June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 21 of 92 sensible starting point in assessing capital adequacy. For the asset heavy company, book values of assets on the balance sheet will not necessarily correspond to their liquidation or market value. In addition, the balance sheet for these companies is more “backward looking”, in that it sometimes concentrates more on the cost of the assets vs. their present value. Therefore the market value approach, while more complicated, typically provides more accurate insights into the actual capital structure. It may be prudent for companies to utilize both approaches in order to provide a clearer picture of the company’s true economic value of equity. Table 3.1 outlines the strengths and weaknesses of either approach Table 3.1 Determining Total Assets Invested Capital Market Value Strengths • Common base that external constituents can relate to • Avoids conflicting assumptions regarding values • Provides link to financial ratios • More likely reflects true value of assets • Valuation is independent of accounting rules Weaknesses • May not reflect true value of assets • Values are relatively static to changes in the market • Difficult to verify by external constituents • Requires broad assumptions in customer behavior and product sales growth • Often no active market for pricing of assets • Markets may move given large liquidation • Does not provide a link to financial ratios used in analysis • Can be very complex in its determination, given assets with optionality 3.1.5. Total Liabilities Determination