00,000
Appreciation:
Fixed assets 2,00,000
Inventory 1,00,000 3,00,000 10,00,000
(c) Realizable value
Capital 4,00,000
Reserve 3,00,000
Appreciation in inventory 1,20,000
Depreciation in fixed assets (60,000)
Book debts (Bad)∗ (3,400) 7,56,600

37 D-FORTUNE CLASSES, 9589260560

(e) P/E ratio model: Comparable quoted companies have a P/E ratio of 8. X Ltd. is prima
facie small company.

∗ it has been assumed that estimated bad debts would not be relevant for estimating
values under bases (a) and (b).

If a P/E ratio of 6 is adopted, the valuation will be 80,000 x 6 = Rs 4,80,000

If a P/E ratio of 7 were to be adopted, the valuation will be 80,000 x 7 = Rs 5,60,000

Valuation of Shares: Yield Basis

Q16. (Homework)
Capital structure of Lot Ltd. as at 31.3.2017 as under:
(Rs in lakhs)
Equity share capital 10
10% preference share capital 5
15% debentures 8
Reserves 4
Lot Ltd. earns profits of Rs 5 lakhs annually on an average before deduction of interest on
debentures and income tax which works out to 40%.
Normal return on equity shares of companies similarly placed is 12% provided:
(a) Profit after tax covers fixed interest and fixed dividends at least 3 times.
(b) Capital gearing ratio is .75.
(c) Yield on share is calculated at 50% of profits distributed and at 5% on undistributed
profits.
Lot Ltd. has been regularly paying equity dividend of 10%.
Compute the value per equity share of the company considering the paid up value of ` 100
per share.

[Answer: Profit for calculation of interest and fixed dividend coverage Rs

3,48,000; Calculation of interest and fixed dividend coverage:
3,48,000/1,70,000=2.05 times; Capital gearing ratio:
13,00,000/14,00,000=0.93 (approximately ); yield on equity shares:
53,900×100/10,00,000=5.93%; Expceted yield of equity shares: 13.00;
5.39×Rs100/13.00=Rs41.46]

Ans.: Earning 53900, earning rate 5.39% NRR 13% Value of Share 4.15 paid up
value assumed Rs.10.

Q17. The Capital Structure of XYZ Ltd., on 31st March, 2017 was as follows:
Rs.
Equity Capital – 18,000 Shares of Rs 100 each 18,00,000

38 D-FORTUNE CLASSES, 9589260560

 12% Preference Capital – 5,000 Shares of Rs 100 each 5,00,000
12% Secured Debentures 5,00,000
Reserves 5,00,000
Profit earned before Interest and Taxes during the year 7,20,000
Tax Rate 40%
Generally the return on equity shares of this type of Industry is 15%.
Subject to:
(a) The profit after tax covers Fixed Interest and Fixed Dividends at least 4 times.
(b) The Debt Equity ratio shall be at least 2;
(c) Yield on shares is calculated at 60% of distributed profits and 10% of undistributed
profits;
(d) The Company has been paying regularly an Equity dividend of 15%.
(e) The risk premium for Dividends is generally assumed at 1%.
Find out the value of Equity shares of the Company.
Answer
Calculation of profit after tax (PAT) Rs Rs
Profit before interest & tax (PBIT) 7,20,000
Less: Debenture interest (Rs 5,00,000 × 12/100) (60,000)
Profit before tax (PBT) 6,60,000
Less: Tax @ 40% (2,64,000)
Profit after tax (PAT) 3,96,000
Less: Preference dividend (Rs 5,00,000 × 12 / 100) 60,000
Equity dividend (Rs 18,00,000 × 15 / 100) 2,70,000 (3,30,000)
Retained earnings (undistributed profit) 66,000
Calculation of Interest and Fixed Dividend Coverage
=PAT + Debenture interest / Debenture interest + Preference dividend
Rs 3,96,000 + Rs 60,000 / Rs 60,000 + Rs 60,000 = Rs 4,56,000 / Rs 1,20,000 = 3.8 times
Calculation of Debt Equity Ratio
Debt Equity Ratio = Debt (long term loans) / Equity (shareholders' funds)
Debentures / Preference share capital + Equity share capital + Reserves
5,00,000 / 5,00,000 + 18,00,000 + 5,00,000
Debt Equity Ratio = Rs 5,00,000 / Rs 28,00,000 = .179
The ratio is less than the prescribed ratio.
Calculation of Yield on Equity Shares
Yield on equity shares is calculated at 60% of distributed profits and 10% of undistributed
profits:
60% of distributed profits (60% of Rs 2,70,000) 1,62,000
10% of undistributed profits (10% of Rs 66,000) 6,600
1,68,600
Yields on equity shares = Yield on shares × 100 / Equity share capital
Rs 1,68,600 × 100 / Rs 18,00,000 = 9.37%
Calculation of Expected Yield on Equity Shares

39 D-FORTUNE CLASSES, 9589260560

 Normal return expected 15%
Add: Risk premium for low interest and fixed dividend coverage 1%*
(3.8 < 4)
Risk for debt equity ratio not required Nil**
16%
Value of an Equity Share = Actual yield × Paid up value of a share /
Expected yield = 9.37 × 100 / 16 = 58.56
* When interest and fixed dividend coverage is lower than the prescribed norm, the
riskiness of equity investors is high. They should claim additional risk premium over and
above the normal rate of return.
** The debt equity ratio is lower than the prescribed ratio that means outside funds
(Debts) are lower as compared to shareholders‟ funds. Therefore, the risk is less for
equity shareholders. Therefore, no risk premium is required to be added in this case.
Ans.: Earning Rate 9.37%, Earning 168600, Value of equity share 58.56 NRR 16%
(without considering advantages)

Q18.(Homework)

The capital structure of M/s Global Ltd. on 31st March, 2015 was as follows:

Equity share capital (25000 shares of Rs. 100 each) Rs. 25,00,000
12% Preference Share capital (7000 shares of Rs. 100 each) Rs. 7,00,000
12% Secured Debentures Rs. 7,00,000
Reserves Rs. 5,00,000
PBIT during the year was Rs. 9,90,000
Tax Rate was 40%
Additional Information:

(1) The profit after tax covers fixed interest and fixed dividend at least 4 times.
(2) The debt equity ratio is at least 2.
(3) The rate of return on equity shares of this type of industry is 15%.
(4) Yield on shares is calculated at 60% of distributed profit and 10% of undistributed
profits.
(5) The company has been paying regularly an Equity dividend of 15%
(6) The risk premium for dividends is generally assumed at 2%.

