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Risk adjustment - uncertainty relating to cash flows (5% x 419.65) 20.98
Total Expected Cash Flows (419.65+20.98) 440.63
Discount rate to be considered = risk-free rate + 5% + 3.5% 8.5%
entity’s non-performance risk
Expected present value at 8.5% for 10 years (440.63 / (1.08510)) 194.88
Working Note:
Expected labour cost:
Cash Flows Estimates Probability Expected Cash Flows
100 Cr 25% 25.00 Cr
125 Cr 50% 62.50 Cr
175 Cr 25% 43.75 Cr
Total 131.25 Cr
Q3 (Nov. 21 & Also Newly Added in ICAI May 22 Module)
i) Entity A owns 250 ordinary shares in company XYZ, an unquoted company. Company XYZ has a total
share capital of 5,000 shares with nominal value of Rs. 10. Entity XYZ’s after-tax maintainable profits are
estimated at Rs. 70,000 per year. An appropriate price/earnings ratio determined from published industry
data is 15 (before lack of marketability adjustment). Entity A’s management estimates that the discount
for the lack of marketability of company XYZ’s shares and restrictions on their transfer is 20%. Entity A
values its holding in company XYZ’s shares based on earnings. Determine the fair value of Entity A’s
investment in XYZ’s shares.
ii) Based on the facts given in the aforementioned part (i), assume that Entity A estimates the fair value
of the shares it owns in company XYZ using a net asset valuation technique. The fair value of company
XYZ’s net assets including those recognised in its balance sheet and those that are not recognised is Rs.
8,50,000. Determine the fair value of Entity A’s investment in XYZ’s shares.
SOLUTION
Particulars Unit
Entity XYZ’s after-tax maintainable profits (A) Rs. 70,000
Price/Earnings ratio (B) 15
Adjusted discount factor (C) (1- 0.20) 0.80
Value of Company XYZ (A) x (B) x (C) Rs. 8,40,000
i) An earnings-based valuation of Entity A’s holding of shares in company XYZ could be calculated as
follows:
Value of a share of XYZ = Rs. 8,40,000 ÷ 5,000 shares = Rs. 168
The fair value of Entity A’s investment in XYZ’s shares is estimated at Rs. 42,000 (that is, 250 shares
× Rs. 168 per share).
ii) Share price = Rs. 8,50,000 ÷ 5,000 shares = Rs. 170 per share.
The fair value of Entity A’s investment in XYZ shares is estimated to be Rs. 42,500 (250 shares × Rs.
170 per share).
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