Valuation of Business and Assets for Corporate Restructuring – CS Professional Study Material

Chapter 6 Valuation of Business and Assets for Corporate Restructuring – Corporate Restructuring Insolvency Liquidation & Winding Up Notes is designed strictly as per the latest syllabus and exam pattern.

Valuation of Business and Assets for Corporate Restructuring – Corporate Restructuring Insolvency Liquidation & Winding Up Study Material

Question 1.
Write a note on ‘valuation of slump sale. (Dec 2014, 5 marks)
Answer:
Slump Sale:

  • Section 2(42C) of the Income tax Act, 1961 define the term ‘slump sale’ as transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities.
  • The undertaking has to be transferred as a result of sale.
  • The consideration for transfer is a lump sum consideration.
  • This consideration should be arrived at without assigning values to individual assets and liabilities.

Valuation of lump Sale:
Slump sale shougl be valued as the difference between ‘the aggregate value of total assets of the undertaking or division’ and ‘the value of its liabilities as appearing in books of account’.

The ‘aggregate value of total assets of the undertaking or division’ is the sum total of:

  1. WDV as determined u/s 43(6)(c)(i)(C) in case of depreciable assets.
  2. The book value in case of other assets.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 2.
Write a short note on the valuation of stock options under SEBI (Share Based Employee Benefits) Regulations, 2014. (June 2016, 5 marks)
Answer:
Valuation under SEBI (Share Based Employee Benefits) Regulations, 2014:
Regulation 17 states that the company granting option to its employees pursuant to ESOS will have the freedom to determine the exercise price subject to conforming to the accounting policies specified in Regulation 15. Regulation 15 states that the any company implementing any of the share based schemes shall follow the requirements of the ‘Guidance Note on accounting for employee share based payments’ (Guidance Note) or Accounting Standards as prescribed by the Institute of Chartered Accountants of India (ICAI) including the disclosure requirements.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 3.
Write a note on International Valuation Standards Council. (June 2017, 5 marks)
Answer:
The International Valuation Standards Council is the established international standard setter for valuation. Through the International Valuation Standards Board, the IVSC develops and maintains standards on how to undertake and report valuations, especially those that will be relied upon by investors and other third party stakeholders. The IVSC also supports the need to develop a framework of guidance on best practice for valuations of the various classes of assets and liabilities and for the consistent delivery of the standards by properly trained professionals around the globe.

The IVSC has published International Valuation Standards (IVS) since 1985. Membership of IVSC is open to organisations of users, providers, professional institutes, educators, and regulators of valuation services. IVSC members appoint the IVSC Board of Trustees.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 4.
Where no mistake is found in valuation of exchange ratio worked out by a recognised firm of chartered accountants and the same has been accepted by the shareholders/creditors with overwhelming majority, Tribunal still has a right to substitute its own exchange ratio. Do you agree? Discuss. (June 2012, 5 marks)
Answer:

  • The Tribunal does not go into the matter of fixing of exchange ratio in great detail.
  • Tribunal will only see ¡f there is any fraud or unreasonableness involved in the scheme.
  • If the exchange ratio is being worked out by the recognized firm of Chartered Accountants and the same has been accepted by the shareholders / creditors with overwhelming majority, then the Tribunal does not go into the matter of fixing of exchange ratio in great detail. Miheer H. Mafatial y. Ma tafia! Industries Ltd. [1996]87 Comp. Cas. 792 (SC).

Question 5.
(i) In case of pricing of equity shares through ‘red-herring prospectus’, i.e., through book building process, what is the maximum gap between the floor price and the ceiling in the price band? Give example. (Dec 2012, 2 marks)
(ii) If the floor price/price band is not mentioned in the red-herring prospectus—
(a) What is the time limit to inform the same by the issuer for the initial public offer (IPO)?
(b) What is the time limit to inform the same by the issuer for the further public offer (FPO)? (2 marks)
Answer:
(i) According to SEBI (ICDR) Regulations, the cap on price band shall be less than or equal to one hundred and twenty percent of the floor price. For example, if the floor price is ₹ 100, then the ceiling on the price band is ₹ 120.

(ii) (a) The issuer is required to announce the floor price or price band at least five working days before the opening of the bid (in case of initial public offer).
(b) The issuer is required in case of further public offer, at least one working day before the opening of the bid in all the newspapers in which pre issue advertisement was released.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 6.
What is the relevance of price-earnings ratio in a company? (Dec 2012, 5 marks)
Answer:
Price- earning ratio (or P/E ratio) is the ratio between the market price and earnings per share. It is an indicator to measure company’s market performance. The higher the price earning ratio, the more is market willing to pay.

In cases of takeover, price earning of both offeror & offeree companies are compared to judge the relative growth prospects. Company with lower P/E ratio show a record of low growth earning per share with depressed market price of shares in comparison to high growth potential company.

Question 7.
Explain ‘fair value of shares’. When is fair value of shares considered the appropriate method for valuation? (June 2013, 7 marks)
Answer:
Fair value of shares:

  • Valuation by fair value is appropriate when market value of a company is independent of its profitability.
  • The fair value of shares means the value which is arrived on the basis of various method such as net Asset Value Method, Yield method,
  • Fair value of share can be calculated by using formula:
    Fair value of shares
    \(=\frac{\text { Value by net assets method }+ \text { Value by yield method }}{2}\)

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(i) Net Assets Method (the net worth method or the break-up value method):
According to this method, value of equity share is determined as follows:
= \(\frac{\text { Net Asset AvailabletoEquity Shareholders }}{\text { NumberofEquityShares }}\)
Value of tangible fixed assets & the value of intangibles should be taken at their current cost for valuing investment, market price is to be taken for the value of assets and the liabilities are deducted to arrive at net assets.

If the objective is to determine ex-dividend value of equity shares, proposed equity dividend is also to be deducted.

Note: If some shares are paitly paid up a notional call equivalent to the calls unpaid is added with the net assets

(ii) Earning Method:
Earning method ¡s also an important method of valuation of shares. To arrive at this method, the following steps are to be followed : –

  1. Determine the Future Maintainable Profit (FMP).
  2. Next step is to calculate the normal rate of return.
  3. Divide the FMP by the normal rate of return.
  4. Divide the value arrived at step (iii) by the number of the shares of the company.

(iii) Market Price Method :
Under this method, average market prices of shares quoted on the Stock Exchange are to be taken to arrive at the value of shares.

Note: This method will be applicable only on those cases where the shares are listed in stock exchange.
Thus, it can be said that a combination of different methods will give a proper valuation of shares. Valuation of company’s shares is a highly technical & complex matter. One should not be restricted to only one method but should combine the various methods of valuation of shares to arrive at correct valuation of shares.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 8.
(a) Explain ‘earnings based valuation technique’. (June 2014) (5 marks)
(b) “Where no mistake is found in computation of exchange ratio worked out by a recognised firm of chartered accountants and same has been accepted by the shareholders/creditors with overwhelming majority, still Court/Tribunal has a right to substitute its own exchange ratio.” Comment on the statement in the light of judicial pronouncements. (5 marks)
(c) What do you understand by ‘brand valuation’? What is its importance? (5 marks)
Answer:
(a) The normal purpose of the contemplated purchase is to provide for the buyer the annuity for his outlay. Hie will expect yearly income, return great or small, stable or fluctuating but nevertheless some return which is commensurate with the price paid therefore. Valuation based on earning based on the rate of return, on capital employed is a more modern method being adopted. From the last earnings declared by a company, items such as tax, preference dividend, if any are deducted and net earnings are taken.

An alternate to this method is the use of the price-earnings (P/E) ratio instead of the rate of return. The P/E ratio of a listed company can be calculated by dividing the current price of the share by earnings per share (EPS). Therefore, the reciprocal of P/E ratio is called earnings – price ratio or earning yield.
Thus, P/E = \(\frac{P}{\text { EPS }}\)
Where, P is the current price of the shares. ,
The share price can thus be determined as: P = EPS × P/E ratio

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b)

  • The Court/Tribunal does not go into the matter of fixing of exchange ratio in great detail.
  • Court/Tribunal will only see if there is any fraud or unreasonableness involved in the scheme.
  • If the exchange ratio is being worked out by the recognized firm of Chartered Accountants & the same has been accepted by the shareholders/creditors with overwhelming majority, then the Court/Tribunal does not go into the matter of fixing of exchange ratio in great detail.

(c)

  • Brands/marks are a class of assets like human resource, knowledge etc.
  • They create a value premium for the goods and services.
  • Therefore, without the brand/mark, the goods/services may be address less.
  • In order to market it or use this asset wisely valuing the same is essential.
  • Valuing a brand is a very difficult task since there is no prescribed manner to value a brand.
  • Brands do not command any value unless they are able bring cash flows to the Company that has adopted the same.
  • With incremental cash flows increasing, value of brand increases proportionately.
  • In order to sustain the valuation of the brand, there must be a constant attempt to secure registration of the Brand in all relevant classes.
  • For the purpose of valuation of brands, it may be necessary to make a thorough enquiry into the policies and business of the company to the extent they relate to brands.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 9.
(a) Briefly explain, how offer price is determined in respect of a proposed acquisition by the acquirer from public shareholders under the open offer in terms of Regulation 8 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
You may assume that the shares of the target company whose shares are ’ proposed to be acquired are frequently traded on the stock exchanges. ( (Dec 2014) 5 marks)

(b) State the procedures that are typically adopted by the valuer in a valuation report. (5 marks)
Answer:
(a) If the target company’s shares are frequently traded then the open offer price for acquisition of shares under the minimum open offer shall be highest of the following:

  • Highest negotiated price per share under the share purchase agreement (“SPA”) triggering the offer;
  • Volume weighted average price of shares acquired by the acquire” during 52 weeks preceding the public announcement (“PA”);
  • Highest price paid for any acquisition by the acquirer during 26 weeks immediately preceding the PA;
  • Volume weighted average market price for sixty trading day£ preceding the PA.

If the shares are not frequently traded –

  • where the shares are not frequently traded, the price determined bi the acquirer and the manager to the open offer taking into accoun1 valuation parameters including, book value,
  • comparable trading multiples, and such other parameters as ar# customary for valuation of shares of such companies.

