Question

Discuss why a firm’s book value may differ significantly from its market capitalization or enterprise value Identify 3-4 factors that could cause the market cap to greatly exceed book value. How or why should book value impact the valuation of a firm? When might you use book value as a measure of a firm’s value? Discuss how balance sheets items could affect your valuation of a firm. Provide examples.

Answer 1

Answer

The book value of the firm is a crucial element for enhancing the shareholders' wealth of the business along with that it helps to generate the shareholder's interest. If a firm follows the generally accepted accounting principle then the financial statement of the company becomes quite accurate. This helps the firm to accelerate the value of the business or the book value of the firm. The factors which create an impact on the book value of the firm are discussed below:

• The firm needs to consider the financial factors which are the method of cost control, reducing cost control along with that it is needed to project the movement of projected profit and cash flows used in the business.
• There are some of the external factors which are associated with the business like the level of demand and current interest rate which are associated with it.
• A strong relationship with the customers and brand value will automatically leverage the business growth potential.
• The overall value of the assets and liabilities of the business along with the flow of the working capital of the company creates an impact on the book value along with the potential interest of the shareholders of the business.

The balance sheet of the firm provides a wide view of the current financial performance of the business along with that it helps the shareholders or potential investors to make an effective investment in the process. Suppose, a particular investor before making an investment in the business must understand the financial performance of the company by utilizing the tool and techniques such as the ratio analysis, NPV, IRR and many more. This will help the individual to make decisions regarding acceptance or rejection of the project which is associated with the business. For this reason, the balance sheet plays a significant role to understand the financial aspects of the business as well as helps the potential shareholders to make investment decisions associated with the process which will enhance the book value of the firm.