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:

1.Valuing a listed company is a complex task, and several different measures are used to arrive at a fair valuation. While none of the methods is precise and each presents a different version with varying results, investors use them in combination to get a good understanding of how stocks have performed. Two most commonly used quantitative measures for valuing a company are market value and book value.

The book value literally means the value of a business according to its books (accounts) that is reflected through its financial statements. Theoretically, book value represents the total amount a company is worth if all its assets are sold and all the liabilities are paid back. This is the amount that the company’s creditors and investors can expect to receive if the company is liquidated whereas the market value represents the value of a company according to the stock market. While market value is a generic term that represents the price an asset would get in the marketplace, it represents the market capitalization in the context of companies. It is the aggregate market value of a company represented as a dollar amount. Since it represents the “market” value of a company, it is computed based on the current market price (CMP) of its shares.

2. Factors that would cause the market value to exceed the book value:

• When the market value exceeds the book value, the stock market is assigning a higher value to the company due to the potential of it and its assets' earnings power.
• It indicates that investors believe the company has excellent future prospects for growth, expansion, and increased profits that will eventually raise the book value of the company.
• They may also believe the value of the company is higher than what the current book value calculation shows.
• Consistently, profitable companies typically have market values greater than book values, and most of the companies in the top indexes meet this criterion, as seen from the examples of Microsoft and Walmart mentioned above.

3. Book value impact the valuation of the firm because the primary advantage of using book value as a basis for a company's valuation is that there's little or no subjectivity involved in calculating the figure. When you buy an asset, its cost becomes the starting entry on the balance sheet for the value of that asset.

4. The balance sheet items could affect the valuation of the firm by:

The balance sheet provides an illustration of a company's financial position. The final calculation on a balance sheet report indicates the difference between the assets and liabilities. This figure, labeled "Owner's Equity" or "Stockholder's Equity," shows the amount of cash the business would have on hand if all of the assets were liquidated and liabilities were paid off.

Assets

The first section of the balance sheet lists the company assets. Assets for the balance sheet include cash, inventory, accounts receivable and prepaid accounts. Buildings, land and equipment owned by the company are categorized as assets on the balance sheet. Assets represent the equity in the business. As the value of the assets increases, the equity in the business increases. The equity calculation on the balance sheet is directly impacted by the value of the company assets.

Liabilities

The second section of a balance sheet details the company's liabilities. Liabilities are financial commitments, or claims against a company's assets. Payable accounts in the ledger, including wages, accounts payable and taxes due are all liabilities that reduce the owner's equity. When customers pay advanced deposits, those funds are recorded as unearned revenue. The revenue is not earned until the order is delivered. This unearned amount is a liability because it is a commitment to deliver goods in the future. The greater a company's liability balance, the lower the owner's equity from the reported assets.

Stockholder or Owner Equity

The stock shares in the marketplace, treasury shares and retained earnings are the final things listed on the balance sheet. The value of the shares in the market can increase or decrease the retained earnings figures. The sum of these values equals the stockholder's equity, if your business issues stock. If the business is privately owned, this section is simply owner's equity and is the difference between the assets and liabilities.