Page 281 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

Notes open market the investors (buyers and sellers) are more concerned and influenced by the rate of
earning than by complicated calculation of net assets. In such a situation, earning can be taken
as the basis for the valuation of shares. In this method, shares can be valued on the following
basis:
(a) Valuation of Shares Based on Rate of Dividend: From the point of view of a holder of
a small number of shares, this method is suitable because the small investors are only
interested in the dividend (or earning) that the directors of a company have declared. The
small investor is primarily interested in the profits or return on his invested amount and
price of investments (shares) which he would pay for, would depend upon the amount of
profit (dividend) that he can expect. Thus, in this method the value of shares is computed
by comparing the rate of dividend and normal rate of return. To ascertain the market value
of the share, the following formula is used:

ExpectedRateof Dividend
Value per share = × Paid-up Value of the Share.
NormalRateof Return
Or
DividendperShare
Value per share = ×100
NormalRateof Return
Expected Rate of Dividend: To compute the value of the shares on the basis of rate of dividend,
it is necessary to find out the rate of dividend on shares. From the point of view of small
investors, generally the latest rate of dividend is taken. If rates of dividend of the previous
years are given, average rate of dividend of these rates is taken. In the case of constant
increase or decrease in the rates of the dividends, weighted average of rates should be
taken. If in a question, the rate of dividend is not given, it can be calculated on the basis
of distributed profits available for equity shareholders’ dividend. The distributable profits
available for equity shareholders’ dividend should be taken after payment of income tax,
transfer to reserve and payment of preference dividend. For expected rate of dividend, the
formula will be:

Divident Profits to Equity Shares
Expected Rate of Dividend = ×100
Paid-up equity Share Capital
Or

Dividendper sharein `
Expected Rate of Return = ×100
Paid-up valueper share
Normal Rate of Return: This is that rate of earning which is generally expected by the investors
on their investments in a particular type of industry. This rate may differ from industry
to industry. The normal rate of return has been discussed in the chapter “Valuation of
Goodwill”. In the light of normal rate of return, some other factors are also being mentioned
below:
(i) If there is uniformity in the rate of dividend of the company, investors may be
satisfied with the lower normal rate of return. When the rates of dividend have been
fluctuating, investors expect a higher normal rate of return.
(ii) If there is restriction on the transfer of shares as per the Articles of Association
of a Company, for the valuation of shares of such a company, the normal rate of
return should be slightly increased. Increase of 0.5% to the normal rate of return is
considered reasonable.

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