Question

1. The value of any investment is found by computing the

C. present value of all future cash flows.  

2.In a one−period valuation model, a decrease in the required return on investments in equity causes a(n) ________ in the ________ price of a stock.

D. increase; current

These are the answers to these question, could you explain why this is the answer? Please give me an explanation.

Answer 1

Question-1;

As we know that the value of any investment is found by computing present value of all future cash flows. Present value of future cash flows helps in knowing real value of future cash flows. If we do not calculate present value of future cash flows then we will not be able to know real discounted cash inflows.

For knowing the value of any investment, discounting of future cash flows is necessary that is why computation of present value of future cash flows is done for knowing the value of any investment.

Value of investment = Present value of future cash flows – Initial investment.

Question -2;

In a one−period valuation model, a decrease in the required return on investments in equity causes an increase in the current price of a stock.

As we know that when required return on the investment is decreased that means discounting rate has been decreased and when discounting rate is decreased then it will cause an increase in the current price of the stock.

In other words we can say that when the required return increases then current price of the stock will decrease. And when the required return decreases then current price of the stock will increase.

Hence, it is true that a decrease in the required return on investments in equity causes an increase in the current price of a stock.