(b) Procedures that are typically adopted by the valuer in the valuation report are:

  • Review of Past Financials.
  • Review and Analysis of Financial Projections.
  • Industry Analysis.
  • SWOT Analysis.
  • Comparison with similar transactions.
  • Comparison with other similar listed companies.
  • Discussions with Management.
  • Review of principal agreements/documents etc.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 10.
(a) While market based approach to valuation is an effective tool in the hands of strategic buyer, the same is not relevant and therefore not useful in certain cases. List out the cases where market based approach to valuation is not a suitable method. (Dec 2014) (5 marks)
(b) When shall equity shares be deemed to be infrequently traded on a stock exchange, if the company notifies the stock exchange of the Board meeting in which the delisting proposal was considered? (5 marks)
Answer:
(a) Market based approach to valuation is an effective tool in the hands Of the strategic buyer. In case the company is listed, market price method may prove to be very useful.

But market based valuation approach may not be useful in some cases. Some of them are:

  • When we need to do valuation of a division of a company.
  • Where the share are not listed or are thinly traded.
  • In the case of a merger, where the shares of one of the companies under consideration are not listed on any stock exchange.
  • In case of companies, where there is an intention to liquidate it and to realise the assets and distribute the net proceeds.
  • In case of significant and unusual fluctuations in market price the market price may not be indicative of the true value of the share.
  • If the period for which prices are considered also has impact on account of Bonus Shares, Rights Issue, etc., the valuer needs to adjust the market prices for such corporate events.

(b) Equity shares shall be deemed to be infrequently traded, if on the , recognised stock exchange, the annualised trading turnover in such shares during the preceding six calendar months prior to month in which the recognised stock exchanges were notified of the board meeting in which the delisting proposal was considered, is less than five percent (by number of equity shares) of the total listed equity shares of that class.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 11.
Valuation of shares of an enterprise demands a detailed and comprehensive analysis embracing a host of factors at macro and micro level.
List out five important factors that influence the determination of price of the shares. (June 2015, 5 marks)
Answer:
The factors which are to be taken into account while valuing shares of a company are as follows :

  1. Determination of future earning potential of the company.
  2. Determining the risk involved.
  3. An analysis of physical & intangible assets of the company.
  4. The stock exchange price of both the companies before the commencement of negotiations or announcement of the bid.
  5. Estimated growth prospects of both the companies.
  6. Dividend paid.
  7. P/E ratio of the company.
  8. The relative gearings of the two companies.
  9. Past history of the prices of the shares of the two companies.
  10. The extent of competition.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 12.
(a) Various judicial pronouncements on valuation principles demonstrate salient dicta of courts/tribunal in relation to the subject. You are required to list out the principles set-out by the courts in this regard. (June 2015) (6 marks)
(b) In which circumstances, is the market based approach to valuation not relevant and useful? (4 marks)
Answer:
(a) Some of the salient dicta of Courts/Tribunal in relation to valuation principles and valuation reports are stated under:
In BahooJ. Coyajee v. Shanta Genevieve PrommeretParulekar[1991] (3) Bom. LR 319, the Court/Tribunal observed:

“If the thing complained of is a thing which in substance the majority of the company are entitled to do or if something has been done irregularly which the majority of the company are entitled to do regularly, or if something has been done illegally which the majority of the company are entitled to do legally, there can be no use in having litigation about it, the ultimate end of which is only that a meeting has to be called and then ultimately the majority gets its wishes”.

In Miheer H. Mafatlal v. Mafatlal Industries Ltd. [1996] 87 Comp. Cas. 792 (SC), the Hon’ble Supreme Court held:

“If Share Exchange Ratio is fixed by Chartered Accountant upon consideration of various factors and approved by majority of shareholders in meeting, the Tribunal will not disturb ratio”.

In.Re. Maknam Investments Ltd. [1995] (4) Comp.LJ page 330, the Calcutta High Court observed:

‘Tribunal does not go into the matter of fixing of exchange ratios in great detail or to sit in appeal over the expert decision of concerned Chartered Accountant of repute. Tribunal only sees whether there is any manifest unreasonableness or manifest fraud involved in the matter”.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

In Hindustan Lever Employees Union v. Hindustan Lever Limited [1995] (Supp.) (1) SCC 499 at 517(519), the Hon’ble Court stated:

“The valuation of shares is a technical matter. It requires considerable skill and experience. There are bound to be differences of opinion, among Accountants as to what is the correct value of the shares of a company. It was emphasized that more than 99% of the shareholders had approved the valuation. The test of fairness of this valuation is not whether the offer is fair to a particular shareholder…. who may have reasons of his own for not agreeing to the valuation of the shares but the overwhelming majority of the shareholders have approved of the valuation. The Tribunal should not interfere with such valuation”. The Hindustan Lever case also repelled the case that valuation particulars needed a proper disclosure as material facts in the Explanatory Statement. It confirmed the judgment of Jitendra R. Sukhadia v. Alembic Chemical Works Co. Ltd.,(1987) 3 Comp.L.J 141 (Guj) as follows:

“How this exchange ratio was worked out, however, was not required to be stated in the statement contemplated.

The Hindustan Lever’s judgment (1995) Supp. (1) SCC 499 at 502 noted:

“In the absence of it being shown to be vitiated by fraud and malafide, the mere fact that the determination one by slightly different method might have resulted in different conclusion would not justify interference of Tribunal.”

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 13.
Explain the pricing of shares issued under FDI Policy, 2015 to persons resident outside India by an Indian company. (Dec 2015, 5 marks)
Answer:
Price of shares issued to persons resident outside India under the FDI Policy, shall not be less than:

(a) the price worked out in accordance with the SEBI guidelines, as applicable where the shares of the company are listed on any recognised stock exchange in India;

(b) the fair valuation of shares done by a SEBI registered Merchant Banker or a Chartered Accountant as per any internationally accepted pricing methodology on ai’m’s length basis, where the shares of the company are not listed on any recognised stock exchange in India and

(c) the price as applicable to transfer of shares from resident to non-resident as per the pricing guidelines laid down by the Reserve Bank from time to time, where the issue of shares is on preferential allotment.

However, where non-residents (including NRIs) are making investments in an Indian company in compliance with the provisions of the Companies Act, as applicable, by way of subscription to its Memorandum of Association, such investments may be made at face value subject to their eligibility to invest under the FDI scheme.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 14.
“Super profits are calculated as the difference between maintainable future profits and the return on net assets.” Comment. (Dec 2015, 5 marks)
Answer:
Valuation based on Super Profits:
This approach is based on the concept of the company as a going concern. The value of the net tangible assets is taken into consideration and it is assumed that the business, if sold, will in addition to the net asset value, fetch a premium. The super profits are calculated as the difference between maintainable future profits and the return on net assets. In examining the recent profit and loss accounts of the target, the acquirer must carefully consider the accounting policies underlying those accounts.

Question 15.
Explain the provisions of the Income-tax Act, 1961 in relation to computation of capital gains arising out of slump sale. (June 2016, 5 marks)
Answer:
It is well settled that business is property and the undertaking of a business is a capital asset of the owner of the undertaking. When an undertaking as a whole is transferred as a going concern together with its goodwill and all other assets, what is sold is not the individual itemised property but what is sold is the capital asset consisting of the business of the undertaking and any tax that can be attracted to such a transaction for a slump price at book value would be merely capital gains tax and nothing else but capital gains tax.

Plant or machinery or any fixture or furniture is not being sold as such. What is sold is the business of undertaking for a slump price. If the capital asset, namely, the business of the undertaking, has a greater value than its original cost of acquisition, then, capital gains may be attracted in the ordinary case of a sale of an undertaking.

The Bombay High Court also recognised that there will be a capital gains tax when a sale of business as a whole occurs (Refer Killic Nixon and Co. v. CIT 49ITR244).

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 16.
(a) “Market based approach to valuation is adopted for determination of price in the case of preferential allotment, buy-back and open offer. But the market price is not so reliable for the purpose of valuation.” In the light of the statement, state the limitations of market based approach particularly in case of preferential allotment, buy-back and open offer. ‘ (June 2016) (5 marks)
(b) Apart from comprehensive analysis covering the past, present and future earnings and prospects of the company, several other factors are to be taken into account for the valuation of an enterprise.
List out the important factors that deserve consideration for proper valuation of an enterprise. (5 marks)
Answer:
(a) It is important to note that Regulatory bodies have often considered market value as one of the very important basis – Preferential allotment, Buyback, Open offer price calculation under the Takeover Code. However, Market Price Method is not relevant in the following cases:

  • Due to unusual and significant fluctuations in the market prices of the shares due to many reasons which may include rumors and market sentiments also, valuer cannot believe on this value because it does not actually indicate the fair status of the company’s assets and profitability.
  • Where the shares are not listed or are thinly traded.
  • Market price of shares are also affected due to corporate actions like right issue, bonus shares etc, the valuer, therefore, is required to make adjustments in the market prices of the shares accordingly due to such corporate actions.
  • Considering high and low of monthly share prices under market price method is replaced with weighted average market price based on volume and value of each transactions reported at the stock exchange.

(b) The factors which are to be taken into account while valuing shares of a company are as follows:

  1. Determination of future earning potential of the company.
  2. Determining the risk involved.
  3. An analysis of physical & intangible assets of the company.
  4. The stock exchange price of the both company before the commencement of negotiations or announcement of the bid.
  5. Estimated growth prospects of both the company.
  6. Dividend paid on the shares.
  7. P/E ratio of the company.
  8. The relative gearings of the two companies.
  9. Past history of the prices of the shares of the two companies.
  10. The extent of competition.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 17.
“Brands do not command any value unless they are able to bring cash flows to the company that has adopted the same. In order to sustain the value of the brand, there must a constant effort by the company on various aspects.” Comment. (Dec 2016, 5 marks)
Answer:
With incremental cash flows increasing, value of brand also increases proportionately. Brands have to be constantly associated with good quality goods and services; they require proper show casing and servicing and they should remain active in appropriate markets. In order to sustain the valuation of the brand, there must be a constant attempt from the company on the following aspects:

1. To secure registration of the Brand in all relevant classes.

2. To secure registration of the Brand in all countries where there are opportunities to sell Branded Products of the Company.

3. To set up a “surveillance team” within the Marketing Department of the Company so as to ensure that there is no dilution to the value of the Brand.

