Either total assets or market capitalization can be used as proxies for firm replacement value. I think both of them can be effected by number of factors. The total asset is sensitive to accounting practices. The market capitalization is sensitive to market trends. What i want to know is which one is better and why? When specifically can we use any of these measures?
Thank you so much for answers.
You can't actually measure a firm replacement value using market capitalization simply because a firm is not a "total" unit. A firm consists of resources (machinery (assets), human as well as liabilities). Thus asset values are the appropriate measure. You mentioned that total asset is sensitive to accounting practices, which I suppose you mean there are choice of methods you may use. If you use accepted accounting methods (GAAP) & use them consistently you are fine. Since asset replacement measurement is long-term you will need to use capital budgeting technique, e.g. NPV in measuring the asset & replacement value.
Dear keong choong, I totally agree with your analysis. I personally prefer total assets as replacement value of a firm. However , in recent literature I.e. shariah equity investments, they have used market capitalization as proxy for firms replacement value. Even the Dow Jones and S&P Shariah indices use market capitalization. But the points you highlighted are of more interest to me. Thank you so much
Tobin’s q-ratio is widely used in studies examining how the level of firm value varies with firm structure. Calculation of q requires assumptions about rates of depreciation and inflation to estimate the firm’s replacement value. In addition, valuation studies do not generally industry-adjust q despite its large variation across industries. Attempting to industry-adjust q is, however, problematic when studying diversification, because neither segment market values nor segment replacement values can be computed directly from available data.
http://lib.cufe.edu.cn/upload_files/other/4_20140512024815_19.pdf
- I refer to the question: What is the most appropriate measure of firm replacement value?, posted by Prof/Dr Muhammad Wajid Raza. As I have commented earlier, the most appropriate method will be one that is based on firm basis in determining the long-term value (replacement value) of the assets. A capital budgeting method is one suggestion as individual assets with different depreciation rates, savage values, cash flows, etc. can be calculated. Tobin q-ratio may be used but is not the most appropriate method as Krishnan Umachandran acknowledged as the method is not useful for certain valuation circumstances & using industry data. However Tobin q can be useful if you just want an estimate (i.e. less accurate) result of a research question, say finding the cross-section value of firms.
- Badges
- Science topic
- Similar topics
- Analytical Chemistry
- Column