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DO NOT ANSWER the following questions regarding the balance sheet and market values of debt and...

DO NOT ANSWER the following questions regarding the balance sheet and market values of debt and equity.

  1. What is the balance sheet, and what information does it provide? What determines the order of the information shown on the left and right side of the balance sheet?
  2. Why do changes in retained earnings occur? Explain why the following statement is true: “The retained earnings account, as reported on the balance sheet, does not represent cash and is not available for the payment of dividends or anything else.”
  3. How is book value per share (of equity) calculated? What about market value of equity? Explain why equity’s market value often deviates from its book values and which one is generally higher?
  4. Why does market value of debt differ from book value of debt? Is the difference between book value and market value of equity generally larger than that of debt? Explain.
  5. What is the role of accumulated depreciation on the balance sheet?

Solutions

Expert Solution

The primary reason for change in retained earnings in balance sheet is Net Income and Dividend

The same is shown as under

Particulars Amount
Opening Balance xx
Add : Net Income During the Year xx
Less : Dividend paid during the year xx
Closing balance xx

Net Income added in retained earnings is not a cash profit

It is based on accrual basis of accounting

therefore it does not represent cash and hence not availabe for payment as dividend

Book Value

There are two methods of calculating book value

1. Share Capital + Reserves and Surplus

2. Total Assets - Long term debt - Short Term Debt

Market value of equity = Number of Shares x Market Price per share

Market Value is determined on the basis of various valuation methods (ie DCF, EV/EBITDA, Price to Book) which are based on the future earning potential of the company

Whereas book value is a accounting based concept which takes into account balance sheet values in its calculation

Generally market value is higher than book value because it takes into account future earning potential of the company;s profit,

jeff jeffy answered 1 year ago
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