Question 2.2: The Klingon Corporation has fixed assets with a book value o...
The Klingon Corporation has fixed assets with a book value of $700 and an appraised market value of about $1,000. Net working capital is $400 on the books, but approximately $600 would be realized if all the current accounts were liquidated. Klingon has $500 in long-term debt, both book value and market value. What is the book value of the equity? What is the market value?
We can construct two simplified balance sheets, one in accounting (book value) terms and one in economic (market value) terms:
| KLINGON CORPORATION | |||||
| Balance Sheets | |||||
| Market Value versus Book Value | |||||
| Book | Market | Book | Market | ||
| Assets | Liabilities and Shareholders’ Equity | ||||
| Net working capital | $ 400 | $ 600 | Long-term debt | $ 500 | $ 500 |
| Net fixed assets | \underline{700} | \underline{1,000} | Shareholders’ equity | \underline{600} | \underline{1,100} |
| $ \underline{\underline{1,100}} | $ \underline{\underline{1,600}} | $ \underline{\underline{1,100}} | $ \underline{\underline{1,600}} | ||
In this example, shareholders’ equity is actually worth almost twice as much as what is shown on the books. The distinction between book and market values is important precisely because book values can be so different from true economic value.
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