Chapter 5

Week 2 Homework Assignment Chapter 2

FIN 534 Financial Management

Karla Zaldana

Dr. Jeffrey Woo

04/20/2013

CHAPTER 2

1. 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 it’s EPS, other things held

constant.

CORRECT:

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.

If a company went belly-up and sold all of its assets and subtracted any liabilities, the remaining value investors would receive represents the company’s book value. In other words, the book value represents the total value of all the assets minus any liabilities. This value often gets referred to as shareholders’ equity or owners’ equity. Book value really ties into how accountants value the company on a per-share basis and has nothing to do with how the market values the company’s stock.

Because the market value of a stock is driven by supply and demand, many companies trade well above or often below their book value. Google Inc. is a good example of market value vs. book value. As of the close of the market on Dec. 3, 2010, Google’s book value per share stood at $135.38, but at the final bell, the company’s stock closed at $573 per share. The company’s market value trades well above its book value, but investors willingly purchase the stock at the inflated price.

Although comparing a company’s book value to its market value can help you determine...