Market value versus book value of shareholders' equity. Firms prepare their balance sheets using GAAP for the recognition and valuation of assets and liabilities.

Accountants refer to the total common shareholders" equity appearing on the balance sheet as the book value of shareholders' equity. The market value of shareholders' equity equals the number of shares of common stock outstanding times the market price per share. Financial analysts frequently examine the ratio of the market value of shareholders" equity to the book value of shareholders' equity, referred to as the market-to-book ratio, in assessing current market prices. Recent theoretical and empirical research suggests that the size of the market-to-book ratio is related to ( 1 ) a firm's ability to generate higher rates of profitability than its competitors, (2) its rate of growth, and (3) its use of GAAP in measuring assets and liabilities, which net to the book value of shareholders' equity.

Exhibit 2.17 presents balance sheet information for six firms at the end of a recent year. It also shows their market-to-book ratios. These ratios differ from 1.0 in part because the rates of profitability and growth of these six firms differ from those of their competitors. This problem does not provide you with sufficient information to assess the impact of these two factors on the market-to-book ratio. The ratios also differ from 1.0 because of the use of GAAP for assets and liabilities, which this chapter discussed. Identify the GAAP that most likely explain the market-to-book ratios for each of the six firms (that is, identify which accounting principles cause the book values of assets and liabilities to differ from the market value of shareholders" equity).

Additional information regarding the six companies follows:

(1) Merck is a pharmaceutical company headquartered in the United States. Merck recently acquired a large, prescription drug-management firm.

(2) Nestle is a consumer products company headquartered in Switzerland. In addition to its chocolate products, it manufactures and distributes beverages (Nestea, Poulin Springs mineral water), frozen foods (Stouffers), milk products (infant formulas), and pet foods (Alpo).

(3) Promodes is a French company that operates chains of supermarkets (Champion), hypermarkets

(Continent, Continentc), convenience stores (Promocash, Punt&Cash), and restaurant supply stores (Prodirest).

(4) Deutsche Bank is a German commercial bank that provides both traditional commercial banking services (deposit taking, loan making) and investment banking services

(investment management, financial consulting).