You are required to find out value of Equity Shares of the Company.

(May 2016 - 8 Marks)

Solution:

40 D-FORTUNE CLASSES, 9589260560

(a) Calculation of profit after tax (PAT)
Rs Rs
Profit before interest & tax (PBIT) 9,90,000
Less: Debenture interest (Rs 7,00,000 × 12/100) (84,000)
Profit before tax (PBT) 9,06,000
Less: Tax @ 40% (3,62,400)
Profit after tax (PAT) 5,43,600
Less: Preference dividend (Rs 7,00,000 × 12 / 100) 84,000
Equity dividend (Rs 25,00,00 × 15 / 100) 3,75,000 (4,59,000)
Retained earnings (undistributed profit) 84,600
Calculation of Interest and Fixed Dividend Coverage
= PAT + Debenture interest / Debenture interest + Preference dividend
= 5,43,600 + 84,000 / 84,000 + 84,000 = 6,27,600 / 1,68,000 = 3.74 times
Note: In the above equation, coverage ratio is calculated by taking into account profit
before interest but after tax.

Calculation of Debt Equity Ratio

Debt Equity Ratio = Debt (Long term loans) / Equity (Shareholder‟s funds)
= Debentures / Preference share capital + Equity share capital + Reserves
= 7,00,000 / 7,00,000 + 25,00,000 + 5,00,000
Debt Equity Ratio = 7,00,000 / 37,00,000 = 0.189
The ratio is less than the prescribed ratio.

Calculation of Yield on Equity Shares

Yield on equity shares is calculated at 60% of distributed profits and 10% of undistributed
profits:
60% of distributed profits (60% of Rs 3,75,000) 2,25,000
10% of undistributed profits (10% of Rs 84,600) 8,460
2,33,460
Yields on equity shares =Yield on shares / Equity share capital × 100
=2,33,460 / 25,00,000 = 9.34%
Calculation of Expected Yield on Equity Shares
Normal rate of return expected 15%
Add: Risk premium for low interest and fixed dividend coverage 2%*
(3.74< 4)
Risk for debt equity ratio not required Nil**
17%
Value of an equity share = Actual yield × Paid up value of a share /
Expected yield = 9.34 / 17 x 100 = 54.94 per share
* When interest and fixed dividend coverage is lower than the prescribed norm, the
riskiness of equity investors is high. They should claim additional risk premium over and
above the normal rate of return.

41 D-FORTUNE CLASSES, 9589260560

** The debt equity ratio is lower than the prescribed ratio that means outside funds

(Debts) are lower as compared to shareholders‟ funds. Therefore, the risk is less for

equity shareholders. Therefore, no risk premium is required to be added in this case.

Q19. Following information is given of the two companies for the year ended 31st March,
2017:
Particulars Company A Rs in Company B Rs in
lakhs lakhs
Equity shares of Rs 100 each 12.00 15.00
10% Preference shares of Rs 100 each 9.00 6.00
Profit after tax 4.50 4.50
Assuming market expectation is 15% and 80% of the profits are distributed, what would
you pay for the equity shares of the company, if
(i) You are buying in a small lot?
(ii) You are buying controlling interest in the company?
Answer
(i) Buying a small lot of equity shares: If the purpose of valuation is to provide data
base to aid a decision of buying a small lot (non-controlling position) of the company,
dividend capitalization method is most appropriate. Under this method, value of an
equity share will be:
Dividend per share/Market capitalization rate × 100
Company A: (24/15) × 100 = Rs 160 per eq. share
Company B: (20.80/15) × 100 = Rs 138.67 per eq. share
(ii) Buying controlling interest in the company: If the purpose of valuation is to
provide data base to aid a decision of buying controlling interest in the company,
EPS method is most appropriate. Under this method, value of an equity share will
be:-
Earnings per share/Market capitalization rate x 100
Company A: (30/15) x 100 = Rs 200 per eq. share
Company B: (26/15) x 100 = Rs 173.33 per eq. share
Working Note:
Calculation of dividend
Company A Rs in Company B Rs in
lakhs lakhs
Profit after tax 4.50 4.50
Less: Preference dividend 0.90 0.60
3.60 3.90
No. of shares 12,000 15,000
Earnings for equity share holders 30.00 26.00
Dividend (80%) 24.00 20.80

42 D-FORTUNE CLASSES, 9589260560

Q20. From the following information, calculate the value of a share if you want to
(i) buy a small lot of shares;
(ii) buy a controlling interest in the company.
Year Profit Capital Employed Dividend
(Rs) (Rs) %
2013 55,00,000 3,43,75,000 12
2014 1,60,00,000 8,00,00,000 15
2015 2,20,00,000 10,00,00,000 18
2016 2,50,00,000 10,00,00,000 20
The market expectation is 12%.
Answer
(i) Buying a small lot of shares: If the purpose of valuation is to provide data base
to aid a decision of buying a small (non-controlling) position of the equity of a
company, dividend yield method is most appropriate. Dividend rate is rising
continuously, weighted average will be more appropriate for calculation of average
dividend
Year Rate of dividend Weight Product
2013 12 1 12
2014 15 2 30
2015 18 3 54
2016 20 4 80
10 176
Average dividend = 176 ÷ 10 = 17.6%
Value of share on the basis of dividend for buying a small lot of shares will be
Average dividend rate × 100 / Market expectation rate = 17.6×100/12 = Rs 146.67 per
share.
(ii) Buying a controlling interest in the company: If the purpose of valuation is to
provide data base to aid a decision of buying controlling interest in the company,
total profit will be relevant to determine the value of shares as the shareholders
have capacity to influence the decision of distribution of profit. As the profit is
rising, weighted average will be more appropriate for calculation of average
profit/yield.
Year Yield % Weight Product
(Profit/Capital employed) x 100
2013 16 1 16
2014 20 2 40
2015 22 3 66
2016 25 4 100
10 222
Average yield = 22.2% = 22210
If controlling interest in the company is being taken over, then the value per share will be
= Average yield rate ×100 / Market expectation rate = 22.2 × 100 ÷ 12 = Rs 185 per share.

