In finance, valuation is the process of calculating an asset's present value (PV). Valuations can be performed on either assets or liabilities. Valuations are required for a variety of purposes, including investment analysis, capital planning, merger and acquisition transactions, financial reporting, and taxable events to calculate the appropriate tax responsibility.
What is it?
Market value, fair value, and inherent value are all words used to describe the worth of an asset or obligation. These words have different meanings. For example, an analyst may issue a "buy" recommendation if he or she feels a stock's intrinsic worth is greater than its market price. Furthermore, an asset's intrinsic value may be subjective and differ amongst analysts. The International Valuation Standards provide definitions for common valuation bases as well as generally accepted practice techniques for evaluating all sorts of assets.
Absolute value models are used to calculate the present worth of an asset's projected future cash flows. These models are classified into two types: multi-period models like discounted cash flow models and single-period models like the Gordon model. Rather than price observation, these models rely on mathematics.
Diving in Deep
Relative value models calculate value by observing market prices of 'similar' assets in relation to a shared variable such as profits, cashflows, book value, or sales. This conclusion is frequently used to supplement / evaluate the intrinsic valuation.
In this context, option pricing models are used to value individual balance-sheet components or the asset itself when they contain option-like features. Warrants, employee stock options, and assets with embedded options, such as callable bonds, are examples of the first kind; genuine options are often of the second type. The Black–Scholes–Merton and lattice models are the most often used option pricing models in this context. This method is also known as contingent claim valuation since the value is dependent on another asset.
Valuation analysis is needed in finance for a variety of reasons, including tax assessment, wills and estates, divorce settlements, company analysis, and basic bookkeeping and accounting. Because the worth of objects changes over time, valuations are made as of a certain date, such as the end of an accounting quarter or year. They might also represent mark-to-market assessments of the current worth of assets or liabilities as of this minute or day for the purpose of managing portfolios and related financial risk.