QUESTIONS AND

ANSWERS
BUSINESS VALUATION
ICAG‟S ADVANCED FINANCIAL REPORTING
 May 2013 Q4.
• Quality Handicraft Ltd [QHL] produces handicrafts
for both local and foreign market.
• The company was incorporated in the year 2008 and
now employs about 150 craftsmen.
The shareholders of QHL mainly comprise the original
founder and close family members who would now like
to realize their investment.
• In order to arrive at an estimate of what they
believe the business is worth, they have
identified a long established quoted company,
Suama Handicraft Company [SHC] which has
similar business, though it also produces for the
European market.
• Summarized financial statistics for the two
companies for the most recent financial year are
as follows:
 QHL SHC
• Issued shares (million) 8.0 20
• Net assets value [GHC ‟million] 14.4 30
• Earnings per share (pesewas) 35.0 28
• Dividend per share (pesewas) 20.0 24
• Debt: Equity ratio 1:7 1:6.5
• Share price (as quoted on the stock market) - 160Gp
• Expected rate of growth in earnings/dividends 5% 5%
 Additional Information
i. The net assets of QHL stated above are the net book
values of tangible non-current assets plus working capital.
However:
• A recent valuation of the buildings was GHC1,500,000
above book value
• An investment held which is designated as available for
sale with a carrying value of GHC1,000,000 is fair
valued at GHC1,100,000
• Due to a dispute with one of their clients, an additional
allowance for bad debts of GHC750,000 could prudently be
made.
• An item of plant with a carrying value of GHC800,000 is
assessed to have value-in-use of GHC760,000 and fair value less
cost to sell of GHC780,000.
ii. Growth rate should be assumed to be constant per
annum. QHL‟s earnings growth rate estimate was
provided by the marketing manager, based on
expected growth in sales adjusted by normal profit
margins. SHC‟s growth rates are gleaned from press
reports.
iii. The dividend yield of SHC approximates its cost
of equity.
 Required:
a. Compute a range of valuations for the business of
QHL, using the information available and stating any
assumptions made. Use the following methods for the
valuation (Net Assets, Price-earning method and
dividend growth methods)
b. Comment on the strengths and weaknesses of the
methods used in (a) and their suitability for valuing
QHL
• Note: The additional information (i)
may affect the net asset value and the
earnings per share stated above. Ignore
tax implications.
 SOLUTION
Net Assets Method GHC‟000
• Net Assets as per the draft account 14,400
• Adjustments:
• Revaluation surplus –buildings 1,500
• Fair valuation surplus –AFSFA 100
• Allowance for doubtful debts (750)
• Impairment loss (20)
• Value of business 15,230
 Price earnings Ratio Method
• Value of business = Earnings x PE Ratio
• Earnings GHC‟000
• Per draft accounts [GHC0.35 X 8 m shares] 2,800
• Adjustments
• Allowance for doubtful debts (750)
• Impairment loss (20)
2,030
PE Ratio
• Taken that the PE Ratio of the unlisted entity must be
adjusted for lack of marketability and higher risk
• PE Ratio of SHC = 160p/28 p =5.7
• Adjusted to say 4
• Value of business = GHC2,030,000×4
= GHC8,120,000
 Dividend Growth method
• Value of business = Do(1+g)/(DY-g)
• Do = GHS0.20 X 8,000,000 shares = GHC1,600,000
• DY = that of listed entity (appropriately adjusted)
= 24p/160p =15%
• Adjusted to say 20%
GHC1,600,000× 1.05
• Value of business = 0.20 – 0.05

= GHC1,680,000/0.15
= GHC11,200,000
Summary GHC
• PE Ratio 8,120,000
• Dividend growth 11,200,000
• Net Assets 15,230,000
 b. Comment on relative merits of the
methods used, and their suitability
• Asset Based Valuation
• Valuing a company on the basis of its asset values alone is rarely appropriate
if it is to be sold on a going concern basis. Exceptions would include
property investment companies and investment trusts, the market values of
the assets of which will bear a close relationship to their earning capacities.
• Knowledge of the Net Asset Value (NAV) of
a company will, however, be important as a
floor value for a company in financial
difficulties or subject to a takeover bid.
• Shareholders will be reluctant to sell for less
than the net asset value even if future
prospects are poor.
 P/E Ratio Valuation
• The P/E ratio measures the multiple of the current year’s earnings that is
reflected in the market price of a share.