43 D-FORTUNE CLASSES, 9589260560

Q21. The following abridged Balance Sheet as at 31st March, 2017 pertains to Glorious
Ltd.
Liabilities Rs in lakhs Assets Rs in lakhs
Share Capital: Goodwill, at cost 420
180 lakhs Equity shares of 1,800 Other Fixed Assets 11,166
Rs 10 each, fully paid up Current Assets 2,910
90 lakhs Equity shares of Rs 720 Loans and Advances 933
10 each, Rs 8 paid up
150 lakh Equity shares of Rs 750
5 each, fully paid-up
Reserves and Surplus 5,457
Secured Loans 4,500
Current Liabilities 1,242
Provisions 960 ______
15,429 15,429
You are required to calculate the following for each one of the three categories of equity
shares appearing in the above mentioned Balance Sheet:
(i) Intrinsic value on the basis of book values of Assets and Liabilities including
goodwill;
(ii) Value per share on the basis of dividend yield.
Normal rate of dividend in the concerned industry is 15%, whereas Glorious Ltd. has
been paying 20% dividend for the last four years and is expected to maintain it in
the next few years; and
(iii) Value per share on the basis of EPS.
For the year ended 31st March, 2017 the company has earned Rs 1,371 lakhs as profit
after tax, which can be considered to be normal for the company. Average EPS for a fully
paid share of Rs 10 of a Company in the same industry is Rs 2.
Answer
(i) Intrinsic value on the basis of book values
Rs in lakhs Rs in lakhs
Goodwill 420
Other Fixed Assets 11,166
Current Assets 2,910
Loans and Advances 933
15,429
Less: Secured loans 4,500
Current liabilities 1,242
Provisions 960 (6,702)
8,727
Add: Notional call on 90 lakhs equity shares @ 180
Rs 2 per share
8,907

44 D-FORTUNE CLASSES, 9589260560

Equivalent number of equity shares of Rs 10 each.
No. of Equity shares
Fully paid shares of Rs 10 each 180
Partly-paid shares after notional call 90
Fully paid shares of Rs 5 each, [150 lakhs × 5 /10] 75
345
Value per equivalent share of Rs 10 each = Rs 8,907 lakhs /345 lakhs = Rs25.82
Hence, intrinsic values of each equity share are as follows:
Value of fully paid share of Rs 10 = Rs 25.82 per equity share.
Value of share of Rs 10, Rs 8 paid-up = Rs 25.82 – Rs 2 = Rs 23.82 per equity share.
Value of fully paid share of Rs 5 = 25.82 / 2 = Rs 12.91 per equity share.
(ii) Valuation on dividend yield basis:
Value of fully paid share of Rs 10 = 20 × 10 / 15 = Rs 13.33
Value of share of Rs 10, Rs 8 paid-up = 20 × 8 / 15 = Rs 10.67
Value of fully paid share of Rs 5 = 20 × 5 /15 = Rs 6.67
(iii) Valuation on the basis of EPS:
Profit after tax = Rs 1,371 lakhs
Total share capital = Rs (1,800 + 720 + 750) lakhs = Rs 3,270 lakhs
Earning per rupee of share capital = 1,371 lakhs / 3,270 lakhs = Rs 0.419
Earnings per fully paid share of Rs 10 = Rs 0.419 × 10 = Rs 4.19
Earnings per share of Rs 10 each, Rs 8 paid-up = Rs 0.419 × 8 = Rs 3.35
Earnings per share of Rs 5, fully paid-up = Rs 0.419 × 5 = Rs 2.10
Value of fully paid share of Rs 10 = 4.19 × 10 / 2 = Rs 20.95
Value of share of Rs 10, Rs 8 paid-up = 3.35 × 10 / 2 = Rs 16.75
Value of fully paid share of Rs 5 = 2.10 × 10 / 2 = Rs 10.50

Q22. Yogesh Ltd. showed the following performance over 5 years ended 31st March, 2015:

Year Ended on *Net Profit before Prior Period Remarks

31st March Tax adjustment

2011 4,00,000 (-) 1,00,000 Relating to 2009-10

2012 3,50,000 (-) 2,50,000 Relating equally to 09-10

and 10-11

2013 6,50,000 (+) 1,50,000 Relating to 11-12

2014 5,50,000 (-) 1,75,000 Relating to 11-12

2015 6,00,000 (-) 1,00,000 Relating to 11-12

2015 (+) 25,000 Relating to 13-14

45 D-FORTUNE CLASSES, 9589260560

*Net Profit before tax is after debiting or crediting the figures of loss (-) or gains (+)

mentioned under columns for prior period adjustments.

The net worth of the business as per balance sheet of 31st march, 2010 is Rs. 6,00,000

backed by 10,000 fully paid equity shares of Rs. 10 each. Reserves and surplus constitute

the balance net worth. Yogesh Ltd. has not declared any dividend till date.

You are asked to value Equity Shares on :

(a) Yield basis as on 31.03.2015, assuming:

(i) 40% Tax Rate

(ii) Anticipated after tax yield of 20%

(iii) Differential weight of 1 to 5 given for 5 years starting on 1.04.2010 for the

actual profits of the respective years.

