Question

If the liquidation value of a corporation exceeds the market value of the equity, then the:
Select one:
A. firm is not taking advantage of available growth opportunities.
B. firm's stock will sell for book value.
C. dividend payout ratio has been too high.
D. firm has no value as a going concern.

Answer 1

Hello there,

The liquidation value of a corporation means that amount received after selling all the assets at market price and paying off the liabilities. The remaining money represent the liquidation value of the corporation.

If the market value of equity is less than the liquidation value of the corporation, it means that the assets of the company had more value that are being mismanaged. There is an onld saying in this scenerio that "worth more dead than alive".

Answer to the above problem is (A), reason are as under:

Let us analyse the options given in question:

A. Firm is not taking advantage of available growth opportunities.

Since the liquidation value of the corporation is higher than market value of equity, it means that the corporation is in possion of valuable assets, that might be very opportunistic but company is not able to grab the opportunity in market and therefore its market value of equity is less.

B. Firm's stock will sell for book value.

In no way anyone can say that the stock will sell for book value, it would be sold for market value which may be higher or lower than the book value.

C. Dividend payout ratio has been too high.

Dividend payout ratio means how much of the earned income is paid to shareholder, therefore it is very much unrelated to the situation at hand.

D. Firm has no value as a going concern.

Since the liquidation value exceeds the market value of the corporation, it cannto be said that there is no value as a going concern, since the going concern value of the firm also involves the market price of all the assets minus liabilities.