A drawback of using the price-to-book value ratio as a valuation tool is that book value:
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A. B. C.A
The price-to-book value (P/B) ratio is a commonly used valuation tool in finance that compares a company's market price per share to its book value per share. While the P/B ratio can provide useful insights into a company's valuation, it does have some drawbacks. Let's examine each answer choice to understand the limitations of the P/B ratio.
A. The answer choice suggests that book value does not reflect human capital. Human capital refers to the skills, knowledge, and experience of a company's employees. This is a valid concern because book value primarily focuses on tangible assets and liabilities, such as buildings, equipment, and debt. It does not capture the intangible assets, including human capital, brand value, intellectual property, or customer relationships. Therefore, using the P/B ratio alone may not adequately reflect the overall value of a company, especially those heavily reliant on human capital.
B. The answer choice suggests that book value is not appropriate for valuing firms with large, highly liquid assets. This statement is also accurate. Book value primarily reflects the historical cost of assets, which may not reflect their current market values accurately. Highly liquid assets, such as cash, marketable securities, or short-term investments, can quickly change in value due to market fluctuations. Consequently, relying solely on book value may underestimate the true value of companies with significant liquid assets.
C. The answer choice states that book value is only effective in valuing companies that are not expected to continue as a going concern. This statement is not accurate. Book value is generally relevant for valuing companies that are expected to continue their operations. It represents the shareholders' equity, which is a measure of the company's net worth. However, it is essential to note that book value might not capture the future growth potential, profitability, or changes in market conditions that can impact a company's valuation.
In summary, the correct answer is B. The drawback of using the price-to-book value ratio as a valuation tool is that book value is not appropriate for valuing firms with large, highly liquid assets. The P/B ratio overlooks intangible assets, including human capital, and relies on historical cost, potentially undervaluing companies with significant liquid assets.