(b) Net Asset basis as per corrected balance sheets for each of the Six years ended

31.03.2015

Looking to the performance of the company over 5 years period, would you invest in the

company? (RTP – May 2015)

(Answer: 184/- on yield basis and (46.50, 69, 97.5, 127.5, 172.5 and 213 on net

asset basis)

Solution:

(a) Valuation of Shares on Yield basisas on 31st March, 2015

Year Profits Adjustment Revised Tax After weight Weighted
ended as Increas decrease Profits Provision tax Profits
st
31 given e Profits
March
Rs Rs Rs Rs Rs Rs
2011 4,00,000 1,00,000 1,25,000 3,75,000 1,50,000 2,25,000 1 2,25,000
2012 3,50,000 2,50,000 1,00,000 4,75,000 1,90,000 2,85,000 2 5,70,000
1,50,000 ,1,75,000 .
2013 6,50,000 Nil 1,50,000 5,00,000 2,00,000 3,00,000 3 9,00,000
2014 5,00,000 1,75,000 Nil 7,50,000 3,00,000 4,50,000 4 18,00,000
25,000
2015 6,00,000 1,00,000 25,000 6,75,000 2,70,000 4,05,000 5 20,25,000
15 55,20,000
Weighted average profit (after tax) = Rs 55,20,000 / 15 = Rs 3,68,000
Value of business =Rs 3,68,000 / 20% = 18,40,000
Value of equity share =Rs 18,40,000 / 10,000 = Rs 184

46 D-FORTUNE CLASSES, 9589260560

(b) Valuation of Shares on Net Asset Basis
(i) Revised net worth as on 31st March, 2010 Rs Rs
Net worth 6,00,000
Less: Adjustments relating to
2010-11 1,00,000
2011-12 1,25,000
2,25,000
Less: Relief from tax @ 40% (90,000) (1,35,000)
4,65,000
(ii) Net asset value (No. of shares = 10,000)
As on 31st March Rs
2010: Revised net worth 4,65,000
Value per share 46.50
2011: Revised net worth as on 31.3.2010 4,65,000
Add: After tax revised profits of 2010-11 2,25,000
Net worth as on 31.3.2011 6,90,000
Value per share 69.00
2012: Revised net worth as on 31.3.2011 6,90,000
Add: After tax revised profits of 2011-12 2,85,000
Net worth as on 31.3.2012 9,75,000
Value per share 97.50
2013: Revised net worth as on 31.3.2012 9,75,000
Add: After tax revised profits of 2012-13 3,00,000
Net worth as on 31.3.2013 12,75,000
Value per share 127.50
2014: Revised net worth as on 31.3.2013 12,75,000
Add: After tax revised profits of 2013-14 4,50,000
Net worth as on 31.3.2014 Value per share 172.50
2015: Revised net worth as on 31.3.2014 17,25,000
Add: After tax revised profits of 2014-15 4,05,000
Net worth as on 31.3.2015 21,30,000
Value per share 213.00
Performance Appraisal
Revised net Profit during the Return on
worth as on year ended 31st net Worth
31st March March
Rs Rs %
2010 4,65,000 2011 2,25,000 48.39
2011 6,90,000 2012 2,85,000 41.30
2012 9,75,000 2013 3,00,000 30.77
2013 12,75,000 2014 4,50,000 35.29
2014 17,25,000 2015 4,05,000 23.48

47 D-FORTUNE CLASSES, 9589260560

The company‟s return has fallen from 48.39% to 23.48%. This may be perhaps due to the
fact that the company has been ploughing back its profits without having adequate
reinvestment opportunities. Unless the company has profitable investment opportunities, it
may not be advisable to invest in the company.

Note: Return on net worth may also be calculated on the basis of average net worth
during the relevant year.

VALUATION OF SHARES: FAIR VALUE

Q23. A Company Q is willing to sell its business. The purchaser has sought professional
advice for the valuation of the goodwill of the company. He has the last audited financial
statements together with some additional information. Help him to ascertain the correct
price for the purpose of purchase:
The extract of the Balance Sheet as on 31-3-2016 is as under:
Liabilities Rs Assets Rs
Equity Share Capital 9,50,000 Land & Building 5,45,000
(shares of Rs 100 each)
8% Preference Share 2,25,000 Plant & Machinery 4,55,000
Capital (shares of Rs 100 Investments in 4,85,000
each) shares
Inventories 3,80,000
Reserves & Surplus 7,50,500 Trade Receivables 4,25,620
(net)
9% Debentures 5,60,000 Cash & Bank balance 5,20,520
Current Liabilities 3,25,640
28,11,140 28,11,140
(1) The purchaser wants to acquire all the equity shares of the company.
(2) The Debentures will be redeemed at a discount of 25% of the value in Balance Sheet
and investments in share will be sold at their present market value which is quoted as
Rs 4,95,200. The above will be prior to the purchase of the equity shares.
For the purpose of pricing of Goodwill:
(3) The normal rate of return on net assets for equity shares is 10%.
(4) Profits for the past three years after debenture interest but before Preference
Share Dividend have been as under:
31-3-2016 Rs 2,95,000
31-3-2015 Rs 4,99,000
31-3-2014 Rs 3,25,000
(5) Goodwill is valued at three years purchase of the adjusted average super profit.
(6) In the year 2015, 20% of the profit mentioned above was due to non-recurring
transaction resulting in increase of profit.

