The bare bones
The book value of a business is the value of shareholders’
funds as stated in the balance sheet.
Book value is not the only method for valuing the shareholders’
investment. An alternative method is called ‘market value’ and is calculated
as follows:
Market value = Number of shares in issue x Market price per share
If the Max Spending Corporation has 5 million shares in issue
that are currently valued at $25 each, the market value would be as
follows:
Market value = 5 million shares x $25 per share
= $125 million
This is the value that investors currently place on the company.
In other words, based on the current share price, if somebody wanted
to buy the company right now they would need to pay $125 million
for it. This is very different from the book value of $75 million.
The bare bones
The market value of a company is defined as:
Number of shares in issue
multiplied by the share price
Why would anyone be willing to pay more than the value of the
business as stated in the balance sheet? If the business is indeed bought
for $125 million, the first $75 million of this is being paid for the shareholders’
funds as stated in the balance sheet. Given that shareholders’
funds are tied up in assets, it follows that this $75 million is being paid
to acquire the company’s assets such as property, equipment, inventory,
and so on. So what is the remaining $50 million buying?
The difference between the market value of a business and its
book value is called goodwill
The book value of a business is the value of shareholders’
funds as stated in the balance sheet.
Book value is not the only method for valuing the shareholders’
investment. An alternative method is called ‘market value’ and is calculated
as follows:
Market value = Number of shares in issue x Market price per share
If the Max Spending Corporation has 5 million shares in issue
that are currently valued at $25 each, the market value would be as
follows:
Market value = 5 million shares x $25 per share
= $125 million
This is the value that investors currently place on the company.
In other words, based on the current share price, if somebody wanted
to buy the company right now they would need to pay $125 million
for it. This is very different from the book value of $75 million.
The bare bones
The market value of a company is defined as:
Number of shares in issue
multiplied by the share price
Why would anyone be willing to pay more than the value of the
business as stated in the balance sheet? If the business is indeed bought
for $125 million, the first $75 million of this is being paid for the shareholders’
funds as stated in the balance sheet. Given that shareholders’
funds are tied up in assets, it follows that this $75 million is being paid
to acquire the company’s assets such as property, equipment, inventory,
and so on. So what is the remaining $50 million buying?
The difference between the market value of a business and its
book value is called goodwill
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