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Chapter 4: Q1DQ (page 319)

How is the valuation of any financial asset related to future cash flows?

Short Answer

Expert verified

Valuation of financial assets depends upon valuing the present value of future cash flows from the financial asset.

Step by step solution

01

Financial Assets

Financial assets are the instruments or medium of earning returns. Financial assets are created when investments are made with certain conditions pertaining to the maturity period and yield to maturity (also called the required rate of return).

02

Valuation and future cash flow

Valuation of any financial assets is basically to determine the present value of all returns from the assets at different points in time.

The returns at different points of time are called the future cash flow. So the present value of future cash flows is calculated first. Then the summation of all present values of such future flows is taken to determine the present value of any financial asset.

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Most popular questions from this chapter

Question:Surgical Supplies Corporation paid a dividend of $1.12 per share over the last 12 months. The dividend is expected to grow at a rate of 2.5 percent over the next three years (supernormal growth). It will then grow at a normal, constant rate of 7 percent for the foreseeable future. The required rate of return is 12 percent (this will also serve as the discount rate).

a. Compute the anticipated value of the dividends for the next three years (D1, D2, and D3).

b. Discount each of these dividends back to the present at a discount rate of 12 percent and then sum them.

c. Compute the price of the stock at the end of the third year (P3).

P3 = D4/ (Ke - g)

d. After you have computed P3, discount it back to the present at a discount rate of 12 percent for three years.

e. Add together the answers in part b and part d to get the current value of the stock. (This answer represents the present value of the first three periods of dividends plus the present value of the price of the stock after three periods.)

Your father offers you a choice of \(105,000 in 12 years or \)47,000 today. b. If money is still discounted at 8 percent, but your choice is between \(105,000 in 9 years or \)47,000 today, which should you choose?

Cal Lury owes $10,000 now. A lender will carry the debt for five more years at 10 percent interest. That is, in this particular case, the amount owed will go up by10 percent per year for five years. The lender then will require that Cal pay off the loan over the next 12 years at 11 percent interest. What will his annual payment be?

What are the basic benefits and purposes of developing pro forma statements and a cash budget?

List five different financial applications of the time value of money.
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