48 D-FORTUNE CLASSES, 9589260560

(7) The Land & Building has a current rental value of Rs 62,400 and 8% return is expected
from the property.
(8) On 31-3-2016, 8% of debtors existing on the date had been written as bad and
charged to Profit and Loss Account as Provision for Bad debts. The same are now
recoverable. Tax is applicable at 35%.
(9) A claim of compensation long contingent of Rs 25,000 has perspired and is to be
accounted for.
(10) No Debenture interest shall be payable in future due to its redemption.
Answer
Valuation of goodwill: Super profits method
Particulars Rs Rs
Net trading assets attributable to equity share
holders
As computing in (WN 1) 23,18,506
Less: Preference share Capital (2,25,000) 20,93,506
Normal Rate of Return (NRR) to equity share holders 10%
Normal Profit available to equity share holders (a × b) 2,09,351
Future Maintainable Profits (FMP) to equity share
holders
As computed in (WN 3) 3,75,096
Less: Preference dividend* (8% of 2,25,000) (18,000) 3,57,096
Super profits to equity share holders 1,47,745
Goodwill (1,47,745 x 3) 4,43,235
*Since, NRR is given as percentage of net assets attributable to equity shareholders,
preference share capital and preference share dividend have been deducted from the net
assets and future maintainable profit respectively.
Value Per Equity Share
Net Trading Assets attributable to equity shareholders Rs 20,93,506
Add: Goodwill Rs 4,43,235
Rs 25,36,741
Number of Equity Shares = 9,500 shares,
Value per share =25,36,741/9,500= Rs 267 (approx.)
Working Notes:
1. Computation of net trading assets
Particulars Rs Rs
Sundry assets
i Land & Building (62,400 ÷ 8%) 7,80,000
ii Plant and Machinery 4,55,000
iii Inventory 3,80,000
iv Trade receivables (4,25,620 ÷ 92%) 4,62,630
v Bank balance (given balance 5,20,520 + Sale of
investment 4,95,200 - redemption of debentures 5,95,720 26,73,350

49 D-FORTUNE CLASSES, 9589260560

 5,60,000 × 75%)
Less: Outside liabilities:
i Current Liabilities 3,25,640
ii Contingent Liability now to be accounted for 25,000
iii Tax provision (WN 2) 4,204 (3,54,844)
Net assets 23,18,506
2. Calculation of tax provision
Rs
Profit on reversal of provision for bad debts 37,010
Loss on recognizing omitted claim (assuming tax deductible) (25,000)
Net incremental profit on which tax is payable 12,010
Tax provision 35% 4,204
3. Computation of future maintainable profit for the year ended on 31st March
Particulars 2014 2015 2016
Profit after tax 3,25,000 4,99,000 2,95,000
Less: Non-recurring profits (after - (99,800) -
tax) (20% of 2015 Profit)
Less: Claims not recorded (after tax) - - (16,250)
[25,000 x (1-35%)]
Add: Provision no longer required (net - - 24,057
of tax) [4,25,620 × 8/92 × (1-35%)]
Adjusted profits after tax 3,25,000 3,99,200 3,02,807

Simple average of the profits (as profits are fluctuating) 3,42,336

Adjustments for items which will not be reflected in future
Add: Debenture interest (net of tax) [5,60,000 × 9% × (1 – 0.35)] 32,760
Future maintainable profit [for shareholders- both preference 3,75,096
and equity)
Assumptions
1. Tax effect has been ignored on profit on sale of investments and discount on
redemption of debentures.
2. Assets and liabilities are recorded at realizable value or fair value. In the absence of
information, book values are assumed to be fair values.
3. Additional depreciation on revaluation of property is ignored.
4. Profits for past three years given in the question have been assumed as profits after
tax.

VALUATION OF BUSINESS
Q24. Jayadev Ltd. has earned a PAT of Rs. 48 lakhs for the year ended 2013. It wants

you to ascertain the value of its Business, based on the following information:

50 D-FORTUNE CLASSES, 9589260560

(a) Tax rate for the year 2013 was 36%. Future Tax rate is estimated at 34%.

(b) The company‟s equity shares are quoted at Rs. 120 at the Balance Sheet date. The

company had an equity share capital of Rs. 100 lakhs, dividend into shares of Rs. 50 Each.

(c) Profits for the year 2013 have been calculated after considering the following in the

Profit and Loss Account:

(i) Subsidy of Rs. 2 lakhs received from the Government towards fulfillment of certain

social obligations. The govt. has withdrawn this subsidy and hence this amount will not be

received in future.

(ii) Interest of Rs. 8 lakhs on term loan. The final installment of this term loan was fully

settled this year.

(iii)Managerial remuneration Rs. 15 Lakhs. The Shareholders have approved an increase of

Rs. 6 lakhs in the overall managerial remuneration from the next year onwards.

(iv)Loss on sale of Fixed assets and investment amounting to Rs. 8 lakhs.

(RTP – May 2014)

Solution:

Computation of Future Maintainable Profits

Particulars Rs
Profit after tax for the year 2013 48,00,000
Add: Tax epense (Tax is 36%, So, PAT = 64%. Hence, Tax
= 48,00,000 x 36/64) 27,00,000
Profit before tax for the year 2013 75,00,000
Add/ (Less) Adjustments in respect of non-recurring items
Subsidy income not receivable in future (2,00,000)
Interest on term loan not payable in future, hence saved 8,00,000
Additional managerial remuneration Loss on sale of fixed assets (6,00,000)
and investments (nonrecurring) 8,00,000
Future maintainable profits before tax 83,00,000
Less: Tax expense at 34% (28,22,000)
Future maintainable profits after tax equity earnings 54,78,000
Computation of capitalization rate and value of business
Particulars Rs

51 D-FORTUNE CLASSES, 9589260560

 (a) Profit after tax for the year 2013 Rs 48 lakhs
(b) Number of equity shares (Rs 100 lakhs / Rs 50 per share) 2 lakhs
(c) Earnings per share (EPS) = PAT/Number of Equity Shares Rs 24
(d) Market price per share on balance sheet date Rs120
(e) Price Earnings Ratio = MPS / EPS 5
(f) Capitalisation Rate = (1 / PE Ratio) x 100 20%
(g) Value of Business = Future Maintainable Profits /Capitalisation Rs 273.90
Rate= Rs 54.78 Lakhs / 20% lakhs

Q25. The summarized Balance Sheet of R Ltd. for the year ended on 31st March, 2015,
2016 and 2017 are as follows:
(Rs in thousands)
Liabilities 31.3.2015 31.3.2016 31.3.2017
3,20,000 equity shares of Rs 10 each, fully 3,200 3,200 3,200
paid
General reserve 2,400 2,800 3,200
Profit and Loss account 280 320 480
Trade Payables 1,200 1,600 2,000
7,080 7,920 8,880
Assets
Goodwill 2,000 1,600 1,200
Building and Machinery less, depreciation 2,800 3,200 3,200
Inventory 2,000 2,400 2,800
Trade Receivables 40 320 880
Bank balance 240 400 800
7,080 7,920 8,880
Additional information:
(a) Actual valuations were as under
Building and machinery less, depreciation 3,600 4,000 4,400
Inventory 2,400 2,800 3,200
Net profit (including opening balance after 840 1,240 1,640
writing off depreciation, goodwill, tax
provision and transferred to general
reserve)
(b) Capital employed in the business at market value at the beginning of 2014-2015 was Rs
73,20,000 which included the cost of goodwill. The normal annual return on average
capital employed in the line of business engaged by R Ltd. is 12½%.
(c) The balance in the general reserve on 1st April, 2014 was Rs 20 lakhs.
(d) The goodwill shown on 31.3.2015 was purchased on 1.4.2014 for Rs 20 lakhs on which
date the balance in the Profit and Loss account was Rs 2,40,000. Find out the average
capital employed in each year.

