Again: From the answer sheet to the CFAI Mock2 (the question asked something like which was the least effective reason to use the P/BV) -The historical cost basis of assets in P/B ratio is a drawback not a rationalization for using it as a measure of relative valuation. Ok, but one of the other answer choices was P/BV is a useful measure of companies that are no longer of going concern. I thought P/BV wasn’t useful for companies that aren’t go goign concern? Shouldn’t we look at liquidation values? (Always, it’s down to two good choices…)
and book values are liquidation values (except for historical cost items, which is drawback of P/BV in itself)
I thought P/BV wasn’t useful for companies that aren’t go goign concern? Shouldn’t we look at liquidation values? (Always, it’s down to two good choices…) P/BV is appropriate for firms that are going out of business. Significant differences from market values for good reason is one of the drawbacks of the P/BV.
Drawbacks to P/BV: 1) Other assts besides those recognized in accounting may be critical operating factors (human capital) 2) Can be misleading as a valuation indicator when significant differences exist among companies in terms of level of assets used (may differ due to differing business models) 3) Accounting effects may compromise BV as a measure of shareholders’ investment in the company 4) Inflation and technological change eventually drive a wedge between BV and market value of assets