Posted in Finance, Accounting and Economics Terms, Total Reads: 593
The process of estimating the worth of something is called Valuation. In finance, Valuations are done for assets (tangible like plant, investments and intangible like goodwill, patents) and liabilities (bonds).
Valuations are needed for many reasons such as investment analysis, capital budgeting, financial reporting, mergers and acquisitions, taxable events to determine the proper tax liability, and in litigation.
When valuation is done for businesses, it is based on both objective and subjective aspects.
Valuation of financial assets is done by one of the following ways:-
Models that determine the value of an asset based on the present value of the future cash flows that can be generated by the asset (Absolute value models). These kinds of models take two general forms: multi-period models such as discounted cash flow model or single-period models such as the Gordon model.
Models determine value based on the observation of market prices of similar assets (Relative value models).
Option pricing models that are used for certain types of financial assets (e.g. warrants, put options, call options, employee stock options). The most common option pricing model is the Black–Scholes model.
For example:-When shares are valued i.e. the intrinsic value of shares is calculated, the net present value of expected future cash flows (discounted by an appropriate rate of return) is calculated for the valuation.