52 D-FORTUNE CLASSES, 9589260560

(e) Goodwill is to be valued at 5 year‟s purchase of Super profit (Simple average method).
Find out the total value of the business as on 31.3.2017.
Answer
Total value of business Rs
Total net Asset as on 31.3.2017 84,80,000
Less: Goodwill as per Balance Sheet (12,00,000)
Add: Goodwill as calculated in Working Note 2 41,12,500
Value of Business 1,13,92,500
Working Notes:
1. Capital Employed at the end of each year
31.3.2015 31.3.2016 31.3.2017
Rs Rs Rs
Goodwill 20,00,000 16,00,000 12,00,000
Building and Machinery (Revaluation) 36,00,000 40,00,000 44,00,000
Inventory (Revalued) 24,00,000 28,00,000 32,00,000
Trade Receivables 40,000 3,20,000 8,80,000
Bank Balance 2,40,000 4,00,000 8,00,000
Total Assets 82,80,000 91,20,000 10480000
Less: Trade Payables (12,00,000) (16,00,000) (20,00,000)
Closing Capital 70,80,000 75,20,000 84,80,000
Add: Opening Capital 73,20,000 70,80,000 75,20,000
Total 1,44,00,000 1,46,00,000 1,60,00,000
Average Capital 72,00,000 73,00,000 80,00,000
Since the goodwill has been purchased, it is taken as a part of Capital employed.
2. Valuation of Goodwill
(i) Future Maintainable Profit 31.3.2015 31.3.2016 31.3.2017
Net Profit as given 8,40,000 12,40,000 16,40,000
Less: Opening Balance (2,40,000) (2,80,000) (3,20,000)
Adjustment for Valuation of - (4,00,000) (4,00,000)
Opening Inventory
Add: Adjustment for Valuation of 4,00,000 4,00,000 4,00,000
closing inventory
Goodwill written off - 4,00,000 4,00,000
Transferred to General Reserve 4,00,000 4,00,000 4,00,000
Future Maintainable Profit 14,00,000 17,60,000 21,20,000
Less: 12.50% Normal Return (9,00,000) (9,12,500) (10,00,000)
(ii) Super Profit 5,00,000 8,47,500 11,20,000
(iii) Average Super Profit = Rs (5,00,000 + 8,47,500+11,20,000) ÷ 3 = Rs 8,22,500
(iv) Value of Goodwill at five years‟ purchase= Rs 8,22,500 × 5 = Rs 41,12,500.
(Answer: Goodwill: 5195.85; Value of Business: 12475.85/ 11392.5 on simple avg Or

Goodwill – 4112.5 SP (Avg) – 822.50)

53 D-FORTUNE CLASSES, 9589260560

Q26. Timby Ltd. is in the business of making sports equipment. The Company operates
from Thailand. To globalise its operations, Timby has identified Fine Toys Ltd. an Indian
Company, as a potential takeover candidate. After due diligence of Fine Toys Ltd. the
following information is available:
(a)
Cash Flow Forecasts (Rs in crore)
Year 10 9 8 7 6 5 4 3 2 1
Fine Toys Ltd. 24 21 15 16 15 12 10 8 6 3
Timby Ltd. 108 70 55 60 52 44 32 30 20 16
(b) The net worth of Fine Toys Ltd. (Rs in lakhs) after considering certain adjustments
suggested by the due diligence team reads as under:
Tangible 750
Inventories 145
Receivables 75
970
Less:
Trade Payables 165
Bank Loans 250 (415)
Represented by equity shares of Rs 1,000 each 555
Talks for takeover have crystalized on the following:
1. Timby Ltd. will not be able to use Machinery worth Rs 75 lakhs which will be disposed
of by them subsequent to take over. The expected realization will be Rs 50 lakhs.
2. The inventories and receivables are agreed for takeover at values of Rs 100 and Rs 50
lakhs respectively which is the price they will realize on disposal.
3. The liabilities of Fine Toys Ltd. will be discharged in full on take over alongwith an
employee settlement of Rs 90 lakhs for the employees who are not interested in
continuing under the new management.
4. Timby Ltd. will invest a sum of Rs 150 lakhs for upgrading the Plant of Fine Toys Ltd.
on takeover. A further sum of Rs 50 lakhs will also be incurred in the second year to
revamp the machine shop floor of Fine Toys Ltd.
5. The Anticipated Cash Flows (in Rs crore) post takeover are as follows:
Year 1 2 3 4 5 6 7 8 9 10
Cash Flows 18 24 36 44 60 80 96 100 140 200
You are required to advise the management the maximum price which they can pay per
share of Fine Toys Ltd. if a discount factor of 20 per cent is considered appropriate.
Answer
Calculation of Maximum Price that can be quoted for takeover of Fine Toys Ltd.
Rs in lakhs Rs in lakhs
Present (Discounted) value of incremental cash
flows (Refer Working Note) 7,845.02
Add: Proceeds from disposal of fixed assets 50.00
Proceeds from disposal of inventories 100.00

54 D-FORTUNE CLASSES, 9589260560

 Receipts from Trade Receivables 50.00 200.00
8,045.02
Less: Settlement of Trade Payables 165.00
Bank Loans 250.00
Employee settlement 90.00

