Posted in Finance, Accounting and Economics Terms, Total Reads: 656
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).Valuation is based on both objective (like expected future cash flows) and subjective( managerial efficiency) aspects of a business.
Valuation may be done for any of the following purposes:-
• Investment analysis
• Financial reporting
• Capital budgeting
• Mergers and acquisitions
• Determination of tax liability
Valuation of financial assets is done by one of the following ways:-
1. 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.
2. Models determine value based on the observation of market prices of similar assets (Relative value models).
3. Option pricing models that are used for certain types of financial assets (e.g. put options, call options, employee stock options etc). 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.