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How are redeemable and non-redeemable preference shares valued?
It's known to us that redeemable shares can be bought back by the issuing company on a later date but irredeemable shares cannot be bought back by the issuer before the date of maturity. However, for internal operation and regulatory reasons, shares need to be valued. There are many methods to calculate the value of a share. Let's check some of them.
There are three classical valuation approaches to find the value of shares −
- Income Approach
- Market Approach
- Cost Approach
Income Approach
The discounted cash flow method is an appropriate and suitable method to determine the value of a non-redeemable share. The two inputs required in such models are cash flows and discount factors. Cash flows can occur at any time and some most notable factors related to the valuation of the share are dividends, coupon, redemption, or maturity amount, etc. The underlying equity shares are offered back upon conversion at triggering event or at maturity.
The evaluation is based on the availability of cash flows that trigger the condition and the likelihood of each event that can affect the cash flows as indicated in the share during or at the end of the event.
Market Approach
The market of listed preference shares in India shows broadly that it lacks the depth. Most of the available shares are private and complete disclosure of terms and conditions are not available to the public.
Moreover, the trade information and frequency of trade of listed shares are low in comparison to other mature markets. This poses a challenge in valuing the shares easily and quickly as other big markets of the world. So, the market approach is seldom used to identify the value of shares that are available in the public domain.
Cost Approach
Indian Accounting Standard (Ind AS) 109 allows the recognition of financial assets/liabilities through the amortized cost method. This is done under specific circumstances, as and when the concept of SPPI (Solely held to collect principal and interest) is fully completed, particularly in the case of RPS. RPSs are non-convertible but they are redeemable at maturity
In accordance with India's market conditions, in most cases of valuation of preferred shares is done from the conversion into underlying equity shares. The first point is it would require the business or the equity valuations using the mix of the three approaches mentioned above. This would consider the nature, size, and requirement of valuation.
Note − Valuation of shares requires a combination of Income, Market, and cost approaches to be accurate, especially in India where markets are still immature.
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