Renovation of Plant 150.00

Revamp of machine shop floor (Rs 50 lakhs× 34.72 (689.72)

0.6944)∗
Maximum value that can be offered 7,355.30
Maximum price per share of Fine Toys Ltd. (Rs 7,355.30 lakhs / 55,500 shares)
Rs 13,252.79
Working Note:
Present Value of Incremental Cash Flows
(Rs in lakhs)
Year Cash flow Cash flows Incremental Discount Discounted
after before Cash flows factor @ Cash flows
takeover takeover 20%
1 1,800 1600 200 0.8333 166.66
2 2,400 2000 400 0.6944 277.76
3 3,600 3000 600 0.5787 347.22
4 4,400 3200 1200 0.4823 578.76
5 6,000 4400 1600 0.4019 643.04
6 8,000 5200 2800 0.3349 937.72
7 9,600 6000 3600 0.2791 1,004.76
8 10,000 5500 4500 0.2326 1,046.70
9 14,000 7000 7000 0.1938 1,356.60
10 20,000 10800 9200 0.1615 1,485.80
7,845.02

Q27.(Homework)

From the following information of Aries Ltd. ascertain the Value of Business:

(1) The company‟s equity share capital is Rs. 200 lakhs divided into shares of Rs. 50
each.
(2) The company earned a profit of after tax of Rs. 60 Lakhs for the year ended
March 2016
(3) Tax rate for the year 2016 is 40%. Future tax rate is estimated at 45%
(4) The company‟s equity shares are quoted at Rs. 120 at the Balance Sheet date.

55 D-FORTUNE CLASSES, 9589260560

The profits for the year 2016 have been calculated after considering the following in the
profit and loss account:

(i) Subsidy of Rs. 4 lakhs is received from the Government towards fulfillment of
certain social obligations. The Government has withdrawn this subsidy and
hence, the amount will not be received in future.
(ii) Interest Rs. 10 lakhs is on term loan. The final installment of this term loan is
fully settled in this year.
(iii) Managerial remuneration is Rs. 18 lakhs. The shareholders have approved an
increase of Rs. 8 lakhs in the overall managerial remuneration, from the next
year onwards.
(iv) Loss on sale of fixed assets amounting to Rs. 10 lakhs.
(May 16 - 8 Marks)

(Answer: Business Value – 475.20; Capitalization Rate – 12.50%)

Hint – Capitalization Rate = 1/pe ratio *100

Solution:

(a) Computation of value of business of Aries Ltd.

Particulars Rs
Profit before tax for the year ended 31.3.2016= 60,00,000 / 1,00,00,000
100% - 40%
Adjustments in respect of non-recurring items
Less: Subsidy income not receivable in future (4,00,000)
Add: Interest on term loan not payable in future 10,00,000
Less: Additional managerial remuneration (8,00,000)
Add: Loss on sale of fixed assets and investments (non-recurring) 10,00,000
Future Maintainable Profits before Tax 1,08,00,000
Less: Tax expense @ 45% (48,60,000)
Future Maintainable Profit after Tax attributable to Equity 59,40,000
Value of business = future Maintainable Profit / Capitalisation 4,75,20,000
Rate = 59,40,000 / 12.5%
Working Note:
Computation of Capitalisation Rate Rs
(a) Profit after tax for the year ended 31.3.2016 60 lakh
(b) Number of equity shares share per Rs 200 Lakh / Rs 50 per 4 lakh
share
(c) Earnings per share (EPS) = PAT / shares equity of Number 15
(d) Market Price per share (MPS) on balance sheet date 120
(e) Price earnings ratio=MPS / EPS = 120 / 15 8
(f) Capitalisation rate = 1 / Per Ratio × 100 = 1 / 8 × 100 12.5%

56 D-FORTUNE CLASSES, 9589260560

(b) In case of options bought
A B C
Rs Rs Rs
Premium paid 35,000 15,000 20,000
Less: Premium prevailing on the balance sheet (30,000) (5,000) (8,000)
date
Provision required as on 31.3.16 (A) 5,000 10,000 12,000
Premium prevailing on the balance sheet date 25,000 20,000 15,000
Less: Premium received (20,000) (30,000) (20,000)
Provision required as on 31.3.16 (B) 5,000 (10,000) (5,000)
Net provision to be made in the books of 10,000 Nil* 7,000
account as on 31.3.16 (A +B)
Total provision to be made 17,000
(c) Fair value of ESPP per share = Rs 56 – Rs 50 = Rs 6
Number of share issued = 800 employees x 50 shares = 40,000 shares
Fair value of ESPP = 40,000 shares x Rs 6= Rs 2,40,000
Vesting period = One month
Expense recognised in 2015-16 = RS 2,40,000
Date Rs Rs
April 30, 2015 Bank A/c Dr. 20,00,000 40,000 × Rs 50
Employees‟ Compensation Expense 2,40,000 40,000 × Rs 6
A/c Dr.
To Share Capital A/c 4,00,000 40,000 × Rs 10
To Securities Premium A/c 18,40,000 40,000 × Rs 46

BRAND VALUATION
Brand may be SELF GENERATED or ACQUIRED.

Valuation of Acquired Brand is given below:

1. Brand Value = Price paid to acquire such brand; or

2. Brand Value = Purchase Consideration – Net Assets taken over

Valuation of Self Generated Brand is given below:

1. Historical Cost Method

Brand Value = Actual Cost Incurred in Brand Building (Development + Marketing +

Promotion Cost)

2. Potential Earning Model

57 D-FORTUNE CLASSES, 9589260560

 Brand Value = Profit arising due to Brand / Capitalisation Factor

How to Calculate Profit due to Brand?

