Relating market value to 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-value ratio, in assessing current market prices. Theoretical and empirical research suggests that the size of the market-to-book-value 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.

Additional information regarding the six companies follows:

(1) Pfizer is a pharmaceutical company headquartered in the United States.

(2) Nestlé 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, Continente), 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).

(5) British Airways is headquartered in the United Kingdom and provides air transportation services.

(6) New Oji Paper Co. is a Japanese forest-products company. It purchases wood pulp from Canada and the United States and processes it into various papers for sale in Japan.

a. The market-to-book-value 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).

b. Discuss the likely rationale for the nature and mix of assets and the nature and mix of financing for each of the six firms.

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EXHIBIT 2.17 Common-Size Balance Sheets for Selected Companies (Problem 40) Pfizer Nestl Promodos Deutsche Bank British Airways New Ol Paper Co. ASSETS Cash and Marketable Securities 20.5% 11.5% 12.9% 44.2% 6.5% 2.1% Accounts and Notes Receivable 16.4 18.9 22.6 50.4 13.5 19.8 Inventories 8.1 13.4 18.4 0.7 8.5 Other Current Assets 6.3 1.4 1.5 Total Current Assets 51,3% 45.2% 53.9% 94.6% 20.7% 31.9% Investments in Securities... 7.5 7.1. 8.7 2.7 6.6 24.5 Property, Plant, and Equipment 28.2 43.7 28.3 1.2 72.7 43.6 Other Noncurrent Assets 13.0 4.0 9.1 1.5 Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% LIABILITIES AND SHAREHOLDERS' EQUITY Accounts Payable 5.1% 11.2% 44.3% 66.5% 9.4% 10.2% Short-term Borrowing. 12.8 18.1 3.3 16.0 5.3 16.2 Other Current Liabilities 17.8 9.6 12.6 4.9 15.6 10.7 Total Current Liabilities 35.7% 38.9% 60.2% 87.4% 30.3% 37.1 % Long-term Debt 3.4 6.7 7.7 1.2 36.8 16.9 Other Noncurrent Liabilities 12.9 9.2 4.1 8.0 4.0 4.8 Total Liabilities 52.0% 54.8% 72.0% 96.6% 71.1% 58.8% Common Stock 27.5% 3.0% 0.8% 1.7% 8.1% 17.3 % Retained Earnings 43.9 42.7 27.2 1.7 20.8 23.9 Treasury Stock (23.4) (0.5) - - Total Shareholders' Equity 48.0% 45.2% 28.0% 3.4% 28.9% 41.2% Total Liabilities and Shareholders' Equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Market Value/Book Value Ratio 8.2 3.3 4.6 1.7 2.4 1.4