Can a company have negative book equity value?

Can a company have negative book equity value?

• A. No, book equity can only be positive
• B. Yes, if there are large cash dividends or prolonged losses
• C. Only during bankruptcy
• D. Yes, but only if assets exceed liabilities

Answer: (B)

The correct understanding is that a company can indeed have a negative book equity value, primarily due to prolonged losses or significant cash dividends that exceed its retained earnings. Book equity, also known as shareholders' equity, is calculated as total assets minus total liabilities. If a company has sustained significant losses over time, its retained earnings can decline, potentially leading to negative book equity when the losses cumulatively exceed the company's initial equity investments. Similarly, if a company pays out large cash dividends that surpass its retained earnings, this can also lead to a negative book equity situation, as the dividends reduce the equity available to shareholders. This situation is not restricted to bankruptcy; companies can experience negative book equity in various other scenarios outside of insolvency. Thus, the scenario presented in one of the options that connects negative book equity to prolonged losses or large cash dividends accurately reflects how negative book equity can occur.

The correct understanding is that a company can indeed have a negative book equity value, primarily due to prolonged losses or significant cash dividends that exceed its retained earnings.

Book equity, also known as shareholders' equity, is calculated as total assets minus total liabilities. If a company has sustained significant losses over time, its retained earnings can decline, potentially leading to negative book equity when the losses cumulatively exceed the company's initial equity investments. Similarly, if a company pays out large cash dividends that surpass its retained earnings, this can also lead to a negative book equity situation, as the dividends reduce the equity available to shareholders.

This situation is not restricted to bankruptcy; companies can experience negative book equity in various other scenarios outside of insolvency. Thus, the scenario presented in one of the options that connects negative book equity to prolonged losses or large cash dividends accurately reflects how negative book equity can occur.