4. To ensure that attempts to use take brands that are similar or deceptively similar are challenged with full force so as to spread the message that the Company is conscious of the value of its brand and it will be aggressive in taking steps not only to put an end to such illegal, dishonest and unauthorized use but also to punish such users and claim exemplary damages from those who had passed off their goods to people and those who are found to be guilty of infringement.

5. To ensure that there is always a budget allocation for promoting the ‘ brand and the Company should devise a continuous process for being present in the existing markets and prospective markets.

6. to ensure that there is a conspicuous distinction in the description of the brand when it is used to sell premium products as opposed to use of the same brand for selling goods to the masses.

7. To ensure that the extent of growth in the value of the brand very year is always higher than the depreciation or dent that existing or new competition may cause.

8. To adopt a proper policy with regard to slogans and catchy phrases so that the Company does not knowingly cause any infringement of the industrial and intellectual property rights of any other person in any country or territory.

9. To adopt a proper policy with regard to statements made in advertisements carrying the brand in order to ensure that those statements are not mere attractive words and they would stand the test of the market.

10. To adopt a proper policy to augment IP profile of the Company and constantly update and upgrade the same.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 18.
(a) Explain briefly the features which must be taken into consideration for arriving at valuation of equity shares of a company in a particular transaction. (Dec 2016) (5 marks)
(b) Write a detailed note on discounted cash flows (DCF) valuation method. (5 marks)
Answer:
(a) Valuation of equity shares must take note of special features in the company or in a particular transaction. These are briefly stated as under: Importance of the size of the block of shares: The holder of 75% of the voting power in a company can always alter the provisions of the articles of association; a holder of voting power exceeding 50% and less than 75% can substantially influences the operation of the company even to alter the articles of association of comfortable influences the operation of the company even to alter the articles of association of comfortable pass a special resolution. A controlling interest therefore, carries a separate substantial value.

Restricted transferability: Along with principal consideration of yield and safety of capital, another important factor is easy exchangeability or liquidity. Holders of shares unquoted public companies or private companies do not enjoy easy marketability; therefore such shares, however good, are discounted for lack of liquidity at rates, which may be determined on the basis of circumstances or an increase in the normal rate of return.

Dividends and Valuation: Generally, companies paying dividend at steady rates enjoy greater popularity and the prices of their shares are high while shares of companies with unstable dividends do not enjoy confidence of the investing public as to return they expect to get and, consequently, they suffer in valuation.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b) Discounted Cash Flow (DCF) is one of the method of valuation. DCF method is based upon:

  • Expected future cash flows
  • Discount rates

DCF method is based on the present value concept & as per this method, value of asset is the present value of the expected future cash flows derived from it.

The steps which are to be followed for discounted cash flow method can be summarised as follows : –

  1. First of all future cash flows are estimated.
  2. Then the terminal value is determined.
  3. Determine the cost of capital.
  4. After determining the cost of capital, we have to apply the discount rate on the future cash flows to get the present value.
  5. Add, if any, present value of the cash inflows derived from the disposal of the asset.
  6. Next step is to arrive at the value addition made from the acquisition.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 19.
“Brands belong to a different species. While physical resources could be created easily if augmenting financial resources is not a problem, same is not the case of brands. It is advisable to approach the brand valuation on the basis of premium price method.” Comment on the statement highlighting valuation approach for brands. (Dec 2016, 5 marks)
Answer:
Valuation on going concern basis: Normally, the value of an enterprise could be estimated on a going-concern basis by computing the earning capacity.

Limitation of NAV Method: Net Asset Value method may not be ideal in the cases enterprises with depreciating assets unless the enterprise in question is asset intensive.

Example: For instance, in the case of company engaged in real estate sector, the lands in the hands of the company on ownership basis could be a stock in trade and they may be highly valuable.

Approach in brand valuation: However, in the case of Brands, which form the lifeline of the Company, there has to be a different approach.

Limitation of cost approach: Cost Approach for valuation of Brands may not help. The cost incurred in the last three financial years are not very high as ail resources have been used up for establishing a good quality over a period of time in order to give customers high quality products for value and to ensure that customers are happy.

Competitive forces: A look at the competitive force and the predominance of the brand of the company would show that the brands of the company are premium brands.

Access to new market: In the next phase, the Company would show that the brands of the company are premium brands. In the next phase, the company would incur expenditure brand, returns would be manifold. This enables the company to introduce its branded products in the new markets very easily as entry barriers could be easily overcome.

Conclusion: Considering the above background, it is advisable to approach the Brand Valuation on the basis of Premium Price Method. The commitment of the company to maintain stringent quality gives us confidence in adopting a Premium Price Method for valuing the Brand.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 20.
What is the Valuation documentation and what is the objective of this? (June 2017, 5 marks)
Answer:
Valuation document: Valuation exercise is based on observation, inspection, analysis and calculation. During this process, the valuer goes through various documents, records his observation, makes relevant calculation and records these calculation and analysis results. In this process a lot of documents are generated which forms the basis of him conclusion on the valuation of the subject matter. It is very necessary for his to preserve ail such records so that these documents may help him in substantiate his conclusion on valuation. Moreover these documents also become a matter of reference in future.

Objectives of Documentation in Valuation Exercise
Documentation is “an essential element” of Valuation quality. Valuation documentation provides the principal written record to support the following:

  • Assisting Valuer to plan and perform the Valuation Exercise;
  • Assisting those responsible to direct, supervise, and review the work performed;
  • Providing and demonstrating the accountability of those performing the work (i.e., compliance with applicable standards);
  • Assisting quality-control reviewers to understand and assess how the engagement team reached and supported significant conclusions;
  • Enabling internal and external inspection teams and peer reviewers to assess compliance with professional, legal, and regulatory standards and requirements; and Assisting successor Valuer.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 21.
“Valuation is an important aspect in merger and acquisition and it should be done by a team of experts.” Comment on the statement, mentioning which type of experts should be in the team. (June 2017, 5 marks)
Answer:

  • Valuation Is an important aspect in merger and acquisition and it should be done by a team of experts keeping into consideration the basic objectives of acquisition.
  • Team should comprise of financial experts, accounting specialists technical and legal experts who should look into aspects, of valuation from different angles.
  • Accounting expert has to foresee the impact of the events of merger on profit and loss account and balance sheet through projection for next 5 years and economic forecast.
  • Legal experts advice is also needed on matters of compliance of legal formalities in implementing acquisition, tax aspects, review of corporate laws as applicable, legal procedure in acquisition strategy, laws affecting transfer of stocks and assets, regulatory laws, labour laws preparing drafts of documents to be executed or entered into between different parties, etc.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 22.
he method of valuation of a business, however, depends to a great extent on the acquisition motive. What are those motives of valuation? (June 2017, 5 marks)
Answer:
Valuation and acquisition motives are an important aspect in the merger/ amalgamation/ takeover activity. The method of valuation of business, however, depends to a great extent on the acquisition motives. The acquisition activity is usually guided by strategic behavioral motives. The reasons could be:

  1. Either purely financial, e.g., taxation assets-stripping, financial restructuring involving an attempt to augment the resources base and portfolio-investment;
  2. Business related, e.g., expansion or diversification;
  3. Behavioral reasons of personal ambitions or objectives of the top management, e.g., desire to grow big.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 23.
(a) In calculating fair value, element of guesswork or arbitrariness is imminent. Comment. (Dec 2017) (5 marks)
(b) “ Courts and Tribunals do not substitute or impose their opinion on the valuation report unless there are noticeable irregularities.” Offer your comments with certain judicial pronouncements. (5 marks)
Answer:
(a) Valuation can be done on the basis of fair value. However, resort to valuation by fair value is appropriate when market value of a company is independent of its profitability.

The fair value of shares is arrived at after consideration of different modes of valuation and diverse factors. There is no mathematically accurate formula of valuation. An element of guesswork or arbitrariness is involved in valuation.

The following four factors have to be kept in mind in the valuation of shares:
These are:

  1. Capital cover,
  2. Yield,
  3. Earning capacity, and
  4. Marketability.

(b) In Miheer H. Mafatlal v. Mafatlal Industries Ltd. [1996] 87 Comp. Cas 792 (SC), the Hon’ble Supreme Court held:
“If Share Exchange Ratio is fixed by Chartered Accountant upon consideration of various factors and approved by majority of shareholders in meeting, the Court will not disturb ratio”.

In Re. Makham Investments Ltd. [1995] Comp. LJ page 330, the Calcutta High Court observed:
“Court / Tribunals does not go into the matter of fixing of exchange ratio in great detail or to sit in appeal over the expert decision of concerned Chartered Accountant of repute. Court only sees whether there is any manifest unreasonableness or manifest fraud involved in the matter.”

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 24.
(a) What are the preliminary steps that are to be followed for a proper valuation? (Dec 2017)(5 marks)
(b) What are the common strategies that warrant valuation of shares, business or even an undertaking? (5 marks)
Answer:
(a) The preliminary study to valuation involves the following aspeGts:

  1. Analysis of Business History
  2. Profit trends
  3. Goodwill/Brand name in the market
  4. Identifying economic factors directly affecting business
  5. Study of Exchange risk involved
  6. Study of Employee morale
  7. Study of market capitalization aspects
  8. Identification of hidden liabilities through analysis of material contracts.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b) Whether it is a case of merger, amalgamation or takeover, valuation exercise is imminent to have an amicable bargaining situation. Business top management, however, have different strategies to resort for valuation.

The common reasons could be:
(a) Either purely financial such as taxation, asset-stripping, financial restructuring involving an attempt to augment the resources base and portfolio-investment;
(b) Business related expansion or diversification; or
(c) The behavioural reasons have more to do with the personal ambitions or objectives of the top management.

The expansion and diversification objectives are achievable either by building capacities on one’s own or by buying the existing capacities. In other words ‘make’ or ‘buy’ decisions. The decision criteria in such a situation would be the present value of the differential cash flows. These differential cash flows would, therefore, be the limit on the premium which the acquirer would like to pay. On the other hand, if the acquisition is motivated by financial considerations, the expected gains through taxation or asset stripping would form limit on the premium, over and above the price of physical assets.

Cash flow from operations may not be the main consideration in such a situation. A merger with financial restructuring as its objective needs to be valued mainly in terms of financial gains.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 25.
“Fair value of shares is in fact not precisely fair but a compromise effort for bringing the parties to an agreement, just like providing extra play time in a Hockey or Football match especially in case of a tie”. Justify the statement with your views. (June 2018, 5 marks)
Answer:
Valuation is an exercise to assess the worth of an enterprise or a property. In a merger or amalgamation or demerger or acquisition, valuation is certainly needed. It is essential to fix the value of the shares to be exchanged in a merger or the consideration payable for an acquisition.

