The over and under capitalisation situations of a company can also be ascertained by comparing the book value and real value of equity shares of the company. The book value of equity shares is calculated on the basis of net assets available for equity shareholders. It can be computed by dividing the net assets available for equity shareholders with the number of equity shares.
The real value of equity shares can be determined on the basis of capitalised value of earnings, as below:
Capitalised Value of Earnings = Earnings × 100/Normal Rate of Return
Real Value of an Equity Share = Capitalised Value Earnings/Numbers of Equity Shares
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The company is said to be over-capitalised if the book value exceeds the real value of equity shares of the company. In the reverse situation, i.e. when the book value is less than the real value, the company is said to be under-capitalised.
Illustration 1:
The following is the Balance Sheet of ABC Ltd. in condensed form:
The normal rate of return in case of similar business is 10% Ascertain whether the company is overcapitalised, under capitalised or fairly capitalised when earnings available for equity shareholders are:
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(i) Rs. 25,000
(ii) Rs. 40,000
(iii) Rs. 30,000
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Solution:
