Question

Draw and label the basic valuation model using the correct names.

Answer 1

Valuation is the process that establishes the link between the risk and return to find the value or worth of an asset. The inputs required for basic valuation are:
The expected returns in terms of cash flows with their respective timings of occurrence.
Risk in terms of the required return
The expected returns can either be annual or intermittent or sometimes even for once.
Basic Valuation Model:
The basic value of an asset or a security is the sum of discounted value of all the future expected cash flows. The discount rate is the rate used as the required rate of return which is dependent upon the level of risk. If the investment in the asset is very risky, higher would be the discount rate. If the investment in the asset is less risky, lower would be the discount rate. To sum up, the value of an asset is the present value of all the future expected cash flows discounted at the required rate of return. Symbolically, the Value of an asset (V) =

V=CF1/(1+r)1 + CF2/(1+R)2 + ......CFn/(1+r)n

Where:
CF = Cash flows expected at the respective year-ends
r = Discount rate (required rate of return)
n = The last period of cash flow occurrence