Asset-based Valuation Models

• Asset-based models assign a value to the firm by aggregating the current market value of its individual component assets and liabilities
• When market price exceeds book value, a reason able explanation is that the value of the firm exceeds the sum of ts parts
• When profitability is below normal, (adjusted) book value may exceed market price

Book Value

• Historical cost-based book value reflects the minimum value of the firm. Thus, book value is viewed as a conservative estimate of the firm's value
• The relationship between price and book value depends to a great extent on the nature of the firm's assets, its reporting methods, its profitability, and the overall economy

Tobin's Q Ratio

• It is defined as the market value of the firm divided by its book value on a replacement cost basis
• Q values below 1 imply that the firm earns less than the required rate of return
• Firms with low Q ratios are often seen as prime takeover or merger targets

Stability and Growth of Book Value

• For most firms, retained earnings provide most of the growth in book value. The increase in book value:

B(1) - B(0) = Income - Dividends

= (ROE x B(1)) - (k x ROE x B(0))

= (1 - k) x ROE x B(0)