PAT xxx

Less: Expected Return due to unbranded Products (xxx)

(From Tangible and Intangible Assets other than Brand)

Q28. From the Following, determine the possible value of brand as per potential earning

model:

Rs. In Lakhs

1 Profit after tax (PAT) 2500

2 Tangible Fixed Assets 10000

3 Identifiable intangible assets other than brand 1500

4 Weighted average cost of capital (%) 14%

5 Expected normal return on tangible assets

[weighted average cost (14%) + normal spread 4%] 18%

6 Appropriate capitalization factor for intangibles 25%

Answer
Calculation of possible value of brand
Rs in lakhs
Profit after Tax 2,500
Less: Profit allocated to tangible assets [18% of Rs 10,000 ] (1,800)
Profit allocated to intangible assets including brand 700
Capitalisation factor 25%
Capitalised value of intangibles including brand [700/25×100] 2,800
Less: Identifiable intangibles other than brand (1,500)
Brand value 1,300
Q29. Zed Ltd. is a FMCG player in the range of Men‟s cosmetics and deals in both Branded

and Unbranded products. The Branded products are sold under brand of „Zed‟ and are full

outsourced from third party manufacturers. The Company‟s unbranded products are

58 D-FORTUNE CLASSES, 9589260560

manufactured at its own manufacturing units. The earnings for the last three years (Lakhs

Rs.) are furnished below:

Year 1 Year 2 Year 3

Earnings before interest and Tax from Sale of 5100 7500 9900

Products

Other Income – Royalty from partial use of Zed 190 135 225

Brand

Tangible Fixed Assets employed 9000 10800 13500

Returns (Before interest and Tax) on cost of 14% 12% 14%

tangible assets

Spread over return 2% 3% 3%

The average annual fund‟s used in the company‟s operations is Rs. 5200 lakhs of which Rs.

2800 lakhs is in respect of the branded business. The company‟s tax rate is 33.33% and

has an average cost of funds of 17% after considering tax shelter on cost of borrowed

funds. You are required to determine the value of Brand Zed considering a capitalization

rate of 20%. (November – 2013, 8 Marks)

(Answer: Value of Brand – 19490 by Weighted avg. or 17170 by Simple avg.)

Solution:

1. Calculation of EBIT on unbranded product (Rs In lakhs)

Year 1 Year 2 Year 3

Tangible Fixed Assets 9,000 10,800 13,500
Return on cost +spread (5%) 16 15 17
Absolute value of the above 1,440 1,620 2,295
EBIT from sale of unbranded products 1,440 1,620 2,295
2. Calculation of Average earnings after tax on Branded Products (Rs In Lakhs)
Year 1 Year 2 Year 3
Total EBIT 5,100 7,500 9,900
Less: EBIT in respect of unbranded products 1,440 1,620 2,295
Add: Brand Royalty 90 135 225
EBIT from ZED Branded products 3,750 6,015 7,830
Average EBIT from Branded sold 5,865
[(3750+6015+7830)/3]
Less : Tax @ 33.33% 1,955

59 D-FORTUNE CLASSES, 9589260560

 Average post tax earnings from Branded 3,910
Goods (including tax shelter on interest)
3. Net Earnings from Brand (Rs Lakh)
= Average post tax earnings from Branded Goods less cost of funds used in Branded
operations
= Average post tax earnings from Branded goods = 3,910
Less: Cost of funds used in Branded operations = 2,800 x 17% 476
Net earnings from brand 3,434
Brand Value = Net Earnings from Brand x Capitalisation Rate =
= 3,434 x 100/20 = 17,170
Value of the ZED Brands is ` 17,170 lakh

Q30.
Agile Limited is a manufacturer-cum-dealer of „R Tuff‟ brand of trousers. With passage of
time, its brand has been well accepted in the market. The company has been approached by
a foreign company engaged in the same trade to enter as partner in its business. Agile, in
order to negotiate the deal wants to get its brand valued. The following information based
on market research is available:
(i) Garment industry of which Agile is a constituent, is expected to grow by 9% per
annum during the next five years. The present market size of the industry is Rs
7,500 crores.
(ii) There are other brands both national and international in the market. The
existence of duplicate brands is unavoidable. The share of such players is
estimated to be 63% of the total industry market. The market share of other
national brands will increase @ 0.25% year on year basis in the next 5 years. The
share of international brands is expected to grow 1.5 times of national brands. But
the existence of duplicate brands is to fall by 2.5% over the period of next 5
years, spread equally.
(iii) The expected foreign partner needs the production line of the company to be re-
engineered which will lead to an increase in the yield of the company by 3% after
one year over the present yield of 10% followed thereafter by further increase of
5% year on year.
Following the market oriented approach, determine the brand value to be used for
negotiation with the foreign company, considering the discount factor for 1st five years as
0.909; 0.826; 0.751; 0.683 and 0.621 (Monetary values in crores to be rounded off to
nearest 2 decimal places).

Answer
Market Share of Agile Ltd.
Calculation of last year’s market share = 100% –63% = 37%
Increase or decrease in market share of other players [0.25+(.25 x 150%)-2.5/5] = 0.125%
i.e. increase in others‟ market share every year over the period of 5 years. Hence, market

60 D-FORTUNE CLASSES, 9589260560

share of Agile Ltd. is expected to decrease by 0.125% every year over the period of 5
years, from the current level of 37%.
Brand Valuation under Market Approach
Year Market Market Market Expected Discount Discounted
Size (Rs Share of Share (Rs Profit (Rs Factor Cash Flow (Rs
in Crores) Agile Ltd. in Crores) in Crores) in Crores)
1 7500 x 36.875% 3014.53 @ 10% = 0.909 274.02
109% = 301.45
8,175
2 8,175 x 36.75% 3274.70 @ 13% = 0.826 351.64
109% = 425.71
8910.75
3 8,910.75x 36.625% 3557.28 @18% = 0.751 480.87
109% = 640.31
9712.72
4 9,712.72 36.5% 3864.20 @23% = 0.683 607.03
x 109% = 888.77
10,586.86
5 10,586.86 36.375% 4197.56 @28% = 0.621 729.87
x 109% = 1,175.32
11,539.68
Brand Value 2,443.43

Brand Value of Agile Ltd. under Market Oriented Approach is Rs 2,443.43 crores.

Important Notes:

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62 D-FORTUNE CLASSES, 9589260560