Valuation of Shares – Need & Importance

Introduction

Valuation of shares is the process of estimating the fair value of a company’s shares. For listed companies, market price is available. For unlisted/private companies, valuation is mandatory.

1. Need for Valuation

1. Amalgamation/Absorption: To determine exchange ratio.
2. Conversion: Converting Preference Shares to Equity.
3. Security: Using shares as collateral for loan.
4. Taxation: For Gift Tax or Wealth Tax purposes.
5. Sale/Purchase: Buying a block of shares in private company. (Controlling Interest).

2. Factors Affecting Value

1. Nature of Business: Steady vs Risky.
2. Economic Conditions: Boom vs Recession.
3. Dividend History: Consistent dividends increase value.
4. Asset Backing: Tangible assets provide safety.
5. Future Prospects: Growth potential.

3. Methods of Valuation (Overview)

1. Net Asset Method: (Intrinsic Value / Break-up Value). Focuses on Safety / Assets. Best for Liquidation.
2. Yield Method: (Market Value / Earning Capacity). Focuses on Income. Best for small investors.
3. Fair Value Method: Average of (1) and (2).

Exam Notes: Writing the Answer

Question: "Which method is suitable for a majority shareholder?" (2 Marks)

Answer: Net Asset Method (Intrinsic Value) is suitable for majority shareholders because they have the power to liquidate the company and realize the assets.

Question: "Which method is suitable for a minority shareholder?"

Answer: Yield Method is suitable because minority shareholders are primarily interested in Dividends (Income) and cannot control asset liquidation.

Summary

• Need: Unlisted companies, Mergers.
• Asset Method: For Control/Liquidation.
• Yield Method: For Investment/Income.

Quiz Time! 🎯

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