Question

4. One way to value a company is to sum the discounted expected future earnings of the firm. a. Does this make sense? Show and explain. b. Why then might somebody sell their shares and somebody else buy them? (The answer is drawn from the NPV formula)

Answer 1

ANSWER a

Yes, It makes sense because it is one of the method of valution of firm and it is named as Discounted Future Earning,In this method we estimate the Earnings of the Organisation and their Terminal Value(It is Value of the business which is beyond the estimated period of Future Cash Flow that is it will grow with certain percentage after it's Estimated period) at future date and brings this value at present by using Discounting Rate.

Therefore, The Value of the firm is sum of Discounted Future Earning and Discounted Terminal Value.

For Example= The Expected Discounted Earnings is $100000 and Terminal Value is Estimated is $200000.

Value of firm =$100000+$200000=$300000

Answer b

Buying and Selling of Share depends on psychology of the person or firm , because the value of the firm is depends on certain Estimation .For Somebody that value is right for selling and for other person it is right time to buy .

For example The value of share $50 Person A is thinking it has reached on top as knowledge and psychology but the other person named B is thinking with his knowledge and Pschology that the share is under valued and will go up and he is thinking to buy the share.