There are a number of situations in which a business or a share or any other property may be required to be valued. Valuation is essential for (i) strategic partnerships, (ii) mergers or acquisitions of shares of a company and/or acquisition of a business, (iii) Valuation is also necessary for introducing employee stock option plans (ESOPs) and joint ventures.

Valuation involves lot of estimations and judgements.

Thus Fair valuation of shares is in fact not precisely but a compromise effort for bringing the parties to an agreement.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 26.
Explain the following methods of valuation:
(i) Net Realisable Value Method
(ii) Valuation in case of Slump Sale (June 2018, 5 marks each)
Answer:
(i)

  • This method is generally used in case of liquidation.
  • Where the business of the company is being liquidated, its assets have to be valued as if they were individually sold and not on a going concern basis.
  • Liabilities are deducted from the liquidation value of the assets to determine the liquidation value of the business.
  • One should also consider liabilities which will arise on closure such as retrenchment compensation, termination of critical contracts, etc.
  • Tax consequences of liquidation should also be considered. Any distribution to the shareholders of the company on its liquidation, to the extent of accumulated profits of the company is regarded as deemed dividend.
  • Dividend Distribution tax will have to be captured for such valuation.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 27.
“Valuation is influenced not only by the motive of the acquirer company but also that of target company’s objectives.” Analyse the statement in brief. (Dec 2018, 5 marks)
Answer:
Merger/Amalgamation/Takeover is backed by the aspect of valuation. Appropriate method of valuation of a business depends to a great extent on the acquisition motives. The reasons for valuation could be to achieve the objectives of the top management i.e. either purely financial aspects relating to taxation, assets stripping, financial restructuring or business related such as expansion or diversification.

However, behavioural reasons have more to do than personal ambitions or objectives of the top management. Normally, top management has desire to expand and diversify the needs to be chosen between make buy decision. A criterion adopted to arrive at a decision is to evaluate present value of the differential cash flows. Acquisitions are not only normally market driven but also influenced by non-financial considerations. Thus the value of a target gets affected not only by the motive of the acquirer, but also by the target company’s objectives. The price could be affected by the motives of the other bidders as well.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 28.
Explain Market Comparables Method of valuation. What are the steps involved in this method of valuation ? (Dec 2018, 5 marks)
Answer:
Market Comparables: This method of valuation is generally applied in case of unlisted entities. This method estimates value by relating the same to underlying elements of similar companies for past years. It is based on market multiples of ‘comparable companies’. For example:

  • Earnings/Revenue Multiples (Valuation of Pharmaceutical Brands)
  • Book Value Multiples (Valuation of Financial Institution or Banks)
  • Industry Specific Multiples (Valuation of steel companies based on production capacities like price per ton capacity of steel, per store value in the days of retail boom, price per click in e-commerce)
  • Multiples from recent M&A Transactions

Following steps are involved in this method of valuation:

  1. Comparable assets are identified and their market values are obtained
  2. Market values are converted into standardized values, since the absolute price cannot be compared
  3. Standardised value or multiple for the asset being analysed are compared with the standardised value of the comparable asset, controlling for any difference between the firms that might affect the multiple, to judge whether the asset is under or over-valued.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 29.
‘The key to valuation is finding a common ground between all the companies for the purpose of a fair evaluation.” Comment with reference to factors influencing valuation. (Dec 2018, 5 marks)
Answer:
Determining the value of a business is a complicated and intrinsic process. Valuing a business requires the determination of its future earnings potential, the risks inherent in those future earnings. Strictly speaking, a company’s fair market value is the price at which the business would change hands between a willing buyer and willing seller when neither is under any compulsion to buy or sell and both parties have knowledge of relevant facts.

The other salient factors influencing valuation are:

  • The stock exchange price of the shares of the two companies before the commencement of negotiations or the announcement of the bid.
  • Dividends paid on the shares.
  • Relative growth prospects of the two companies.
  • In case of equity shares, the relative gearing of the shares of the two companies.
  • Debenture stock to the amount of issued ordinary share capital.
  • Net assets of the two companies.
  • Voting strength in the merged enterprise of the shareholders of the two companies.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 30.
Whatever may be the degree of complexity and method of satisfaction, valuation is always an estimate – Explain citing principles to be kept in mind for valuation. (June 2019, 5 marks)
Answer:
Valuation is guessing with tact and intelligence. Different methods are adopted to record the price as near as possible on actual disposal. Certain principles need to be borne in mind before finalising Valuation Report. Report may be required for specific assets or may be for whole business or undertaking.

In case of whole business or undertaking the past data on segment performance is required to be commented and taken into consideration. Valuation as per the report is taken as successful when the fair market value is arrived at the satisfaction of the seller company and the buyer company is willing to pay if it is beneficial to owners.

Broadly following principles are to be kept in mind for valuation: Principle of Time Value of Money:
This principle suggests that the value can be measured by calculating the present value of future cash flows discounted at the appropriate discount rate.

Principle of Risk and Return:
This principle believes that the investors are basically risk averse and on the other hand expects higher amount of wealth. Higher the risk, higher may be possibility of return and vice versa.

Principle of Substitution:
This principle believes that understanding the market with competitive forces is very important in order to decide the price consideration. The risk averse investor will not pay more than that of the substitute available in the market.

Principle of Alternatives:
This principle suggests that one should explore the various alternatives available in the market and should not rest only on one option. The benefits of vetting of various alternatives will give a comparative valuation and a prudent investor will choose the most beneficial alternative to his portfolio.

Principle of Expectation:
Cash flows are based on the expectations about the performance in future and not the past. In the case of mature companies, we may assume that the growth from today or after some certain period would be constant.

Principle of Reasonableness:
In valuation the principle of reasonableness is most important. It takes into consideration various aspects viz. nature of business, historical background, brand image, book value of the stock, earning capacity, dividend track record, etc.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 31.
“A business valuation involves logical application/ analysis of historical future tangible and intangible attributes of business”. Do you agree with this statement? What are the aspects involved in the preliminary study of valuation? (De 2019, 5 marks)
Answer:
Yes, the statement is true and agreeable.
The preliminary study to valuation involves the following aspects:

  1. Purpose of valuation.
  2. Goodwill/Brand name in the market.
  3. Business environment of the entity to be valued.
  4. Estimation/forecast of future cash flows as accurately as possible.
  5. Is company listed on any stock exchange?
  6. If listed, whether shares of the company are traded frequently?
  7. The industry to which the concerned entity belongs to.
  8. The industry P/E ratio, past and future growth rate.
  9. Who are the competitors locally and globally?
  10. Whether any similar valuation has been done recently
  11. The technology concerning the enterprise and its probability of obsolescence.
  12. The accepted discounting rate.
  13. Market capitalization aspects.
  14. Identification of hidden liabilities through analysis of material contracts.
  15. Last years audited balance sheets.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 32.
“Profitability of any business is sensitive to several factors that prompts the analyst to prepare Sensitivity Analysis to help in Management decisions.” Comment. (Aug 2021, 5 marks)
Answer:
Financial performance of any business depends on many factors. The needs of the customer with respect to the product or service are a major factor. Market competition is another factor. Government policies may change cost and hence the price. The product may face obsolescence due to new technologies. Cheaper alternatives may affect the customer preference.

Thus, the profitability of any business may be sensitive to any of the factors. If we take these factors as independent variables, then given a change in or more of the variables affect the profitability. This technique is known as “Sensitivity Analysis”.

This technique can also be used to test the validity of any model. For example, in business valuation, there are variables such as discount rate, future growth rate, market share, beta value, required rate of return, etc. Each of these factors can be varied to test the business valuation model.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 33.
When indirect acquisition is treated as direct acquisition as per SEBI (SAST) Regulation, 2011 ? (Dec 2021, 3 marks)
Answer:
As per Regulation 5(2) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 indirect acquisition will be treated as direct acquisition when:

  1. the proportionate net asset value of the target company as a percentage of the consolidated net asset value of the entity or business being acquired;
  2. the proportionate sales turnover of the target company as a percentage of the consolidated sales turnover of the entity or business being acquired; or
  3. the proportionate market capitalisation of the target company as a percentage of the enterprise value for the entity or business being acquired;

is in excess of eighty per cent, on the basis of the most recent audited annual financial statements, such indirect acquisition shall be regarded as a direct acquisition of the target company for all purposes of these regulations including without limitation, the obligations relating to timing, pricing and other compliance requirements for the open offer.

For the purposes of computing the percentage referred to in clause (c) of this subregulation, the market capitalisation of the target company shall be taken into account on the basis of the volume-weighted average market price of such shares on the stock exchange for a period of sixty trading days preceding the earlier of, the date on which the primary acquisition is contracted, and the date on which the intention or the decision to make the primary acquisition is announced in the public domain, as traded on the stock exchange where the maximum volume of trading in the shares of the target company are recorded during such period.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 34.
List out the various approaches in practice to find out value of shares of each entity post demerger. (Dec 2021, 3 marks)
Answer:
In a demerger, a company splits into tvvo different entities. So the valuation of each entity is estimated- on a standalone basis and the relative value as a ratio is arrived at. The following are the approaches in practice to find out value of shares of each entity post de-merger:

  1. Asset based approach
    (a) Net asset value
  2. Income based approach
    (a) Discounted cash flow method
    (b) Earnings capitalisation
    (c) Excess earnings method
    (d) Incremental cash flows method
  3. Market based approach
    (a) Market price
    (b) Comparable transaction multiple.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 35.
“The valuation of shares is not only a question of facts, but also arises out of technical & complex issues.” Comment and analyse with the help of decided case laws. (June 2022, 5 marks)

Question 36.
Often reputed companies appoint joint valuers for fair valuation of the company. Explain the procedure and purpose of joint valuation. (June 2022, 5 marks)

Question 37.
The shares of XYZ Ltd. are listed on more than one stock exchange. On 3rd February, 2014, its share was quoted @ ₹ 100 per share in Bombay Stock Exchange and @ ₹ 90 per share in National Stock Exchange. The company issued 10,000 sweat equity shares on the same date @ ₹ 90 to Anand. Examine whether the transaction violates SEBI (Issue of Sweat Equity) Regulations, 2002. (June 2014, 5 marks)
Answer:
Under the SEBI (Issue of Sweat Equity) Regulations, 2002, the price of sweat equity shares shall not be less than the higher of the following:
(a) The average of the weekly high and low of the closing prices of the related equity shares during last six months preceding the relevant date; or

(b) The average of the weekly high and low of the closing prices of the related equity shares during the two weeks preceding the relevant date. “Relevant date” for this purpose means the date which is 30 days prior to the date on which the meeting of the General Body of the Shareholders is convened, in terms of clause (a) of Sub-section (1) of Section 54 of the Companies Act.

