Question

Which of the following times are needed to determine the value of a financial asset?

I. holding period

II. amount and time of each cash flow

III. risk-adjusted discount rate

IV. tax rate

	a.	II and III only
	b.	I and IV only
	c.	I and III Only
	d.	II and IV only

justify answer

Answer 1

Ans :- (a) || & ||| only

• Valuation is the process of determining the fair value of a financial asset.
• The fundamental principle of valuation is that the value of any financial asset is the present value of the expected cash flows, the principle applies regardless of the financial asset.
• The valuation of a financial asset involves the following three steps: (1) estimate the expected cash flows.(2) determine the appropriate interest rate or interest rates that should be used to discount the cash flows and (3) calculate the present value of the expected cash flows using the interest rate or interest rates.

Amount & time of cash flow - Cash flow is the cash generated by operations, which is attributed to all providers of capital in the firm's capital structure. This includes debt providers as well as equity. Calculating the cash flows is done by taking earnings before interest and taxes and adjusting for the tax rate, then adding depreciation and taking away capital expenditure, minus change in working capital and minus changes in other assets.

Risk adjusted discount rate - is a valuation method used to estimate the attractiveness of an investment opportunity. It uses future free cash flow projections and discounts them (most often using the weighted average cost of capital,) to arrive at a present value, which is then used to evaluate the potential for investment. If the value arrived at through discount rate is higher than the current cost of the investment, the opportunity may be a good one.