Principles of Managerial Finance

CHAPTER 7 Stock Valuation 333

10. In the event of liquidation, creditors’ claims must be satisfied first, then those of the preferred stockholders.
    Anything left goes to common stockholders. A more detailed discussion of liquidation procedures is presented in
    Chapter 17.

book value per share
The amount per share of common
stock that would be received if all
of the firm’s assets were sold for
their exact book (accounting)
valueand the proceeds remaining
after paying all liabilities (includ-
ing preferred stock) were divided
among the common stockholders.

liquidation value per share
The actual amountper share of
common stock that would be
received if all of the firm’s assets
were sold for their market value,
liabilities (including preferred
stock) were paid, and any
remaining money were divided
among the common stockholders.

Other Approaches to Common Stock Valuation

Many other approaches to common stock valuation exist. The more popular

approaches include book value, liquidation value, and some type of price/earnings

multiple.

Book Value

Book value per shareis simply the amount per share of common stock that

would be received if all of the firm’s assets were sold for their exact book

(accounting) valueand the proceeds remaining after paying all liabilities (includ-

ing preferred stock) were divided among the common stockholders. This method

lacks sophistication and can be criticized on the basis of its reliance on historical

balance sheet data. It ignores the firm’s expected earnings potential and generally

lacks any true relationship to the firm’s value in the marketplace. Let us look at

an example.

EXAMPLE At year-end 2003, Lamar Company’s balance sheet shows total assets of $6 mil-

lion, total liabilities (including preferred stock) of $4.5 million, and 100,000

shares of common stock outstanding. Its book value per share therefore would be

$



1



5



per share

Because this value assumes that assets could be sold for their book value, it may

not represent the minimum price at which shares are valued in the marketplace.

As a matter of fact, although most stocks sell above book value, it is not unusual

to find stocks selling below book value when investors believe either that assets

are overvalued or that the firm’s liabilities are understated.

Liquidation Value

Liquidation value per shareis theactual amountper share of common stock that

would be received if all of the firm’s assets weresold for their market value,liabili-

ties (including preferred stock) were paid, and any remaining money were divided

among the common stockholders.^10 This measure is more realistic than book

value—because it is based on the current market value of the firm’s assets—but it

still fails to consider the earning power of those assets. An example will illustrate.

EXAMPLE Lamar Company found upon investigation that it could obtain only $5.25 mil-

lion if it sold its assets today. The firm’s liquidation value per share therefore

would be

$



7



.



5



0



per share

Ignoring liquidation expenses, this amount would be the firm’s minimum value.

$5,250,000$4,500,000



100,000 shares

$6,000,000$4,500,000



100,000 shares