  1. If the shares are listed on more than one stock exchange, but quoted only on one stock exchange on the given date, then the price on that stock exchange shall be considered.
  2. If the share price is quoted on more than one stock exchange, then the stock exchange where there is highest trading volume during that date shall be considered.
  3. If shares are not quoted on the given date, then the share price on the next trading day shall be considered.

As per the sweat equity regulations, the intellectual property or the value addition in respect of which the company intends to issue the sweat equity should also be valued in accordance with valuation requirements contained in the said regulations.

Considering the above provision issuing of sweat equity shares @ ₹ 90 violates SEBI (issue of Sweat Equity) Regulations 2002.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 38.
(a) Anay Infrastructure Ltd. (AIL) wants to acquire entire business of Pranav Land Ltd. (PLL). AIL has 6,00,000 equity shares and PLL has 4,00,000 equity shares with market value of ₹ 60 and ₹ 40 respectively. Their respective EPS is ₹ 8 per share and ₹ 4.50 per share. It is proposed to give one share of AIL to the shareholders of PLL in the ratio of two shares .held in PLL.
Based on the above, you are required to —
(i) Calculate the EPS after the acquisition of the company; and
(ii) Show the impact on EPS for the shareholders of both the companies. (June 2014, 5 marks)

(b) Bhupen India Ltd. (BIL) is a listed company and the Board of directors of BIL has authorised Managing Director for evaluating the proposal for acquisition of Sahil India Ltd. (SIL). The financial positions of BIL and SIL are given below :
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 1
BIL is willing to pay ₹ 3,32,000 in cash for the acquisition of SIL. If SIL’s market price reflects only its value as a separate entity, calculate the cost of acquisition when acquisition is financed by cash. Give your comment, what would be the impact on shareholders of BIL when the cost of acquisition becomes negative. (5 marks)
Answer:
(a) Calculation of EPS after acquisition of the Company
Total Earnings after acquisition – i.e. [6,00,000 × ₹ 8 (EPS)] + [4,00,000 × ₹ 4.50 (EPS)] ₹ 66,00,000
Total number of equity shares after acquisition:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 2

Impact of EPS for shareholders of both the companies
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 3
Therefore, there is an increase of ₹ 1,50,000 in total earnings of AIL and decrease of ₹ 1,50,000 in total earnings of PLL after acquisition.

(b) When the acquisition is financed by cash then cost of acquisition = (Cash -Market Value of Target Company)+ (Market Value of Target Company – True or Intrinsic Value of the Target Company)
Cash offered for acquisition : ₹ 3,32,000
Market Valued of Target Company (SIL) : ₹ 2,16,000
Cost of acquisition would be as follows, assuming that market value and intrinsic value is same:
Cost of acquisition = 3,32,000 – 2,16,000
Cost of acquisition = ₹ 1,16,000
if the cost of acquisition becomes negative, shareholders of BIL would be benefited, by acquiring SIL in terms of market value.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 39.
Balance sheets of Fair Deal Ltd. (FDL) and Genuine bosmetics Ltd. (GCL) as on 31st March, 2013, i.e., the date on which the companies were amalgamated and a new company Well Worth Ltd. (WWL) was formed are as follows:

Balance sheets as on 31st March, 2013
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 4
The fixed assets of FDL were valued at 10000 thousand and that of GCL were valued at ₹ 9,000 thousand. WWL would issue the requisite number of equity shares of ₹ 10 each at 50% premium to discharge the claim of equity shareholders of FDL and GCL. How many shares of WWL should be issued to takeover the business of the two merging companies? (Dec 2014, 5 marks)
Answer:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 5
Total Value of Net Assets = 11.500 + 11,000 = 22,500
WWL is issuing shares of ₹ 10 each with 50% premium (i.e. ₹ 5 Premium on each share)
No. of shares to be issued by WWL Ltd. = 22,500 / 15 = 1 ,500 thousands shares

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 40.
Zen Ltd. has earned a profit of ₹ 40,00,000 before tax for the year ended 31st March, 2014. Tax amounts to ₹ 11,40,000. The share capital of the company is ₹ 60,00,000 (4,00,000 equity share of ₹ 10 each and 2,00,000, 7% preference shares of ₹ 10 each). Compute earnings per share (EPS) of Zen Ltd. (June 2015, 5 marks)
Answer:
Profit before tax : ₹ 40,00,000
Tax : ₹ 11,40,000
Preference dividend : ₹ 1,40,000
Profit after tax available for equity shareholder : ₹ 27,20,000
Equity share : ₹ 40,00,000 (4,00,000 equity shares of ₹ 10 each)
Preference share : ₹ 20,00,000 (2,00,000 equity shares of ₹ 10 each)
Earning per share = Profit available for equity shareholder/Equity shares
Earning per share = ₹ 27,20,000/ 4,00,000 =
EPS = 6.8

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 41.
Blue Ltd. and Moon Ltd. have agreed to amalgamate to form a new company Blue Moon Ltd. After negotiation, the two companies have decided on the balance sheets as given below: (June 2015)
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 6
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 7
The assets and liabilities are taken over by Blue Moon Ltd. Compute the total number of shares of the Blue Moon Ltd. having a value of ₹ 10 each to be issued to the shareholders of Blue Ltd. and Moon Ltd. using net asset value method. (5 marks)
Answer:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 8

Question 42.
The share capital of Suraj Ltd. is ₹ 1,00,00,000 (60,000 equity shares of ₹ 100 each and 4,00,000,12.5% preference shares of ₹ 10 each). The company has earned a profif of ₹ 65,00,000 after payment of 35% income-tax amounting to ₹ 35,00,000. Calculate earnings per share (EPS) of Suraj Ltd. (Dec 2015, 5 marks)
Answer:
Equity shares = 60000 equity shares of ₹ 100 each
12.5% Preference shares = 4,00,000 preference shares of ₹ 10 each
Profit after tax = ₹ 65,00,000
Less Preference dividend – (12.5% of ₹ 40,00,000) = ₹ 5,00,000
Profit available for equity shareholders = 65.00,000 – 5,00,000
= ₹ 60,00,000
Earnings per share = ₹ 60,00,000/60,000 = 100

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 43.
(a) The Wind Urja Ltd. (WUL) is a closely held unlisted company with financial details as under: (Dec 2015)
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 9
Worldwide Wind Energy Ltd. (WWEL) is ready to take over WUL by paying 35% premium over the market value of assets and liabilities as goodwill. Calculate the price which WWEL is ready to pay to shareholders of WUL. (5 marks)

(b) You are a Company Secretary of Modern India Ltd., which is planning to go for an IPO. The Managing Director of your company asked you to advise about the differential pricing norms necessary to be followed by the issuer company as per the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Advise the company about the conditions for differential pricing. (5 marks)
Answer:
(a) Market value of assets and liabilities are as follows:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 10
Premium = 35% of Net market value of assets = 75,35,00,000 × 35%
= 26,37,25,000
Total = 75,35,00,000 + 26,37,25,000 = 1,01,72,25,000

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b) Differential Pricing:
1. The issuer may offer its specified securities at different prices, subject to the following:
(a) retail individual investors or retail individual shareholders or employees entitled for reservation made under regulation 33 may be offered specified securities at a price not lower than by more than ten per cent, of the price at which net offer is made to other categories of applicants, excluding anchor investors;

(b) in case of a book built issue, the price of the specified securities offered to the anchor investors shall not be lower than the price offered to other applicants;

(c) In case the issuer opts for the alternate method of book building in terms of Part D of Schedule XIII, the issuer may offer the specified securities to its employees at a price not lower than by more than ten per cent, of the floor price.

2. Discount, if any, shall be expressed in rupee terms in the offer document.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 44.
Blue Springs Ltd. incorporated a new company namely Defence Springs Ltd. and transferred its defence component division to it on slump sale basis for a lump sum consideration of ₹ 255 lakh. The assets and liabilities of the defence component division are as under:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 11
Calculate the following:
(i) Aggregate value of total assets;
(ii) Book value of net assets;
(iii) Networth of the defence component division; and
(iv) Capital gains as per section 50B of the Income-tax Act, 1961. (June 2016, 5 marks)
Answer:
In case of slump sale, various figures can be calculated keeping an eye on the provision of Section 50B of the Income Tax Act, 1961.

The desired values are as under:
(i) Aggregate value of total assets = Depreciated value of depreciable assets+ Book value of other assets
Aggregate value of total assets = (410 – 240) + 80 + 30 = 280
Thus, it comes to ₹ 2,80,00,000.

(ii) Book Value of Net Assets = Net Fixed Assets + Current Assets
Book Value of Net Assets =170 + 110 = 280
Thus, it comes to ₹ 2,80,00,000.

(iii) Net Worth of the Defence Component Division = Aggregate value of total assets – Value of liabilities
Net Worth of the Defence Component Division = 280 – 140 = 140
Thus, it comes to ₹ 1,40,00.000.

(iv) Capital Gains as per Section 50B of the Income Tax Act = Net Consideration – Net Worth of the Defence Component Division
= ₹ 255 – 140 = 115.
Thus, it comes to ₹ 1,15,00,000.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 45.
White Chicks Ltd. is listed on Bombay Stock Exchange. The management wishes to issue sweat equity shares to the new Chairman and Managing Director for which extrai-ordinary general meeting is scheduled on 15th July, 2016. (June 2016, 5 marks)

Based on the following information, calculate the minimum value at which sweat equity shares can be issued, and submit your opinion to the management making your own assumptions, wherever required. Substantiate your answer with relevant provisions of SEBI Regulations.
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 12
Answer:
Under the SEBI (Issue of Sweat Equity) Regulations, 2002, the price of sweat equity shares shall not be less than the higher of the following:
(a) The average of the weekly high and low of the closing prices of the related equity shares during last six months preceding the relevant date; or

(b) The average of the weekly high and low of the closing prices of the related equity shares during last two weeks while calculating the minimum price, following assumptions have been made (in ₹)

  1. Share of White Chick Limited is listed only on BSE.
  2. Prices given have been considered on relevant date as per SEBI regulations.
  3. The intellectual property or the value addition for which sweat equity shares are proposed to be issued has been valued as per the provisions of SEBI Regulations.

