Main content
Finance and capital markets
Course: Finance and capital markets > Unit 6
Lesson 3: Understanding company statements and capital structureMarket value of assets
Market value of assets. Created by Sal Khan.
Want to join the conversation?
So would either of these companies be considered over valued? If yes why and if not, why? Thanks.(10 votes)
I would have to say that Jason's company is over valued. Ben has achieved the same results as Jason, without the debt. Why? Better management skills? Better location? Who knows! The reality is that if both companies had to dissolve the day following this assessment, Ben's share holders would be far better served than Jason's. This is the one major drawback to market valuation: as long as it's business as usual then things are fine, but in case of economic downturn or any other hiccup, the reality of that market cap is not so real. See Enron and or Facebook.(45 votes)
He says at the end, "what I'll address in the next video is, which company is a better deal..." But there is no next video, it moves onto another section. Does anyone know which video is it where he compares which is the better deal, the company with debt or without? (please don't say 'obviously' the one without debt because that is not correct)(29 votes)
I don't know what he was planning to say but there is no easy answer to that question. It depends on your risk tolerance, taxes, costs of financial distress. Typically a little bit of debt enhances the total value, and therefore the equity value, because interest is tax deductible. Too much detracts from value because the chances of bankruptcy go up.(7 votes)
Just thinking, doesn't it make more sense for assets to equal equity-liabilities? Because Jason's company has a greater market cap than Ben, even though he has $100,000 in debt. Shouldn't Ben's company have a greater market cap or market value than Jason's since he really has more money? Thanks, great videos(10 votes)
Think of equity as how much the owners of the company have claim on the assets. So maybe a more intuitive way of thinking about the equation is
Equity = Assets - Liabilities
So that is just saying that the owners of the company (Equity) have (=) all of the stuff that a company owns (Assets) minus what they owe to others (Liabilities).
Andrew M got the point that the market cap is based on how investors value the company. You'd be surprised at how much money is owed to others from huge companies like Google, yet their market value is high.(6 votes)
How can people put a price tag on something intangible, for example patents, copyrights, brand value, customer loyalty, etc? One can sell patents and copyrights, and get a price for each. How about brand value and customer loyalty?(2 votes)- If you buy an entire company, you get everything. You get their factories, inventory, patents, brand value and customer loyalty etc. In order to sell their company, the owners would want to be compensated for all of those things. They didn't just build a factory and create a product. They built a recognizable brand and found customers.
The problem comes down to how do you value those assets? There are various ways, but the way that is easiest to understand is to look at comparable publicly traded companies. Find similar companies that are publicly traded, figure out how much of their value is in tangible assets and intangibles, and price your company's intangibles similarly.
This will depend on the company and industry. Some beverage and snack companies (Coke, Hershey's) have the majority of their value in intangibles (their internationally recognized brand name). Whereas commodity based companies (mining, oil refiners) usually have less intangibles because every one of them sells the same product and the only thing that matters is price.(15 votes)
- We see a scenario here (for both Jason & Ben) where the equity portion is carrying a value which makes the Assets smaller than the Equity+Debt. What will happen in case the the Equity+Debt goes below the assets OR is it that the Equity per share has a minimum value always and the share price is not allowed to go below that?(3 votes)
- Assets always equal L + E. That's the accounting definition of equity, basically.
The market value of assets, liabilities, and equity does not have to be related at all to the accounting value.
A company cannot "pay off the shareholders". The shareholders own it. Whatever is left after settling the debt goes to the shareholders. They ARE the owners. That equity is theirs.(5 votes)
- Using the "market's value of the equity" seems to introduce problems. Before this video, we used the assets and liabilities (A-L) to calculate the equity. Now we're using the equity and the liabilities to calculate the assets (E+L). In this case, wouldn't taking on more loans increase the liabilities, and therefore increase the assets? How can having more debt increase your assets?(5 votes)
Why are the assets = liabilities + equity? I thought assets are what the company owns, so why doesn't assets = equity - liabilities?(1 vote)- By definition, because the definition of equity is assets - liabilities.
But what the equation is telling you is that everything you own (all of your assets) had to be financed in some way. Either you borrowed money to buy it (liability) or you used your own money (equity).