• It is thus a method that reflects the earnings potential of a company from a
market point of view.
• Provided the market is efficient, it is likely to give the most meaningful basis
for valuation.
• One of the first things to say is that the market price of a share at
any point in time is determined by supply and demand forces
prevalent during small transactions, and will be dependent upon a
lot of factors in addition to a realistic appraisal of future prospects.
• A downturn in the market, economies and political changes can all
affect the day-to-day price of a share, and thus its prevailing P/E
ratio.
• It is not known whether the share price given for SHC was taken on
one particular day, or was some sort of average over a period.
• The latter would perhaps give a sounder basis from which to
compute a applicable P/E ratio.
• Even if the P/E ratio of SHC can be taken to be indicative
of its true worth, using it as a basis to value a smaller,
unquoted company in the same industry can be
problematic.
• The status and marketability of shares in a quoted
company have tangible effect on value but these are
difficult to measure.
• The P/E ratio will also be affected by growth prospects –
the higher the growth expected, the higher the ratio.
• The growth rate incorporated by the shareholders
of SHC is probably based on a more rational
approach than that used by QHL.
• In the valuation in (a) a crude adjustment has been
made to SHC‟s P/E ratio to arrive at a ratio to use
to value QHL‟s earnings.
• This can result in a very inaccurate result if
account has not been taken of all the differences
involved.
 Dividend Based Valuation
• The dividend valuation model (DVM) is a cash flow based
approach, which valued the dividends that the shareholders expect
to receive from the company by discounting them at their required
rate of return.
• It is perhaps more appropriate for valuing a non-controlling
shareholding where the holder has no influence over the level of
dividends to be paid than for valuing a whole company, where the
total cash flows will be of greater relevance.
• The practical problems with the dividend valuation
model lie mainly in its assumptions.
• Even accepting that the required „perfect capital
market‟ assumptions may be satisfied to some extent, in
reality, the formula used in (a) assumes constant growth
rates and constant required rates of return in perpetuity.
• Determination of an appropriate dividend yield/cost of equity is
particularly difficult for an unquoted company, and the use of an
„equivalent‟ quoted company‟s data carries the same drawbacks as
discussed above.
• Similar problems arise in estimating future growth rates and the results
from the model are highly sensitive to changes in both these inputs.
• It is also highly dependent upon the current year‟s dividend being a
representative base from which to start.
• The dividend valuation model valuation provided in (a) results in a higher
valuation than that under the P/E ratio approach.
 Reasons for this may be:
i. The share price of SHC may be currently depressed below
its normal level, resulting in an inappropriate low P/E ratio.
ii. The dividend yield/cost of equity used in the dividend
valuation model was that of SHC. The validity of this will
largely depend upon the relative levels of risk of the two
companies. Although they both operate the same type of
business, the fact that SHC sells its material externally
means it is perhaps less reliant on a fixed customer base.
iii. The adjustment to get to an appropriate P/E ratio for
QHL may have been too harsh, particularly in light of its
apparently better growth prospects.
iv. Even if business risks and gearing risk may be thought to
be comparable, a prospective buyer of QHL may consider
investment in a younger, unquoted company to carry greater
personal risk. His required return may thus be higher than
that envisaged in the dividend valuation model, reducing the
valuation.
• November 2012
 Dagadu Ltd
• Dagadu Ltd is an unlisted private company, which deals in
computer and other ICT equipment. On 1st March, 2012, a
shareholder-director, Mr Kusi, informed you that he was
contemplating disposing of his shares. The regulations of
the company require him to offer his shares first to his
fellow shareholders. If none offers a reasonable price, he
may seek an outside purchaser.