Following prices are relevant to decide the minimum price at which shares are to be issued:
The average of the weekly high and low of the closing prices of the related equity shares during last six months preceding the relevant date = INR 275.00.
The average of the weekly high and low of the closing prices of the related equity shares during last two weeks preceding the relevant date = INR 314.00
Higher of the two, that is. INR 314/- per share is minimum price at which shares can be issued.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 46.
(a) Gama Pesticide Ltd. (GPL) is taking over Theta Fertilizer Ltd. (TFL). The shareholders of TFL would get 0.8 shares of GPL for each share held by them. The merger is not expected to yield in economies of scale and operating synergy. The relevant data of the two companies are as follows: (Dec 2016)
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 13
You are required to calculate the following in respect of the resultant company after merger —
(i) Earnings per share
(ii) Price-earnings ratio
(iii) Market value per share
(iv) Number of shares; and
(v) Total market capitalisation. (5 marks)

(b) Groves Ltd. and Wood Ltd. decided to merge and a new company Groves Wood Ltd. is formed. Following are the extracts from the financial records of Groves Ltd. and Wood Ltd.:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 14
The assets and liabilities of both the companies, excluding the intangible assets are taken over by Groves Wood Ltd. (new company). Compute the total number of shares to be issued to the shareholders of Groves Ltd. and Wood Ltd. of the face value of f 10 each fully paid-up at a premium of ₹ 10
per share. (5 marks)
Answer:
(a) Premium paid to Theta’s shares shareholders:
Value of each shares in Gama: 0.8 × ₹ 30 = ₹ 24
Value of Theta’s shares before merger = ₹ 20
Premium = ₹ 4
Premium Percentage = 4/20 = 20%
Numbers of shares paid to Theta’s shareholders: 3 × 0.8 = 2.4 crore
Numbers of shares of the combined company = 12 + 2.4
= 14.4 crore
Combined profit after tax (₹ 58 + ₹ 12) = ₹ 70 crore

  1. Combined EPS (70/14.4) = ₹ 4.86
  2. Combined P/E ratio = 6.20 × (58/70) + 5 × (12/70) = 6.00
    Combined firm market capitalization
  3. Market value per share = PIE ratio × EPS 6.00 × 4.86 = ₹ 29.16
  4. Number of shares of the combined company = 12 + 2.4 = 14.4 crore
  5. Capitalisation: MVPs x No. of shares = ₹ 29.16 × 14.4 = ₹ 419.9 crore

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b)
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 15

Question 47.
(a) Bell Limited is planning to merge with (takeover) Ring Limited. The following is the data regarding both the companies: (June 2017)
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 16
What should be the basis of exchange ratio so that the Bell Limited gains? (5 marks)

(b) Swan Limited is the holding company of Duck Limited. Swan Limited wants to merge Duck Limited with it.
Swan Limited holds 30,000 Equity Shares of ₹ 10 each fully paid up in Duck Ltd.
The following details are available with us:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 17
Calculate the no. of shares Swan Ltd. will issue to the shareholders of Duck Ltd. If exchange ratio is on the basis of:
(i) Earning Per Share (EPS)
(ii) Market Price. (5 marks)
Answer:
(a) Step: I
Earnings per share method
Earnings per share (EPS): Profit after taxi Total number of shares

Beil Ltd. Ring Ltd.
EPS (₹) 5 6
(20,00,000/4,00,000) (14,40,000/2,40,000)

No. of shares to be issued to shareholders of Ring Ltd. = 6/5 × 2,40,000 = 2,88,000 shares.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Step: II
Market Price Method
Market Price (₹) 40 24
No. of shares to be issued to shareholders of Ring Ltd. = (Market price of shares of Ring Ltd./ Market price of shares of Bell Ltd.) × Total shares of Ring Ltd.
No. of shares to be issued to shareholders of Ring Ltd. = 24/40 × 2,40,000 = 1,44,000 shares.
Since Bell Ltd. is required to issue half the number of shares to Ring Ltd. under market price method as compared to EPS method. So, Bell Limited should offer exchange ratio on the basis of Market Price.

(b) Step: I
Earnings per share method

Swan Ltd. Duck Ltd.
(i) EPS (₹) 5 3
(25,00,000/5,00,000) (12,00,000/4,00,000)

No. of shares to be issued : 3/5 × 3,70,00* = 2,22,000 shares

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Step: II
Market price method
(ii) Market Prices (₹) 50 25
No. of shares to be issued: 25/50 × ,70,000 = 1,85,000 shares
Note: * Total No. of shares of Duck Ltd. – Shares held by Swan Ltd.: (4,00,000 – 30,000) = 3,70,000.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 48.
Balance Sheet of Smileheavy Ltd. as at 31 -3-2017 reveals as under:

Liabilities Amount in INR
1,50,000 equity shares of ₹ 10/- each fully paid up 15,00,000
2,00,000 equity shares of ₹ 6/- each fully paid up 12,00,000
60,000 12% cumulative preference shares of ₹ 10/-
each fully paid up 6,00,000
Secured Loans                                       . 14,00,000
Trade Payables 6,50,000
Total 53,50,000
Assets Amount in INR
Land and Buildings 23,00,000
Furniture, Fixture and Fittings 3,90,000
Profit and Loss Account Debit Balance 13,00,000
Inventories 8,30,000
Trade Receivables 4;10,000
Balance with Bank 1,20,000
Total 53,50,000

Current value of Land and Buildings is ₹ 30,00,000/-, Furniture, Fixture and Fittings is ₹ 2,50,000/-. Inventory is valued at ₹ 9,11,000/-. Debtors are expected to realise 90% of their book value. You are informed that preference dividend has not been paid for the last 5 years. Calculate the intrinsic value of per equity shares by Net Assets Method. (Dec 2017, 5 marks)
Answer:
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 18
Intrinsic value of each of fully paid-up equity share:
28,00,000/3,50,000 = ₹ 8
Intrinsic value of each partly paid-up equity shares: 8 – 4 = ₹ 4

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 49.
The net profits earned during the last 5 years of XYZ Ltd. was ₹ (in lacs) 42, 47, 45, 39 and 47 respectively on the capital employed during all the period was ₹ 4 Crores. Market peers in the said industry expect 10% return of capital employed.

You are required to calculate the goodwill of XYZ Ltd. using:

  • Capitalization of Average Profit Method and
  • Capitalization of Super Profit Method. (Dec 2017, 5 marks)

Answer:
(i) Capitalisation of Average Profit Method (₹ in lakh)
Average Profits for 5 years: (42 + 47 + 45 + 39 + 47)/5 = ₹ 44

(ii) Capitalisation of Super Profit Method
Average profits as calculated above = ₹ 44,00,000
Less: 10% of the capital employed i.e. 10% of ₹ 4 crore = ₹ 40,00,000
Hence, super profits = ₹ 4,00,000
Valuation of goodwill on Average Profit Method is ₹ 44 lakh
Valuation of goodwill on Super Profit method is ₹ 4 lakh.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 50.
(a) Fast Growth Ltd. gave the following information with a request to calculate the value of each of its equity shares: (June 2018)
(i) Subscribed capital consists of fully paid up shares as follows:
10 lakh 13% Preference shares of ₹ 10 each and
20 lakh Equity shares of ₹ 10 each
(ii) Profit after depreciation but before taxation is ₹ 180 lakh
(iii) Transfer to general reserve ₹ 34.50 lakh
(iv) Provision for taxation is 30%
(v) Expected dividend is 20% for the relevant industry. (5 marks)

(b) Simran Simple Synthetics Ltd. is contemplating to issue Sweat equity shares for their staff in R&D department. Shares are listed on both the exchanges i.e., BSE and NSE. As a Company Secretary, you are tasked with enlightening the Board on the manner of fixing price per Sweat equity share in line with the SEBI regulations. (5 marks)
Answer:
(a) Profit before tax = ₹ 1,80,00,000
Tax = 30% of 180 lakh = ₹ 54,00,000
Profit after tax = ₹ 1,26,00,000
Preference dividend = ₹ 13,00,000
Net income attributable for equity share holders = ₹ 1,13,00,000
Number of shareholders = 20,00,000
Value of each shareholder = 1,13,00,000/20,00,000 = ₹ 5.65 per share.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b) Under the SEBI (Issue of Sweat Equity) Regulations, 2002, the price of sweat equity shares shall not be less than the higher of the following:

(a) The average of the weekly high and low of the closing prices of the related equity shares during last six months preceding the relevant date; or

(b) The average of the weekly high and low of the closing prices of the related equity shares during the two weeks preceding the relevant date. “Relevant date” for this purpose means the date which is 30 days prior to the date on which the meeting of the General Body of the Shareholders is convened, in terms of clause (a) of Sub-section (1) of Section 54 of the Companies Act.

  1. If the shares are listed on more than one stock exchange, but quoted only on one stock exchange on the given date, then the price on that stock exchange shall be considered.
  2. If the share price is quoted on more than one stock exchange, then the stock exchange where there is highest trading volume during that date shall be considered.
  3. If shares are not quoted on the given date, then the share price on the next trading day shall be considered.

As per the sweat equity regulations, the intellectual property or the value addition in respect of which the company intends to issue the sweat equity should also be valued in accordance with valuation requirements contained in the said regulations.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 51.
(a) Despite having a statutory warning by Mutual Fund Companies as “Past performance may or may not sustain in future”, past share market price data is quite often used in equity valuation while investing/acquiring equity and SEBI regulations also take into account weekly highs and lows of such market prices as litmus test. However, there may be certain inherent flaws and/or limitations while going by such market based valuation(s). Highlight to your Board of directors certain possible flaws and limitations in such market price based valuation(s) which may be misleading. (June 2018) (5 marks)

(b) From the following data noticed from published financials, ascertain intrinsic value of equity shares:
Goodwill = ₹ 56,400
Market value of other assets = ₹ 18,00,000
Debentures = ₹ 10,00,000
Trade payables = ₹ 2,50,000
Preference capital = ₹ 2,00,000 and
Equity capital consists of 10000 shares of ₹ 10 each fully paid up. (5 marks)
Answer:
(a) It is important to note that Regulatory bodies have often considered market value as one of the very important basis – Preferential allotment, Buyback, Open offer price calculation under the Takeover Code.

