The following is the extract from the Balance Sheets of Popular Ltd. : EQUITY AND LIABILITIES As at 31st March, 2017 As at 31st March, 2018 ASSETS As at 31st March, 2017 As at 31st March, 2018 (1)Shareholder's funds: (1)

CS Professional · Valuations & Business Modelling · PYQS · December 2020
The following is the extract from the Balance Sheets of Popular Ltd. : EQUITY AND LIABILITIES As at 31st March, 2017 As at 31st March, 2018 ASSETS As at 31st March, 2017 As at 31st March, 2018 (1)Shareholder's funds: (1)Non current assets (a)Share capital (a) Fixed assets 550 650 Equity share capital of ₹10 each 500 500 (b)Non current Investments (b)Reserves and surplus 10% Investments 250 250 (i) General Reserve 400 425 (2) Current Assets Profit and loss account 50 80 (a) Inventories 260 300 (2)Non-Current Liabilities (b)Trade receivables Long term borrowings Sundry Debtors 170 110 (i) 18% Debentures 180 165 (c)Cash and Cash Equivalents 46 43 (3) Current Liabilities (a) Trade payables- Sundry Creditors 35 45 (b)Short term provisions Provision for taxation 11 13 Proposed dividend 100 125 TOTAL 1276 1353 TOTAL 1276 1353 The following additional information is also provided : (i) Replacement values of Fixed assets were ₹1,100 lakhs on 31st March, 2017 and ₹1,250 lakhs on 31st March, 2018 respectively. (ii) Rate of depreciation adopted on Fixed Assets was 5% p.a. (iii) 50% of the stock is to be valued at 120% of its book value. (iv) 50% of investments were trade investments. (v) Debtors on 31st March, 2018 included foreign debtors of $35,000 recorded in the books at ₹35 per U.S. Dollar. The closing exchange rate was $1 = ₹39. (vi) Creditors on 31st March, 2018 included foreign creditors of $60,000 recorded in the books at $1 = ₹33. The closing exchange rate was $1 = ₹39. (vii) Profits for the year 2017-18 included ₹60 lakhs of government subsidy which was not likely to recur. (viii) ₹125 lakhs of Research and Development expenditure was written off to the Profit and Loss Account in the current year. This expenditure was not likely to recur. (ix) Future maintainable profits (pre-tax) are likely to be higher by 10%. (x) Tax rate during 2017-18 was 50%, effective future tax rate will be 40%. (xi) Normal rate of return expected is 15%. A Director of the company has expressed his fears that the company does not enjoy a goodwill in the prevalent market circumstances. In this context: (i) Critically examine this and establish whether Popular Ltd. has or does not have any goodwill. (ii) If your answers were positive on the existence of goodwill, show the leverage effect it has on the company's result. Industry average return was 12% on the long-term funds and 15% on equity funds.

Answer & Explanation:

Working Notes (1) Future maintainable profits Particulars ₹ in Lakhs ₹ in Lakhs Increase in General Reserve 25 Increase in profit and loss 30 Proposed Dividend 125 Profit after Tax 180 Pre - Tax Profit = 180/(1-0.5) 360 Less: Non trading Investment Income (10% of ₹125) 12.50 Subsidy 60.00 Exchange loss on creditors ($0.6lakhs *(₹39-₹33)] 3.60 Additional Depreciation on increase in value of fixed assets(current year) [(1250-650=600*(5/100)] i.e., 30.00 253.90 Add: Exchange Gain on Debtors ($0.35lakhs*(₹39- ₹35)] 1.40 Research and development expenses written off 125.00 Stock Adjustment (30-26) 4.00 130.40 384.3 Add: Expected increase of 10% 38.43 Future Maintainable PBT 422.73 Less: Tax @ 40% (40% of ₹422.73) 169.09 Future Maintainable Profit 253.64 (2) Calculation of Capital employed (CE) Particulars ₹ in Lakhs As on 31.03.17 ₹ in Lakhs As on 31.03.18 Replacement cost of fixed assets 1100.00 1250.00 Trade investments (50%) 125.00 125.00 Current cost of stock 130+130*(120/100) 286.00 150+150*(120/100) 330.00 Debtors 170.00 111.40 Cash at bank 46.00 43.00 Total (A) 1727.00 1859.4 Less: Outside liabilities 18% Term loan 180.00 165.00 Sundry Creditors 35.00 48.60 Provision for tax 11.00 13.00 Total (B) 26.00 226.60 Capital Employed (A-B) 1501.00 1632.80 Average Capital employed at current value = (CE as on 31.03.2017 +CE as on 31.03.2018)/2 = (1501+1632.80)/2 = 1,566.90 Lakhs * Average capital employed can also be calculated in the following manner: Closing capital employed as on 31/03/2018 = ₹1632.80 lakhs Less: ½ of actual post tax profit for 2017-2018 = ₹90.00 lakhs Average Capital Employed = ₹1542.80 lakhs (3) Valuation of Goodwill (i) According to Capitalisation of Future Maintainable Profit Method ₹ in lakhs Capitalised value of Future Maintainable Profit (253.64/15)x 100 1,690.93 Less: Average capital employed 1,566.90 Value of Goodwill 124.03 Or (ii) According to Capitalisation of Super Profit Method ₹ in lakhs Future Maintainable Profit 253.64 Less: Normal Profit @15% on average capital employed (1566.90 x 15%) 235.04 Super profit 18.60 Capitalised value of super profit i.e., Goodwill 124.00 Goodwill exists; hence director's fear is not valid. Leverage Effect on Goodwill: ₹ in lakhs Future Maintainable Profit on equity fund 253.64 Future Maintainable Profit on Long-term Trading Capital employed Future Maintainable Profit After Tax 253.64 Add: Interest on Long-term Loan (Term Loan) (After considering Tax) 165 x 18% = 29.7 x (50/100) 14.85 268.49 Average capital employed (Equity approach) 1,566.90 Add: 18% Term Loan (180+165)/2 172.50 Average capital employed (Long-term Fund approach) 1739.40 Value of Goodwill: ₹ in lakhs (A) Equity Approach Capitalised value of Future Maintainable Profit = (253.64/15) x 100 1690.93 Less: Average capital employed 1566.90 Value of Goodwill 124.03 (B) Long-Term Fund Approach Capitalised value of Future Maintainable Profit = (268.49/12) x 100 2237.42 Less: Average capital employed 1739.40 Value of Goodwill 498.02 Comments on Leverage effect of Goodwill: Adverse Leverage effect on goodwill is 373.99 lakhs (i.e., ₹498.02 - 124.03). In other words, Leverage Ratio of Popular Ltd. is low as compared to industry for which its goodwill value has been reduced when calculated with reference to equity fund as compared to the value arrived at with reference to long term fund.

Topics: Valuation of Goodwill

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