Business Valuation Questions and Answers

SECTION – A

Question 1.
What is valuation/business valuation?
Answer:
Valuation is the process, of determining the current worth of an asset or a company; there are many techniques used to determine value. An analyst placing a value on a company looks at the company’s management, the composition of its capital structure, the prospect of future earnings and market value of assets.

Question 2.
What is Share?
Answer:
Shares are units of ownership interest in a corporation or financial asset that provide for an equal distribution in any profits, if any are declared, in the form of dividends. The two main types of shares are common shares and preferred shares.

Question 3.
What is the efficient market hypothesis?
Answer:
The efficient market hypothesis is the hypothesis that the stock, market reacts immediately to all the information that is available. Three forms of the efficient market hypothesis can explain the theory behind share price movements.

SECTION – B

Question 1.
Explain the Nature and purpose of the valuation of business.
Answer:
The Nature and Purpose of Business Valuations:
(A) When valuations are required – A share valuation will be necessary:
(a) For quoted companies, when there is a takeover bid and the offer price is an estimated fair value in excess of the current market price of the shares.

(b) For unquoted companies, when:

the company wishes to go public and must fix an issue price for its shares.
there is a scheme of merger.
shares are sold.
shares need to be valued for the purposes of taxation.
shares are pledged as collateral for a loan.

(c) For subsidiary companies, when the group’s holding company is negotiating the sale of the subsidiary to a management buyout or to an external buyer.

(d) For any company, where a shareholder wishes to dispose of his or her holding.

(e) For any company, when the company is being broken up in a liquidation situation or the company needs to obtain finance, or re-finance current debt.

(B) Information requirements for valuation: There is wide range of information that will be needed in order to value a business.

Financial statements: statement of financial positions, income statements, statements of shareholders equity for the past five years.
Summary of non-current assets list and depreciation schedule.
Aged accounts receivable summary.
Aged accounts payable summary.
List of marketable, securities.
Inventory summary.
Details of any existing contracts, e.g. leases, supplier agreements.
List of shareholders with number of shares owned by each.
Budgets or projections, for a minimum of five years.

Question 2.
Explain the Net Assets Method of valuation of Share.
Answer:
Net assets method of valuation of share:
Under this method, the net value of assets of the company are divided by the number of shares to arrive at the value of each share. For the determination of net value of assets, it is necessary to estimate the worth of the assets and liabilities. The goodwill as well as non-trading assets should also be included in total assets. The following points should be considered while valuing of shares according to this method:

Goodwill must be properly valued.
The fictitious assets such as preliminary expenses, discount on issue of shares and debentures, accumulated losses etc. should be eliminated.
The fixed assets should be taken at their realizable value.
Provision for bad debts, depreciation etc. must be considered.
All unrecorded assets and liabilities ( if any) should be considered.
Floating assets should be taken at market value.
The external liabilities such as sundry creditors, bills payable, loan, debentures etc. should be deducted from the value of assets for the determination of net value.

The net value of assets, determined so has to be divided by number of equity shares for finding out the value of share. Thus the value per share can be determined by using the following formula: Value Per Share=(Net Assets- Preference Share Capital)/Number Of Equity Shares.

Question 3.
Explain the Market Value Method of valuation of Share.
Answer:
Market value method of valuation of shares:
The expected rate of return in investment is denoted by yield. The term “rate of return” refers to the return which a shareholder earns on his investment. Further it can be classified as (a) Rate of earning and (b) Rate of dividend. In other words, yield may be earning yield and dividend yield.
(a) Earning Yield:
Under this method, shares are valued on the basis of expected earning and normal rate of return. The value per share is calculated by applying following formula:
Value Per Share = (Expected rate of earning/Normal rate of return) x Paid up value of equity share
Expected rate of earning – (Profit after tax/paid up value of equity share) x 100

(b) Dividend Yield:
Under this method, shares are valued on the basis of expected dividend and normal rate of return. The value per share is calculated by applying following formula:
Expected rate of dividend – (profit available for dividend/paid up equity share capital) x 100
Value per share = (Expected rate of dividend/normal rate of return) x 100

Question 4.
Explain the Earning Capacity Method of valuation of Share.
Answer:
Earning capacity method of valuation of shares:
Under this method, the value per share is calculated on the basis of disposable profit of the company. The disposable profit is found out by deducting reserves and taxes from net profit. The following steps are applied for the determination of value per share under earning capacity:
Step 1: To find out the profit available for dividend

Step 2: To find out the capitalized value
Capitalized Value =( Profit available for equity dividend/Normal rate of return) x 100

Step 3: To find out value per share
Value per share = Capitalized Value/Number of Shares
The valuation of debt and other financial assets

Question 5.
Write short note on efficient market hypothesis.
Answer:
The efficient market hypothesis is the hypothesis that the stock market reacts immediately to all the information that is available. Three forms of the efficient market hypothesis can explain the theory behind share price movements. These are:

Weak form efficiency:
Weak form efficiency implies that prices reflect all relevant information about past price movements and their implications. Share prices reflect all available information about past changes in the share price. Since new information arrives unexpectedly, changes in share prices should occur in a random fashion. Technical analysis to study past share price movements will not give anyone an advantage, because the information they use to predict share prices is already reflected in the share price.

Semi-strong form efficiency:
Semi-strong form implies that share prices reflect all relevant information about past price movement and their implications, and all knowledge that is available publicly. Therefore, an individual cannot beat the market by reading the newspaper or annual reports since the information contained in these will be reflected in the share price.

Strong form efficiency:
This implies that prices reflect past price movements, publicly available knowledge and inside knowledge.

What are the different types of efficiencies in the context of the operation of financial markets?
1. Allocative efficiency: Allocative efficiency can be achieved if financial markets allow funds to be directed towards firms that make the. most productive use of them.

2. Operational efficiency: Operational efficiency can be achieved if there is open competition between brokers and other market participants so that transaction costs are kept as low as possible.

3. Informational processing efficiency: Information processing efficiency of a stock market can be achieved if the stock market is able to price stocks and shares fairly and quickly because market prices of all securities reflect all the available information.

Question 6.
State the features of efficient market.
Answer:
Features of an efficient market:

The prices of securities bought and sold reflect all the relevant information that is available to buyers and sellers.
No individual dominates the market.
Transaction costs of buying and selling are not so high as to discourage trading significantly.
Investors are rational.
There are low to no costs of acquiring information.