Yield Method – Rate of Return Basis

Introduction

Use this method for Minority Shareholders or "Going Concern" valuation. It assumes the true worth of a share is its ability to generate income.

Two Approaches:

1. Dividend Yield Method (For small block of shares).
2. Earning Capacity Method (For large block of shares).

1. General Formula

Value Per Share = (Rate of Earnings / Normal Rate of Return) × Paid-up Value per Share

Logic: If Company earns 20% and Market Expectation (NRR) is 10%, the share is worth Double (20/10) its Paid-up value.

2. Calculation of Rate of Earnings

Step 1: Profit Available for Equity

• Proj. Profit After Tax
• Less: Transfer to Reserves
• Less: Preference Dividend

Step 2: Rate of Earnings (ROE)

(Profit Avail for Equity / Paid-up Equity Capital) × 100

Step 3: Value per Share

(ROE / NRR) × Paid-up Value

3. Dividend Yield Method

Similar, but replace "Rate of Earnings" with "Expected Rate of Dividend".

Value = (Exp Rate of Dividend / NRR) × Paid-up Value

Used when company follows a strict low-dividend policy and investor only cares about cash flow.

Illustration

Data:

• Equity Capital: ₹10,00,000 (Shares of ₹10).
• Profit After Tax: ₹2,50,000.
• Transfer to Reserve: 20%.
• NRR: 10%.

Solution:

1. Profit Available:
   • PAT: 2,50,000.
   • Less Reserve (20%): 50,000.
   • Available: 2,00,000.
2. Rate of Earnings:
   • (2,00,000 / 10,00,000) x 100 = 20%.
3. Value per Share:
   • (20 / 10) x 10 = ₹20.

(Since Company earns double the normal rate, Share value is double the Face Value).

Exam Notes: Writing the Answer

Question: "When is Earning Capacity Method preferred?" (2 Marks)

Answer: It is preferred when the investor wants to judge the total earning power of the company, regardless of how much starts distributed as dividend. Suitable for substantial holdings.

Summary

• Formula: (Rate / NRR) x Paid-up Value.
• Basis: Income generation.
• Two Types: Dividend Yield vs Earning Yield.

Quiz Time! 🎯

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