Ist Situation : When debentures or pref. Shares are converted into shares at that time it is necessary to calculate value of share.
2nd Situation : When shares are given as a gift, at that time also need to calculate value of share for paying gift tax. Gift tax is calculated on the total value of Shares .
3rd Situation : When loan is given on security of shares at that time calculation the value of shares is done by accountant.
Method of valuation of Share
There are two method of valuation of shares.
- Net Asset method
Under this method, value of share is equal to net assets. So, we first calculate net assets
Net assets = total tangible assets – total liabilities (Including pref. share capital) + Goodwill
Value of Share = Net Assets / No. of Shares
Suppose total tangible assets are RS. 100000, Goodwill Rs. 10000, pref. share capital Rs. 20000 ,Other liabilities = RS. 40000 , Equity shares capital is Rs. 60000 of 10000 shares. Calculate the value of shares
Net Asset = 100000 – 20000 -40000 + 10000
Value of Shares = 50000 / 10000 = Rs. 5
2. Earning Capacity Method
Under this method, value of share is equal to the proportion of expected earning and normal earning of paid up value of shares.
Value of Share
= Expected earning rate / Normal earning rate X Paid up Value of Shares
Expected Earning Rate = Expected profit / total equity share capital X 100
Expected profit = Average annual profit – taxation – reserve – pref. dividend
Calculate the value of share with earning capacity method, if company has issued 10000 shares @ 10 each and fully paid up. Suppose average profit is Rs 20000 and taxation is 2000, reserve is Rs. 500 and pref. share dividend is Rs. 600. Normal rate of earning is 10 % of total profit before tax.
We know, we first calculate expected profit rate
Expected profit = 20000 -2000-500-600 = 16900
Expected profit rate = 16900 / 100000 X 100 = 16.9 %
Value of Share = 16.9 / 10 X 10 = Rs. 16.90