However, Market Price Method is not relevant in the following cases:

  • Due to unusual and significant fluctuations in the market prices of the shares due to many reasons which may include rumors and market sentiments also, valuer cannot believe on this value because it does not actually indicate the fair status of the company’s assets and profitability
  • Where the shares are not listed or are thinly traded.
  • Market price of shares are also affected due to corporate actions like right issue, bonus shares etc, the valuer, therefore, is required to make adjustments in the market prices of the shares accordingly due to such corporate actions.
  • Considering high and low of monthly share prices under market price method is replaced with weighted average market price based on volume and value of each transactions reported at the stock exchange.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(b)

Particulars Amount
Goodwill 56,400
Market value of other assets 18,00,000
Total 18,56,400
Less:
Debentures 10,00,000
Trade Payables 2,50,000
Net Assets 6,06,400
Less: Preference Share capital 2,00,000
Intrinsic value for 10,000 shares 4,06,400
Intrinsic value per share ₹ 40.64

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 52.
The Managing Director of a company decides that his company will not pay any dividend till he survives. His current life expectancy is 20 years. After that time it is expected that the company could pay dividend of ₹ 30 per share indefinitely. At present the company could afford to pay ₹ 5 per share forever. The shareholders of the company expect return on equity @ 10%.
Find out:
(i) What would be the share price at the end of 20 years ?
(ii) What would be the present value of a share using discounting factor of 0.1468 (at 10% for 20 years period)?
(iii) What is the current price of a share if dividend payment is ₹ 5 per share?
(iv) What is the loss to the shareholders in the aforesaid scenario ? (Dec 2018, 5 marks)
Answer:
As per Managing Director’s policy:
(i) The value of the share at the end of 20 years = 30/0.10 = ₹ 300
(ii) The present value of share = 300 × (0.1468) = ₹ 44.04

As per current status of company:
(iii) If the company could pay dividends of ₹ 5 per share forever from the beginning, the current price of share would be = 5/0.10 = ₹ 50.00
(iv) Thus, the loss to each shareholder is the difference of two prices: ₹ 50 – ₹ 44.04 = ₹ 5.96 per share

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 53.
From the following information determine the possible value of brand : (Dec 2018, 5 marks)
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 19
Answer:
Calculation of possible value of brand
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 20
Hence, value of the brand = ₹ 400 lakh

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 54.
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.
Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material 21
The market expectation is 15% from the similar industry. (Dec 2018, 5 marks)
Answer:
(i) Buying a small lot of shares: For this purpose dividend yield method is most appropriate for valuation of shares. For calculation of average dividend, weighted average will be more appropriate since dividend rate is rising:

Year Rate of dividend (%) Weights Products
2015 15 1 15
2016 18 2 36
2017 20 3 60
2018 25 4 100
10 211

Average dividend = 211/10 = 21.10%
Value of a share on the basis of dividend for buying a small lot
= (Average dividend rate/Market expectation) × 100
= (21.10/15) × 100 = ₹ 140.67 per share

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

(ii) Buying a controlling interest in the company: For this purpose, total profit will be relevant to determine the value of shares as the shareholders have the capacity to influence the decision of distribution of profit. As the profit is displaying a rising trend, weighted average will be more appropriate for calculation purposes:

Year Yield (%) = (Profit/capital employed) × 100 Weights Products
2015 7 1 7
2016 8 2 16
2017 10 3 30
2018 12 4 48
10 101

Average yield = 101/1o = 10.10%
Ave:age value per share = (10.10/15) × 100 = ₹ 67.33

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 55.
Sun Ltd. (listed company) has paid dividend of ₹ 10 per share in the current year. The estimated annual growth rate of the dividend is 5% per annum and share price is ₹ 120. Moon Private Ltd. (unlisted company), has paid dividend of ₹ 2 per share. The annual growth rate of the company is estimated to be 10% per annum. Calculate the rate of return of the listed company. Sun Ltd. and apply the same to unlisted company to compute the value of the share of the unlisted company Moon Private Ltd. (Assuming annual growth rate will continue for the future also.) (June 2019, 5 marks)
Answer:
Gordon Growth model provides as under:
P0 = D0(1 + g)/(re – g)
Where:
P0 = Share price
D0 = Current dividend
g = Rate of growth of dividend
re = Rate of return required by the equity shareholders (student may also use Ke instead of re)

Computation of Rate of return required by shareholder of Sun Ltd. (listed company)
By using the following formula rearranged as:
re = D0(1 + g)/P0 + g
Rate of return (re) = 10(1 + 5%)/120 + 5%
= 10 (1 + 0.05)/120 + 0.05 = 0.1375 = 13.75%

Computation of Value of share of Moon Pvt. Ltd.
P0 = D0(1 + g)/(re – g)
Value of share (P0) = 2 (1 + 10%) / (13.75% – 10%)
= 2(1 + 0.1)/(0.1375 – 0.1)
= 2.2/0.0375 = ₹ 58.67 per share

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 56.
Ram Ltd. is considering Merger with Shyam Ltd. Ram Ltd. shares are currently traded at ₹ 20. It has 1,70,000 shares and its Profit After Taxes (PAT) amounts to ₹ 8,50,000. Shyam Ltd. has 40,000 shares having market price of ₹ 15 and its PAT is ₹ 3,00,000.
(a) If the merger goes through by exchange of equity shares and the exchange ratio is based on the current market price, what would be the new earning per share of Ram Ltd.?
(b) Shyam Ltd. wants to ensure earnings available to its shareholders are not reduced due to proposed merger. What would be the exchange ratio in such a case? (Dec 2020, 5 marks)
Answer:
(a) Calculation of New EPS of Ram Ltd.
Number of Equity shares to be issued to shareholders of Shyam Ltd.:
40,000 × 15/20 = 30,000
Total Number of Shares in Ram Ltd. after merger:
1,70,000 + 30,000 = 2,00,000
Total EPS post-merger:
8,50,000 + 3,00,000 = 11,50,000
Thus, EPS post-merger is 11,50,000/2,00,000 = ₹ 5.75

(b) Exchange Ratio with Earning Assurance:
If the exchange ratio is decided with a view to maintain pre-merger EPS of the Transferor Company, shareholders of both the companies should get the same share in earnings as they were getting before the merger.
Pre-merger EPS Ram Ltd. – 8,50,000/1,70,000 = 5
Shyam Ltd. – 3,00,000/40,000 = 7.5
Exchange Ratio: 7.5 /5 = 1.5 or 3 shares in Ram Ltd. for every 2 shares held in Shyam Ltd.
Or 40,000 × 3/2 = 60,000
Total number of Shares after merger: 1,70,000+60,000 = 2,30,000
EPS =11,50,000/2,30,000 = ₹ 5
Earnings for Shareholders of Shyam Ltd. after Merger = 60.000 × 5 = ₹ 3,00,000 that confirms to pre-merger earnings of Shyam Ltd.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 57.
The valuation of NETWORKS LTD. was done by an investment Analyst. Based on an expected free cash flow of ₹ 54 million for the following year and an expected growth rate of 9%, the analyst has estimated the book value of the firm to be ₹ 1800 million. However, he committed a mistake of using the book values of debt and equity.

You do not know the book value weights employed by him but you know that the firm has a cost of equity of 20% and a post-tax cost of debt of 10%. The market value of equity is thrice its book value, whereas the market value of its debt is nine-tenths of its book value. What is the correct value of the firm? (Aug 2021, 5 marks)
Answer:
1800 = \(\frac{54}{(r 0.09)}\) ⇒ r = 0.12 or 12%.
0.12 = [X * 0.20 + (1 – X)* 0.10]
X = 0.20
X is the weight assigned to equity i.e. = 0.20
So, debt / equity = 0.8/0.2 = 4

Since the market value of equity is thrice its book value and the market value of debt is nine-tenths of its book value, the market value weights of equity and debt are:
0.2*3/and 0.8 *0.9 = 0.6 and 0.72
Hence the WACC is:
[(0.6 / 1.32) * 0.20 + (0.72 / 1.32) * 0.10] = 0.1454 or 14.54 %
Hence the value of the firm is:
[54 / (0.1454 – 0.09)] = 974.7 million.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 58.
From the details given below, find out the value of Santosh Ltd. an unlisted company: (Dec 2021, 5 marks)

No. of shares issued and paid up of ₹ 10 each 5,00,000
Current Dividend ₹ 5 per share
Annual Dividend growth rate 10%

Assume that this growth rate will be maintained in future also. The values for similar listed company are as under:

Share price ₹ 120 per share
Current Dividend ₹ 20 per share
Annual Dividend Growth rate 10%

Answer:
Calculation of Value of Santosh Limited:
Step -l (Rate of return of similar Listed Company)
Rate of Return required by shareholders
= {Dividend Current (1+ rate of growth ¡n dividend) / share price] + Rate of growth of dividend
= (20(1+0.10)/ 120] +0.10
= 0.283 or say 28.3%

Step – II (Unlisted Company -Santosh Limited)
Share Price = {Current Dividend (1 + rate of growth in dividend)} / (Rate of Return required by shareholders – rate of growth in dividend}
= {5 (1+0.1)}/{0.283-o.1o}
= 30.05
Value of Santosh Limited = No. of shares × Price per share
= 500000 × .30.05
= ₹ 1,50,25,000.00

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Question 59.
X Ltd. is considering the proposal to acquire Y Ltd. and their financial information is given below:

Particulars X Ltd. Y Ltd.
No. of Equity Shares 1000000 600000
Market price per share (₹) 30 18
Market Capitalization (₹) 30000000 10800000

X Ltd. intend to pay ₹ 1,40,00,000 in cash for Y Ltd., if Y Ltd.’s market price reflects only its value as a separate entity, calculate the cost of merger:
(i) When merger is financed by cash.
(ii) When merger is financed by stock. (Assume that X Ltd. agrees to exchange 5,00,000 shares in exchange of shares in Y Ltd. instead of payment of cash of ₹ 1 ,40,00,000). (June 2022, 5 marks)

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Valuation of Business and Assets for Corporate Restructuring Notes

Business valuation
Valuation is the process of determining the economic worth of a company/business based on its business model and external environment and supported with reasons and empirical evidence.

