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Answer on Economics of Enterprise Question for Lamarcus Streeter

Question #5968

Which of the following statements is CORRECT?

a. Typically, a firm’s DPS should exceed its EPS.
b. Typically, a firm’s EBIT should exceed its EBITDA.
c. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.
d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.
e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.

Expert's answer

c. If
a firm is more profitable than average (e.g., Google), we would normally expect
to see its stock price exceed its book value per share.


For the
most part the book value really doesn't tell us a whole lot. Cory's Tequila Co.
is trading at over $100 and the BV is only $3.57? What is up with that? Well BV
is considered to be the accounting value of each share, drastically different
than what the market is valuing the stock at. And the truth is that market and
book value have nothing in common. Market value is what the investment
community's expectations are and book value is based on costs and retained
earnings. One situation where BV can be useful is if the market value is trading
below the book value, this rarely happens, but if it does it could mean that the
company is undervalued and might be an attractive buy.

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