Play linda Surf Shop provided the following information from its 2012 financial
ID: 2421928 • Letter: P
Question
Play linda Surf Shop provided the following information from its 2012 financial statements:
Total Assets
$655,000
Total Liabilities
225,000
In addition, the stockholders' equity section of the balance sheet showed:
Preferred stock, 10%, $2 par value, 10,000 authorized,
8,000 issued and outstanding, $5 liquidation value
$16,000
Common stock, $4 par value, 20,000 shares authorized,
10,000 issued and outstanding
40,000
The common stock had a year-end market price of $24.
A)
Calculate the book value per common share at year-end.
B)
Indicate the usefulness of this ratio for Play linda Surf Shop.
Total Assets
$655,000
Total Liabilities
225,000
Explanation / Answer
1. Total Assets = $ 655,000
2. Total Liabilities = $ 225,000
Common Stock Value = Total Assets - Total Liabilities = $ 655,000 - $ 225,000 = $ 430,000
3. Liquidation Value of Share outstanding = $ 16,000
Net Common stock value = $ 430,000 - $ 16,000 = $ 414,000
4. Common Stock issued and outstanding = 10,000 share
Therefore, Book Value per one common stock = $ 414,000 / 10,000 = $ 41.4
Book Value per common share = $ 41.4
Note: While calculating the Book value per shares, Authorised Stock should NOT be considered.
B. Usefulness of the Book Value per share:
The Book Value of per share = $ 41.4
The Market price of the share = $ 24
That means the common stock of Play linda Surf Shop is quoted below the book value.
Indicator: When compared with the market value, book value can indicate whether a stock is overvalued or undervalued. For companies with negative earnings which cannot be valued using the price-to-earnings ratio, the price-to-book value multiple can be used, especially for relative comparison, as the number of companies with negative book value is far less than the number of companies with negative earnings.
A stock may quoted below its book value for several reasons, the lack of investor confidence in the company's future. If it is widely believed that the company's performance will deteriorate, its stock will possibly trade at a discount to its book value. Another reason could be belief that the company is adopting aggressive accounting policies to bloat its net worth.