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Corporate Financial Decisions


Flow of Presentation

Market Value Added

Book to Market Ratio

Tobin’s Q
Market Value Added
Market Value Added

• Market value added (MVA) is a • It is calculated as:

calculation that shows the difference
between the market value of a MVA = V - K
company and the capital contributed
where MVA is the market value
by all investors, both bondholders
added of the firm, V is the market
and shareholders. In other words, it is
value of the firm, including the value
the sum of all capital claims held
of the firm's equity and debt (its
against the company plus the market
enterprise value), and K is the total
value of debt and equity.
amount of capital invested in the

Source :
Market Value Added

• MVAs are representations of value created by the actions and investments of a

company's management.
• A high MVA is evidence that the value of management's actions and investments is
less than the value of the capital contributed by shareholders, whereas a low MVA
means just the opposite.
• MVAs should not be considered a reliable indication of management performance
during strong bull markets when stock prices rise in general.
Market Value Added ~ Examples
➢ Alphabet Inc., (GOOGL) the parent of Google, is among the most valuable
companies in the world with high growth potential. Its stock returned 1,293% in its
first 10 years of operation. While much of its MVA in the early years can be attributed
to market exuberance over its shares, the company has managed to nearly triple it
over the last five years. Alphabet’s MVA has grown from $128.4 billion in 2011 to
$354.25 billion in December 2015 to $606.17 billion in December 2017.
➢ On the other end of the spectrum is one of the most established companies in the
S&P 500 index, the Coca-Cola Company (KO). Coca-Cola is one of Warren Buffett’s
favorite stock holdings because its management is so effective at increasing
shareholder value. At the end of the year 2017, the company's MVA was $158.52
billion, up from $150.4 billion in 2015 and $119.8 billion in 2011, and that does not
include the nearly $6 billion in dividend payments to shareholders. As of 2016, Coca
Cola has increased its dividends each year for the last 25 years by an average of 8% per
Market Value Added
➢MVA Reflects Commitment to Shareholder Value
Companies with a high MVA are attractive to investors not only because of the greater
likelihood they will produce positive returns but also because it is a good indication
they have strong leadership and sound governance. MVA can be interpreted as the
amount of wealth that management has created for investors over and above their
investment in the company. Companies that are able to sustain or increase MVA over
time typically attract more investment, which continues to enhance MVA. The MVA
may actually understate the performance of a company because it does not account
for cash pay-outs, such as dividends and stock buybacks, made to shareholders. MVA
may not be a reliable indicator of management performance during strong bull
markets when stock prices rise in general.
Book to Market Ratio
Book to Market Ratio

• The book-to-market ratio is used to • The Formula for Book-to-Market

find a company's value by comparing Ratio is :
its book value to its market value. A
company's book value is calculated by
looking at the company's historical 𝐵𝑜𝑜𝑘 − 𝑡𝑜 − 𝑀𝑎𝑟𝑘𝑒𝑡
cost, or accounting value. A firm's
market value is determined from its 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
share price in the stock market and =
the number of shares it has 𝑀𝑎𝑟𝑘𝑒𝑡 𝐶𝑎𝑝
outstanding, which is its market

Source :
Book to Market Ratio

What Does the Book-to-Market Ratio Tell ?

➢ If the market value of a company is trading higher than its book value per share, it is considered to be overvalued. If the
book value is higher than the market value, analysts consider the company to be undervalued. To compare a company’s
net asset value or book value to its current or market value, the book-to-market ratio is used.

➢ The book value of a firm is its historical cost or accounting value calculated from the company’s balance sheet. Book value
can be calculated by subtracting total liabilities, preferred shares, and intangible assets from the total assets of a company.
In effect, the book value represents how much a company would have left in assets if it went out of business today. Some
analysts use the total shareholders' equity figure on the balance sheet as the book value.

➢ The market value of a publicly traded company is determined by calculating its market capitalization, which is simply the
total number of shares outstanding multiplied by the current share price. The market value is the price that investors are
willing to pay to acquire or sell the stock in the secondary markets. Since it is determined by supply and demand in the
market, it does not always represent the actual value of a firm.
Book to Market Ratio

• The book-to-market ratio helps investors find the value of a company by comparing
the firm's book value to its market value.
• High book-to-market ratios can be interpreted as the market valuing the company's
equity cheaply compared to its book value.
• Many investors are familiar with the price-to-book ratio, which is simply the inverse
of the book-to-market ratio formula.
Tobin’s Q
Tobin’s Q
Definition: Or,

• The Tobin's Q ratio equals the market 𝑇𝑜𝑏𝑖𝑛′ 𝑠 𝑄

value of a company divided by its Equity Market Value + Liabilities Market Value
assets' replacement cost. Thus, Equity Book Value + Liabilities Book Value
equilibrium is when market value
equals replacement cost.
• Q Ratio Formula and Calculation: Or,
𝑇𝑜𝑏𝑖𝑛′ 𝑠 𝑄 𝑇𝑜𝑏𝑖𝑛′ 𝑠 𝑄
Total Market Value of Firm Equity Market Value
= =
Total Asset Value of Firm Equity Book Value

Source :
Tobin’s Q

Limitations of Tobin’s Q ?

➢ Tobin's Q is still used in practice, but others have since found, using data of the US economy from the
1920s to the 1990s, that so-called "fundamentals" predict investment results much better than the Q ratio.
These include the rate of profit – either for a company or the average rate of profit for a nation's economy.

➢ Others, like Doug Henwood in his book Wall Street: How It Works and For Whom, find that the Q ratio
fails to accurately predict investment outcomes over an important time period. The data for Tobin's original
(1977) paper covered the years 1960 to 1974, a period for which Q seemed to explain investment pretty well.
But looking at other time periods, the Q fails to predict over- or undervalued markets or firms. While the Q
and the investment seemed to move together for the first half of the 1970s, the Q collapsed during the
bearish stock markets of the late 1970s, even as investment in assets rose.
Tobin’s Q

• The Q Ratio was popularized by Novel Laureate James Tobin and invented in 1966 by
Nicholas Kaldor.
• The Q measures if either a firm or an aggregate market is relatively over- or under-
• It relies on the concepts of market value and replacement value.
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