A company has 25,000 equity shares of Rs.100 each, Rs.90 paid up. The profit before tax is Rs.250,000. The company has a practice of transferring 30% of profit to general reserve every year. The…

Value of Equity Share Using Earning Capacity Method

1. Calculate Net Profit After Tax (NPAT): $$\text{NPAT}=\text{Profit before tax}\times (1-\text{Tax rate})=250,000\times (1-0.25)=\text{Rs. }187,500$$

2. Determine Transfer to General Reserve: $$\text{Transfer}=30\%\text{ of NPAT}=0.30\times 187,500=\text{Rs. }56,250$$

3. Calculate Available Earnings for Equity Shareholders: $$\text{Available Earnings}=\text{NPAT}-\text{Transfer}=187,500-56,250=\text{Rs. }131,250$$

4. Compute Normal Rate of Return on Paid-up Capital: $$\text{Paid-up Capital}=25,000\times 90=\text{Rs. }2,250,000$$ $$\text{Normal Earnings}=12\%\text{ of Paid-up Capital}=0.12\times 2,250,000=\text{Rs. }270,000$$

5. Calculate Earning Power (EP): $$\text{EP}=\frac{\text{Available Earnings}}{\text{Normal Earnings}}=\frac{131,250}{270,000}=0.486$$

6. Determine Value per Equity Share: $$\text{Value per Share}=\text{Paid-up per Share}\times \text{EP}=90\times 0.486=\text{Rs. }43.74$$

Final Value of Equity Share: Rs. 43.74