Chartered Financial Analyst (CFA) Practice Exam Level 2

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What is one of the disadvantages of Book Value (BV)?

It is always equal to Market Value (MV)
It is influenced by accounting choices
It represents the true economic value of a company
It measures the ongoing cash flow of the company

The correct answer is: It is influenced by accounting choices

Book Value (BV) being influenced by accounting choices is a key disadvantage because it means that BV can vary significantly depending on the accounting methods and judgments applied by management. Different accounting standards, such as GAAP or IFRS, allow for various approaches to asset valuation, depreciation, and revenue recognition, which can lead to discrepancies in how BV is calculated. These discrepancies may not accurately reflect the underlying economic realities of a company's situation. For instance, if a company uses aggressive depreciation methods, it may appear to have a lower BV, potentially misrepresenting its actual value when compared to its market value (MV). This variability can complicate comparisons across companies or industries, making it harder for investors to gauge the true value of a company based solely on its book value. In essence, while BV can provide useful information, its dependence on accounting choices can distort its reliability and relevance in decision-making processes.