Assets are what the company owns. Liabilities and equity are the way those assets were financed and they tell us how cash flows (income) generated by those assets gets divided up among the people who provided the financing.(5 votes)
- Hi Sal, given the market capitalization of the company being valued at a price higher than that stated on the books, i.e. book value; it was mentioned by you in the example given in this video, that it could potentially be attributed to the company/management expertise and thus recorded as an intangible asset. Could this perhaps be thought of as, or rather, is the same concept as brand equity? In that, was the asset side of the balance sheet debited by the increase in the amount (of market cap-book value) to counterbalance the crediting of the same amount on the equity side of things, in the form of brand equity? Thanks!(2 votes)
Could it be considered that the Market value also holds future expectations (growth of the tangible assets)?(2 votes)
Hello, With reference to the 'intangible' element of the fixed assets, in the example which is given in the video would it fall under such sub-categories as intellectual property, goodwill, etc?(1 vote)- No. Intellectual property usually refers to patents and copyrights. Goodwill is used when a company buys another company. They will have to buy it for more than it's market value. The difference between the purchase price and the market value is the goodwill.
Some assets simply cannot be adequately identified in order to put on a balance sheet. Regardless, they are still usually reflected in the market price.(3 votes)
Video transcript
In the last video, we saw that
if Ben's Shoe Company's stock prices are trading
at $21.50 per share, and if Ben's Shoe Company
has 10,000 shares-- and we saw that over here on the
left, if it had 10,000 shares. Actually both of the shoe
companies have 10,000 shares. Then the market is
essentially valuing the equity of Ben's Shoe
Company at $215,000, even though the book value
of the equity was $135,000. What I want to do
in this video is think about what does
that mean, or how should we perceive
the market's value of the assets of
Ben's Shoe Company. Then we can also think
about Jason's Shoe Company. So remember, assets are
equal to liabilities plus the shareholders' equity. So if all of a sudden the market
value of the equity, the market capitalization for
Ben's Shoe Company is $215,000, that's the
equity part right over here, this is the equity. And the only liability
that Ben's Shoe Company had was this $5,000 in
accounts payable. So let me show you
that right over here, he had this $5,000
in accounts payable, also depicted over there. So the only liability
is this $5,000. So the liabilities
plus the equity, in the case of Ben's company,
is $215,000 plus $5,000. So this piece right
over here is $220,000. Now, you might remember
from previous videos that the book value of the
assets in Ben's company are only $140,000. $20,000 of cash, $100,000
of inventory, $20,000-- this isn't equity, this
is equipment, I should call it--
$20,000 of equipment. So The question is,
what makes up the gap here, when we think about the
market value of the equity? Because remember, this piece
right here only adds up to $140,000. But our total assets-- or
the market's perception of the total assets
of the company-- are essentially what
it's willing to pay for the equity
plus the liability. So the market is saying that
Ben's assets, the assets in that company,
are worth $220,000. So what makes the difference? And even better, let's
assume that Ben has actually done a good job of
saying the market value of his inventory, the
market value of his equipment. Well, what the market's
saying in this situation-- and this is actually what
tends to happen in general, the market value of
a company's equity tends to be higher than
the book value-- is that this company has
some type of intangibles. Things that you really can't put
a finger on, or touch, or feel, or hold. But it makes this company's
assets-- or this company has more than just
the sum of its parts. There's more to this company
than just the equipment, the inventory, and the cash. It might be Ben's
management expertise. It might be a certain way
they have of doing business. It might be a certain
location they have. It might be their assortment. Who knows what it has,
but the market is saying that the combination of this
plus all of the expertise and how the business
is organized means that it actually has more
assets than are on the books. And the same thing is true
of Jason's company, when they assign a $120,000
market cap there. This is the $120,000 in
equity-- market value of equity. He has another $105,000
in liabilities. So the market's valuing
their equity plus liabilities at $225,000. Is that right? 120 plus 100 plus 5. So 225,000. So once again, they're valuing
all of the assets at $225,000, because assets are
equal to liabilities-- these are the liabilities
right here-- plus equity. So once again,
you're saying there's something above and
beyond the $140,000 that makes this company special. And an interesting
thing to think about-- and we'll address it
in the next video-- is which one is a
better deal, considering that these companies
are pretty similar?