Table of Contents
Comparison of Over and Under-capitalization
Illustration1:
The following example illustrates the over and under-capitalization situation of a company:
Liabilities |
Amount in Rs. |
Assets |
Amount in Rs. |
Share Capital |
10,00,000 |
Fixed Assets |
12,00,000 |
Debentures |
5,00,000 |
Current Assets |
13,00,000 |
Current liabilities |
10,00,000 |
||
25,00,000 |
25,00,000 |
here the excess of fixed liability over fixed assets is (15,00,000-12,00,000) = Rs. 3,00,000. Thus, we say that the firm is over-capitalized to the extent of Rs.3,00,000
Liabilities |
Amount in Rs. |
Assets |
Amount in Rs. |
Share Capital |
10,00,000 |
Fixed Assets |
16,00,000 |
Debentures |
5,00,000 |
Current Assets |
9,00,000 |
Current liabilities |
10,00,000 |
||
25,00,000 |
25,00,000 |
here the excess of fixed assets over fixed liabilities is (16,00,000-15,00,000) = Rs. 1,00,000. Thus, we say that the firm is under-capitalized to the extent of Rs.3,00,000
Liabilities |
Amount in Rs. |
Assets |
Amount in Rs. |
Share Capital |
10,00,000 |
Fixed Assets |
15,00,000 |
Debentures |
5,00,000 |
Current Assets |
10,00,000 |
Current liabilities |
10,00,000 |
||
25,00,000 |
25,00,000 |
here the fixed assets and fixed liabilities are equal. Thus, we say that the firm is Fairly-capitalized.
Comparison of Book Value and Real Value of Shares
Capitalized Value of Earnings = Earning *100/ Normal rate of return
Real Value of an Equity Share = Capitalised Value Earnings/ Number of Equity Shares
Illustration 2:
The following is the Balance Sheet of ABC Ltd. in condensed form:
Liabilities |
Amount in Rs. |
Assets |
Amount in Rs. |
Share capital : |
Fixed Assets |
3,00,000 |
|
2000 Equity Shares of Rs.100 Each |
2,00,000 |
Current Assets |
1,00,000 |
500 10% preference shares of Rs.100 each |
50,000 |
||
Reserve and Surplus |
1,00,000 |
||
Current Liabilities |
50,000 |
||
4,00,000 |
4,00,000 |
The normal rate of return in case of similar business is 10% Ascertain whether the company is over-capitalized, undercapitalized or fairly capitalized when earnings available for equity shareholders are:
- Rs.25,000
- Rs.40,000
- Rs.30,000
Solution:
| Calculation of Book Value of Equity Shares of the Company | |||
| Amount in Rs. | |||
| Fixed Assets | 3,00,000 | ||
| Current Assets | 1,00,000 | ||
| Total Assets | 4,00,000 | ||
| Less: Current Liabilities | 50,000 | ||
| pref.Share Capital | 50,000 | ||
|
Net Assets available for equity shareholders
|
1,00,000 | ||
| Book value of an Equity Share | 3,00,000 | ||
|
Net Assets available for equity shareholders/ No. of Equity Shares = 3,00,000/2,000 = Rs. 150
|
|||
Calculation of Real value of Equity Shares of the Company
When earnings are Rs. 25,000
= Capitalised value of earnings = 25,000*100/10
= Rs.2,50,000
Real Value of equity share = 2,50,000/2,000
= Rs.125
As the book value exceeds the real value of equity shares of the company, the company is over-capitalized.
When earnings are Rs.40,000
= Capitalised value of earnings = 40,000*100/10
= Rs.4,00,000
Real Value of equity share = 4,00,000/2,000
= Rs.200
As the book value is less than the real value of equity shares of the company, the company is Under- capitalized.
When earnings are Rs.30,000
= Capitalised value of earnings = 30,000*100/10
= Rs.3,00,000
Real Value of equity share = 3,00,000/2,000
= Rs.150
As the book value is equal to the real value of equity shares of the company, the company is Fairly- capitalized.