• You have been given the financial statements of the
company as follows:
 Income Statements for year to 31st December
Projected
2010 2011 2012
GHC000 GHC000 GHC000
• Sales 10,800 12,000 13,200
• Cost of sales 8,820 9,900 10,683
• Gross profit 1,980 2,100 2,517
Other trading costs 750 900 990
Net trading costs 1,230 1,200 1,527
Interest payables:
15% Debentures - 144 144
Bank overdraft 75 0 0
Net profit before tax 1,155 1,056 1,383
Taxation 600 540 720
Net profit for the year 555 516 663
Dividends:
10% Cum Preference shares 60 60 60
Ordinary shares 240 300 300
Retained earnings for the year 255 156 303
The statements of financial position as at the end of
2012
Projected
2010 2011 2012
GHC000 GHC000 GHC000
• Non-current assets 2,115 2,220 3,135
• Current assets 2,982 3,609 4,206
Total Assets 5,097 5,829 7,341
Less Liabilities
Current liabilities (1,344) (840) (1,365)
Net Assets 3,753 4,989 5,976
 Financed by:
10% Cum Pref shares issued @ GHC3 600 600 600
• Ordinary shares 1,200 1,500 1,500
• Capital surplus 900 600 600
• Income surplus 1,032 1,248 2,226
3,732 3,948 4,926
• 15% Debenture (redeemable 2016) 750 750
• Deferred taxation 21 291 300
3,753 4,989 5,976
 Additional information:
1. Changes in the stated capital over the last three years are as follows:
• Issued for cash at 1/1/2009:
• 200,000 10% Cumulative Preference Shares issued at GHC3 fully paid and
250,000 ordinary shares issued at GHC3 fully paid.
• Issued for cash at 1/1/2010:
• 150,000 ordinary shares issued at GHC3 fully paid.
• Bonus issue at 1/1/2011:
• 100,000 ordinary shares issued at GHC3 per share, fully paid by capitalising
from Capital Surplus Account and ranking for dividend in 2011 and thereafter.
2. The ordinary shares carry one vote each at general meetings. The
preference shares do not carry votes unless their dividends are in
arrears when each share carries one vote.
• Statistics selected from similar listed company include the
following:
• Earning per share GHC0.60
• Market capitalisation GHC2,700,000
• No. of shares 450,000
• Dividend pay-out ratio 80%
Assume that investment in unlisted entity is
20% more risky than investment in quoted
securities.
 Required:
a. Estimate the range of prices per share that Mr Kusi can reasonably
expect to realise from the sale of his 50,000 ordinary shares to his fellow
shareholders using the following methods:
• Dividend Yield
• Earnings Yield
• Net Assets (12 marks)
b. Estimate the highest price per share that he can reasonably obtain
from an outside purchaser. (2 marks)
 SOLUTION: Dagadu Ltd
i. Dividend Yield Method
Dividend per share
• Price per share =
Appropriate Dividend Yield
Gross Dividend 300,000
• Dividend per share =
No of Ordinary Shares
=
500,000
=
GHC0.60
• Assuming a yield similar to that a comparable listed entity and
discounted by 20%
GHC0.48
• Dividend yield = GHC600
× 100 = 8% raised by 20% = 9.6%
 GHC0.60
• Hence, Price per share = 9.6%
= GHC6.25
• Therefore, Value of 50,000 shares
= GHC6.25 × 50,000
= GHC312,500
 ii. Earnings Yield Method
Earnings per share
• Price per share = Appropriate Earnings Yield
Profit after tax less Preference Dividend
EPS =
No of Ordinary Shares
GHC516,000 – 60,000
= = GHC1.206
500,000
495,000 456,000
• Average EPS = (
400,000
+
500,000
)/2
GHC1.2375 : GHC0.912
= = GHC1.075
2
• Using appropriate earnings yield of 12%, (see workings)
GHC0.912
• Current price per share = 0.12
= GHC7.60
• Value of 50,000 ordinary shares = GHC7.60 × 50,000
= GHC380,000
GHC1.26
• Value based on projected earnings = 0.12
× 50,000
= GHC502,500
GHC1.075
• Value based on average earnings = 0.12
× 50,000
= GHC447,917
 iii. Net Asset Basis

2011 Projected
GHC000 GHC000
• Shareholders fund 3,948 4,926
• Less preference shares 600 600
• Net assets of Ordinary Shareholders 3,348 4,326
 GHC3,348 GHC4,326
• Value per share 500 500
= GHC6.7 GHC8.7

Valuation of 50,000 shares GHC335,000 435,000

• The lowest price Mr. Kusi could receive from his
co-shareholders is GHC312,500.
• The highest price that he could receive is
GHC502,500.
 May, 2012
Obuoba Ltd
• Obuoba Ltd is a family controlled company that has grown
over the years. The company is now considering listing on the
Stock Market.
• The MD believes that as the company has assets with a book
value of GHC46 million and shareholders fund GHC24 million,
the company‟s value, when listed should be at least GHC70
million.
