Fair Value Method – Combined Basis
Introduction
The Fair Value Method is simply the Simple Average of the Intrinsic Value (Net Asset Method) and the Yield Value (Earning Capacity Method).
It attempts to balance the two conflicting views:
- Asset Backing (Safety).
- Earning Power (Income).
1. Formula
Fair Value = (Intrinsic Value + Yield Value) / 2
Application: This method is often mentioned in Partnership Deeds or Articles of Association to resolve disputes between buying and selling partners/shareholders as it is considered equitable.
Illustration
Problem:
- Intrinsic Value calculated as ₹14.
- Yield Value calculated as ₹20.
- Find Fair Value.
Solution:
Fair Value = (14 + 20) / 2 = 34 / 2 = ₹17.
Exam Notes: Writing the Answer
Question: "Why is Fair Value considered more equitable?" (2 Marks)
Answer: It avoids the extremes. Intrinsic value might be high due to undervalued assets but low earnings. Yield value might be high due to temporary high earnings but low asset backing. Averaging them smooths out these anomalies.
Summary
- Formula: (IV + YV) / 2.
- Usage: Dispute resolution, balanced view.
Quiz Time! 🎯
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