Valuation Motives

  • Financial
  • Business related
  • Behavioral reasons

Situations Requiring Valuation

  • IPO (initial public offer)
  • Pricing a first issue or a further issue,
  • investment in a joint venture
  • ‘Open offer’ for acquisition of Shares.
  • Introduction of ‘buy back’ or ‘delisting of shares’.
  • In schemes involving mergers/demergers,
  • On directions of Tribunal or Authority or Arbitration Tribunals.

Factors influencing valuation

  • Mix of physical and intangible assets
  • General economic and industry conditions.
  • The stock exchange pricing of shares
  • Dividends paid on the shares.
  • Relative growth prospects of companies.
  • Relative gearing of shares in case of equity shares
  • Net assets of companies.
  • Voting strength in the merged enterprise
  • Past history of share prices of two companies.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Preliminary steps in valuation

  • Purpose of valuation.
  • Goodwill/Brand name in the market.
  • Business environment of the entity
  • Estimation of future cash flows
  • Is company listed on any stock exchange?
  • If listed, whether shares of the company are traded frequently?
  • The industry in which the entity is part of
  • The industry P/E ratio, past and future growth rate.
  • Who are the competitors locally, internationally?
  • Whether any similar valuation has been done recently
  • The technology concerning the enterprise and its probability of obsolescence.
  • Accepted discounting rate.
  • Study of market capitalization aspects.
  • Identification of hidden liabilities through analysis of material contracts.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Methods of valuation

  • Assets-based method
  • Income-based method
  • Market capitalisation method
  • Discounted cash flow method
  • Liquidation value method

Asset based Approach
3 ways to compute:

  • Net book value: Since historical cost does not reflects true value of assets, it may not give correct value
  • Replacement cost
  • Fair value of the assets: Arrive at net realizable value, also called the liquidation value. It is most reasonable and likely to give correct valuation

Income based Approach

  • Value of the business is calculated based on future income flows of the entity.
  • Another variant: market capitalization where net earnings are capitalised.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Cash Flow based Approach

  • Consider growth in the annual dividend paid by the company
  • Also known as the Gordon Growth model
  • Useful for the valuation of an unlisted company
    P0 = D0(1 + g)/(re – g)
    Where: P0 = share price
    g = rate of growth of dividend
    d0 = current dividend
    re = rate of return required by the equity shareholders
    Required rate of return, re = Rf + β(Rm – Rf)

Discounted Cash Flow Method (DCF)

  • Discounting future cash flow projections, from the newly for med company, to its present value.
  • If present value is higher than actual cost of merger, then merger is viable.
  • Present value is calculated using the weighted average cost of capital
    PV = CF1/(1+r) + CF2 / (1+r)2 + …[TCF / (r – g)] / (1+r)n-1

Where,
PV = present value
CF1= cash flow in year 1
r = discount rate
TCF = the terminal year cash flow
g = growth rate assumption in perpetuity beyond terminal year
n = the number of periods in the valuation model including the terminal year
Free cash flows = operating profit + depreciation + amortization of goodwill – capital expenditures – cash taxes – change in working capital.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Profit Multiplier Method or EBIDTA Multiple method
EBIDTA of entity is multiplied by Price/Earnings ratio to arrive at the value

Market Based Approach
Similar business is looked for which has changed hands in the recent past and value the target entity on the same basis

Valuation of Goodwill
Goodwill is the excess of purchase consideration over the fair value of the net assets acquired. Goodwill can be calculated in two ways:
1. Capitalisation of Future Maintainable profit (CFMP) method
Value of Goodwill = CFMP – ACE, where
CFMP – Capitalised value of Future Maintainable Profit
ACE – Average capital employed
CFMP =FMP/NR
FMP – Future maintainable profit
NR – Normal rate of return

2. Capitalisation of Super Profit method
Value of goodwill = (FMP – Normal Profit) / NR
Normal profit = ACE × NR

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Valuation of Intangible Assets
Intangible assets valuation at national level are governed by following legal provisions:

  • Companies Act, 2013, Schedule II
  • Patents (Amendment) Act, 2005 & Patents (Amendment) Rules, 2006
  • Trade Marks Act, 1999 & Trade Marks Rules, 2002
  • Copyright Amendment Act, 2012
  • Indian Accounting Standards (AS 26,14,12,22,19,21)

Valuation is done based on 2 approaches:

  • Income Approach – Discount Cash Flow Models
  • Cost Approach – What it cost to generate the brand value
  • Market Approach

Economic Value Added
EVA reflects the profitability of the enterprise. If positive, means that the enterprise generates true economic profit.
EVA = NOPAT – (INVESTED CAPITAL × WACC)
Where NOPAT – Net operating profit after tax
WACC – Weighted Average Cost of Capital
NOPAT = EBIT (1 – Tax rate)
Where EBIT – Earnings before interest and tax
Invested Capital = (Total assets – non-interest bearing liabilities)
WACC = (Ke × E) + (Kd × D)(1 – Tx)
Where Ke – Cost of equity
E – % of equity in total financing
Kd – Cost of debt
D – % of debt in total financing
Tx – Corporate tax rate
Ke = rf + β (rm – rf)
Where, Ke = Cost of equity
rf = Risk-free rate
rm = Rate of market return,
β = Systematic risk available from the market

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Sensitivity Analysis
Study of change in profitability upon change in variables such as discount rate, future growth rate, market share, beta value, required rate of return is known as“Sensitivity Analysis”

Valuation under SEBI (SAST) Regulations, 2011
As per Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, open offer for acquiring shares under regulation 3, regulation 4, regulation 5 or regulation 6 shall be made at a price not lower than the price determined in accordance with sub regulation (2) or sub-regulation (3), as the case may be.

Valuation and issue of Sweat Equity Shares
Sweat equity shares are issued for consideration other than cash such as technical know-how, brand equity, design, patent or any other intangible asset.

Conditions for issuing sweat equity shares

  • Issue is authorised by special resolution passed by the company;
  • Resolution specifies \number of shares, current market price, consideration, and class of directors or employees to whom such equity shares are to be issued;
  • Not less than one year has, at the date of such issue, elapsed since the date on which the company had commenced business;
  • Where the equity shares of the company are listed on a recognised ptock exchange, the sweat equity shares are issued in accordance with the regulations made by SEBI in this behalf
  • Same rights, limitations, restrictions and provisions will be applicable to them as equity shares

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Valuation of sweat equity shares involves two steps:

  1. Valuation of the share price
  2. Valuation of the intangible asset

Methods for valuation of intangible assets:

  • Historical cost method
  • Replacement cost method
  • Present value of future cash flows method
  • The Lev and Schwartz method

Valuation of stock options under SEBI (ESOP) Guidelines
ESOP or employee stock option scheme means a scheme under which a L company grants employee stock option directly or through a trust.

The value of the share price for ESOP can be determined in two ways:

  • Intrinsic value method
    Intrinsic value of the share = Market price – ESOP exercise price
  • Fair value method
    Black-Scholes formula can be used
    C = SN (d1) – N(d2)Ke – rt
    d1 = In (S/K) +(r + s2/2)t / s.vt
    d2 = d1 – s.vt
    Where:
    C – call premium
    S – current market price
    t – time until option exercise
    K – option striking price
    r – risk free interest
    N – Cumulative normal distribution
    e – exponential term
    s – standard deviation
    In – natural log

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Valuation of shares under SEBI (Delisting of Securities) Guidelines
Regulation 8 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations., the floor price shall be higher of the following:
1. the highest negotiated price per share of the target company for any acquisition under the agreement attracting the obligation to make a public announcement of an open offer;

2. the volume-weighted average price paid or payable for acquisitions, whether by the acquirer or by any person acting in concert with him, during the fifty-two weeks immediately preceding the date of the public announcement;

3. the highest price paid or payable for any acquisition, whether by the acquirer or by any person acting in concert with him, during the twenty six weeks immediately preceding the date of the public announcement;

4. the volume-weighted average market price of such shares for a period of sixty trading days immediately preceding the date of the public announcement as traded on the stock exchange where the maximum volume of trading in the shares of the target company are recorded during such period, provided such shares are frequently traded;

5. where the shares are not frequently traded, the price determined by the acquirer and the manager to the open offer taking into account valuation parameters including, book value, comparable trading multiples, and such other parameters as are customary for valuation of shares of such companies;

6. the per share value computed under Regulation 8(5) of the Takeover Regulations.

The “Discovered Price” is the minimum price per Offer Share payable by the Acquirer for the Offer Shares it acquires pursuant to the Delisting Offer, as determined in accordance with the Delisting Regulations, which will be the price at which the shareholding of the Acquirer Group reaches 90% pursuant to a reverse book building process conducted in the manner specified in Schedule II of the Delisting Regulations and shall not be lower than the floor Price.

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Valuation of Slump Sale under Income-tax Act, 1961
‘Slump sale’ means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. Section 50B of the Income-tax Act, 1961 provides the mechanism for computation of capital gains arising on slump sale:

  • Capital asset was held for more than 36 months preceding the date of transfer
  • Cost of acquisition will be the net worth of the undertaking or division
  • Certificate of Chartered Accountant certifying the net worth will be required to be obtained
    Net worth = WDV of assets – liabilities as per books

Principles and techniques of reporting
Valuation Report exercise is based on the observation, inspection, analysis, and calculation. During this process, the valuer goes through various documents, records his observation, makes relevant calculation and records these calculation and analyses results.

Contents of Summarized Valuation Report

  1. Background Information
  2. Purpose of Valuation and Appointing Authority
  3. Identity of the valuer and any other experts involved in the valuation
  4. Disclosure of valuer Interest/Conflict, if any
  5. Date of Appointment, Valuation Date and Date of Report
  6. Sources of Information
  7. Procedures adopted in carrying out the Valuation
  8. Valuation Methodology
  9. Major Factors influencing the Valuation
  10. Conclusion
  11. Caveats, Limitations and Disclaimers

Valuation of Business and Assets for Corporate Restructuring - CS Professional Study Material

Swap ratio
The ratio at which the acquiring company offers its own shares in exchange for the target company’s shares, is known as the swap ratio.

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