This should be a pretty basic concept, but I’m getting conflicting information.
In schweser book 4 page 265 it states “The primary goal of firm management is to increase the book value of the firm’s equity and thereby increase the market value of its equity”
On page 186 of the CFAI curriculum for equities, question 18 states:
Which of the following statements is most accurate in describing a company’s book value?
A Book value increases when a company retains its net income.
B Book value is usually equal to the company’s market value.
C The ultimate goal of management is to maximize book value.
The answer they give is A.
I understand that A is a viable answer, but clearly, according to Schweser, C is correct too. Is it because Schweser states “increase the book value” VS CFAI’s “maximize book value”?
This same question puzzled me, in exactly the same way. So hopefully someone smarter comes to enligten us. I finally put it down to the difference between ‘ultimate’ and ‘primary’.
I’mnot a native speaker unfortunately so can’t tell if it really matters.
I have not venture that far yet (as I’m still stuck in FRA) but I can share with you based on what I have learnt during undergraduate days.
B is definitely out as market value of the firm is ultimately based on market forces. It depends on the efficiency of the market (which I think most market are exhibiting semi-strong form effiicency) to price the share price of the firm. The management of the firm know the true value of the firm but not corporate outsiders.
Now we are left with A and C.
Book value is equivalent to the Net Asset Values of the firm (" NAV") i.e.
Total Assets - Total Liabilities = Net Asset Values = Owner’s Equity
Owner’s Equity is defined as the residual interest in assets that remains after subtracting liabilities.
A makes sense as net income is a component of retained earnings which in turn is a component of owner’s equity. As retained earrings increase, shareholder’s value will increase which in another words, means NAV of the firm increases.
For C, I think the ultimate goal of management is to really maximise the owner’s value through different means; while increasing book value of the firm seems correct; another important consideration for the firm is their market value. As in the imperfect world, information asymmetry exist and it is really the management’s responsibilities to convey the message " My firm is a good firm" i.e. signal to the market.
I’m stumped by the same question. I guess the material states that the ultimate goal is to increase book AND market value. So it’s quite a tricky question. If someone could confirm this perhaps?
I agree that the question is being too literal but I think the word ‘Increase’ in schweser and ‘Maximum’ in CFAI both have the same notion.
From what I have read, I’m pretty sure the company’s ultimate objective is to Maximize Market Value and not the book value. Just see what the statement says
“The primary goal of firm management is to increase the book value of the firm’s equity and thereby increase the market value of its equity”
The word thereby kind of gives the hint that the ultimate aim is to achieve increase in Market Value ( or Maximize Market Value). The increase in book value is kind of way or tool to achieve the ultimate aim.
“Your primary aim is to score the goal thereby you can win the match”… sounds relatable ? (my ultimate aim is to win the match)
I know it may sound a little subjective but I believe that’s what they mean. Hope this helps
In my own opinion, “most accurate” makes A 100% the answer to the question. The word “ultimate” makes option C a wrong answer.
Ultimate means “Being the last or concluding element of a series” or “Furthest or highest in degree or order; utmost or extreme”.
schweser clearly states that "The primary goal of firm management is to increase the book value of the firm’s equity and thereby increase the market value of its equity”
Schweser clearly stated that the last/ultimate/furthest or highest goal isn’t to maximize book value.
Maximizing book value precedes improving mkt value of equity. so, I feel the former isn’t the ultimate but the latter
BV is the only thing that is in the hands of a company management. They can work that and try and improve it. Agreed there will be some dilution based on pay outs and other contingency tools like the SOPs and the warrants. Both BV and MV adjust to such diluting forces proportionately
MV is a fn. of Market forces. BV = Value, MV= Price. According to EMH and it’s variants the divergence between the two for long is inconceivable. But here’s the caveat. Even if convergence happens it is practically impossible to tell when that would happen
(my ultimate aim is to win the match)