• He proposes that 500,000 new shares should be issued to the
public to raise approximately GHC3.5 million for future
expansion
 Income statement for the years ended 31
December
2009 2010 2011
GHC‟000 GHC‟000 GHC‟000
• Sales 40,000 45,000 52,000
• Cost of goods sold 25,000 26,000 29,000
• Gross Profit 15,000 19,000 23,000
• Admin expenses 3,000 4,000 4,500
• Selling and general expenses 1,600 2,600 4,500
• Interest payable 1,400 1,400 2,000
• Net Profit before tax 9,000 11,000 12,000
• Current Taxation @ 20% 1,800 2,200 2,400
• Net profit after tax 7,200 8,800 9,600
 Statement of Financial Position as at 31
December
2009 2010 2011
GHC‟000 GHC‟000 GHC‟000
• Non-current assets
• Property, plant and equipment (Net):
• Land and buildings 15,000 16,000 16,000
• Plant 5,000 6,000 7,000
• Investment (FVTPL) 2,000 2,000
• Current Assets
• Inventory 7,000 7,000 11,000
• Trade Receivables 5,000 8,000 9,000
• Cash 1,000 1,000 1000
33,000 40,000 46,000
• Financed by
• Stated Capital (Issued at GHC0.10 per share)
1,000 1,000 1,000
• Retained earnings 18,000 19,000 23,000
• Shareholders fund 19,000 20,000 24,000
• Long term loans 7,000 7,000 11,000
• Current liabilities
• Trade payables 5,000 10,800 8,600
• Taxation 2,000 2,200 2,400
33,000 40,000 46,000
 Additional notes
• i. Obuoba‟s income statement includes GHC 8 million of
revenue for credit sales made on a “sale or return” basis.
• At 31 December 2011, customers who had not paid for the
goods, had the right to return GHC 2·6 million of them.
• Obuoba applied a mark-up on cost of 30% on all these
sales. In the past, Obuoba‟s customers have sometimes
returned goods under this type of agreement.
ii. The property, plant and equipment have not been depreciated for
the year ended 31 December 2011.
• Obuoba has a policy of revaluing its land and buildings at the end of
each accounting year.
• The values in the above statement of financial position are as at 1
January 2011 when the buildings had a remaining life of 20 years.
• A qualified surveyor has valued the land and buildings at 31
December 2011 at GHS 18 million.
• Additional plant was installed in January 2011. Plant is depreciated
at 20% on the reducing balance basis.
iii. The investments at fair value through profit
and loss [FVTPL] are held in a fund whose value
changes directly in proportion to a specified
market index.
• At 1 January 2011 the relevant index was 150
and at 31 December 2011, it was 162.
iv. In late December 2011, the directors of Obuoba
discovered a material fraud perpetrated by the
company‟s financial accountant that had been
continuing for some time.
• Investigations revealed that a total of GHC 2 million
of the trade receivables as shown in the statement of
financial position at 31 December 2011 had in fact
been paid and the money had been stolen by the
Financial Accountant.
• An analysis revealed that GHC 1·5 million had been stolen
in the year to 31 December 2010 with the rest being stolen
in the current year. Obuoba is not insured for this loss and
it cannot be recovered from the Financial Accountant.
v. During the year taxable temporary differences of GHC
500,000 arose.
• The applicable income tax rate is 20%.
• This has not been included in the figures in the financial
statements above.
vi. The long term loans consists of:
a. 20% GHC 7 million debenture stocks issued on 1 January
2009 and redeemable at par on 31 December 2013; and
b. 15% GHS 4 million loan notes issued on 1 January 2011
and redeemable on 31 December 2012 for GHC4,262,000
resulting in an effective interest rate of 18% per annum.
This Financial liability is to be measured at amortised
cost.
vii. The only movements in the statement of changes in
equity [retained earnings column] in 2011 were the
reported draft profit and dividend payment.
• Obuoba‟s management has obtained some financial
information on a listed company in the same industry,
which has the same number of listed equity shares as
Sankofa.
 Dadeba Ltd
• Market capitalization GHC42 million
• Number of shares 10 million
• Earnings per share GHC0.60
• Dividend pay-out ratio 60%
 Required
a. Assess the validity or otherwise of the Managing Director‟s
statement (5marks)
b. Advise the directors of Obuoba Ltd the values to be placed on an
ordinary share using the following methods:
i. Price Earnings ratio
ii. Dividend yield
iii. Net Assets [fair values] (15 marks)
 Note
• The following assumptions and bases may be relevant:
• The revised profit after tax for the current year may be a good
representation of the earnings of the entity.
