Difference between intrinsic value and book value

Question

XYZ explained the difference between intrinsic value and book value in terms of the money spent on a college education. Please provide another example using a different simile.

Answer 1

Intrinsic value basically means a price a knowledgeable investor would be willing to pay for the concerned asset. Book value means the price at which an asset is recorded in the books of accounts. Book value may change due to various reasons such as revaluation of the assets which is in the control of the management but intrinsic value changes due to change in the market perception of the concerned asset. There may be many reasons for change in the market perception of the asset which may be good management, bright prospects of the sector etc.

In the given case, what XYZ meant is that today the book value of money spent on a college education can be low, but its intrinsic value may be quite high. Book value means the actual money spent on the education and intrinsic value means the present value of cash flows i.e, discounted cash flows which a student will get due to the increased salary of the student after say a couple of years say for e.g.  5 years.

Now for a similar situation....lets say that there is a real estate developer, who identified a plot of land in a sub – urban area and he is absolutely sure of huge development in the area in next 5-8years. The developer will buy the same plot of land at a very low cost, as the value of the land is low currently due to low development. He records the asset for say $100,000, which is its purchase cost. Now, the intrinsic value of the land may be too high as in the next 5 years there will be huge development around the particular area and the value of land will definitely shoot up manifold. Further, you can discount the high value you will get in the future and discount the same for a reasonable rate of return and the value of land may be more than $100,000. Alternatively, you may say that after 5 years, the value of the land may be more than $100,000 but its book value will be $100,000 only.