Fair Value
Lesson:
What's an item worth? Sometimes items are worth different amounts in different places and to different people.
The place where the vast majority of sales take place is known as the principal market.
When there is a principal market, we just use the price there (ignoring transaction costs) as the fair value of an item. The theory is that the principal market has the most buying activity, it probably reflects the price best. It will be less likely to be affected by market manipulations or happenstance.
Sometimes, however, there isn't a principal market. There might be two, twenty, or two hundred active markets.
In these cases, how do we decide which market to use in order to value our item?
We pick the market for which the price added to the total costs is least.
Once we've found the correct market, we value our item at that market's price and ignore the transaction costs entirely.
This is what you've been told:
- Charlotte quoted a price of $628.
- San Diego has transaction costs of $66.
- There is no primary market.
- San Diego quoted a price of $638.
- Charlotte has transaction costs of $61.
Answer:
- $628
Explanation:
- First, check to see if there is a primary market.
- Since there is no primary marketplace, calculate the total cost of each market (including transaction costs)
- We know the formula to calculate the total cost for a market participant.
TOTAL COST = QUOTED PRICE + TRANSACTION COST - Let's start with Charlotte
TOTAL COST CHARLOTTE = QUOTED PRICE + TRANSACTION COST - Let's plug in the numbers that we know
$689 = $628 + $61 - And let's do the same for San Diego
TOTAL COST SAN DIEGO = QUOTED PRICE + TRANSACTION COST - Let's plug in the numbers that we know
$704 = $638 + $66 - Since Charlotte offers the lowest total cost, it is considered the most advantageous market. Use its quoted price (ignoring transaction costs) as the fair value.