• Additional information (i) – (iv) above would necessitate a revision of
the 2011 Income statement and statement of financial position profit.
Dividend payment will however not be affected
• Investing in unlisted securities is about 25% more risky than investing
in listed securities.
 SOLUTION
a. The Managing Director‟s statement is incorrect for a
number of reasons:
i. The figures are based on book values. It is more
appropriate to use market values in arriving at a valuation
for listing purposes.
ii. The addition of total assets and surpluses is to double
count since the surplus represents one of the sources of
finance use to acquire the existing assets.
iii. The liabilities should have been deducted from the total
assets figure in order to arrive at the net asset position of the
company.
iv. The issue of 500,000 new shares would bring the total
number of shares of the company to 10,500,000.
If only the new shares are offered on the exchange, this
represents 4.7% of the total number of shares.
The minimum percentage that can be offered in the market
is about 25%.
v. In view of the problems with the net assets
valuation, and taken into account the valuation
estimates given below, Obuoba is unlikely to
achieve the price of GH¢7 per share which
would be necessary to raise GH¢3.5 million
from 500,000 shares
 b. Revised Profit (for PE Ratio method)
GHS’000
• Profit before Tax per draft accounts 12,000
• URP on sale or return [30/130 x GHS2.6 m] (600)
• Depreciation: Land and building (800)
• Plant (1,400)
• Fair valuation gain of FAFVTPL 160
• Embezzlement: current year (500)
• Additional interest [amortization] 720-600 (120)
• Profit before tax 8,740
 ii. Dividend Paid [For Dividend Yield
method]
GHS’000
• Retained earnings as at 31 December 2010 19,000
• Reported profit 9,600
28,600
• Balance as at 31 December 2011 (23,000)
• Dividend paid 5,600
• Taxation: Current Tax @ 20% 1,748
• Deferred Tax [20% 500) 100
(1,848)
• Profit after tax 6,892
 An alternative is to prepare a revised Income
Statement as follows:
GHS‟000
• Sales (52000-2,600] 49,400
• Cost of sales [29,000 – 2,000 + 800+1400] (29,200)
• Gross Profit 20,200
• Selling expense (4,500)
• Admin (4,500)
• Interest [2000+120] (2,120)
• Fair valuation gain 160
• Profit before tax 8,740
• Taxation (1,848)
• Net Profit 6,892
 iii. Revised Net Asset [ For Net Assets
Method]
GHS‟000
• Per the trial balance 24,000
• Prior year adjustment [embezzlement] (1,500)
• Adjustment to reported profit [9,600 – 6,892] (2,708)
• Revaluation surplus – Land and buildings 2,800
22,592
 An alternative is to prepare the revised SOFP
as follows
GHS‟000
• Land and buildings 18,000
• Plant 5,600
• FAFVTPL 2,160
25,760
• Current assets
• Inventory 11,000+ 2000 13,000
• Trade receivables [9,000-2,000 -2,600] 4,400
• Cash 1,000
18,400
• Total assets 44,160
• Equity
• Stated capital 1,000
• Revaluation surplus 2,800
• Retained earnings [23,000- 1500 - 2708] 18,792
22,592
• Non-current- liabilities
• Long term loans [7,000 + 4120] 11,120
• Deferred tax provision 100
• Current liabilities
• Trade payables 8,600
• Current tax 1,748
44,160
 i. Price Earnings Ratio
• Value per share = EPS × PE ratio
• EPS = GHS6,892,000/10 million shares = GHS 0. 6892
• PE ratio = That of Dadeba as adjusted
= (GHS4.20/GHS0.60) = 7 adjusted to 5.25
• Value per share = GHS0.6892 x 5.25 = GHS3.6183
 ii. Dividend Yield Method
• Value per share = Do/Dividend yield
• Do = GHS5,600,000 /10m shares = GHS0.5600
• Dividend yield = That of Dadeba as adjusted
= (GHS0.36/GHS4.20) = 8.57%
adjusted to 10.71% or 11.42%
• Value per share = GHS0.5600/0.1142 = GHS4.9037
• or GHS0.5600/0.1071 = GHS5.228
 iv. Net Assets Method
• Value /share = Net Assets/No of ordinary shares
= GHS22,592,000/10 million shares
= GHS2.2592