Describe the rules and discuss the main disadvantages of the following models: Asset Based Valuations Method of Comparables Dividend Discount Model
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Describe the rules and discuss the main disadvantages of the following models:
Asset Based Valuations
Method of Comparables
Answer -
Rules of Asset-based valuation model - It considers a company's prospective earning potential for valuation.
Disadvantages of Asset-based valuation
The major disadvantage of the asset-based valuation method is that it considers the company's prospective earnings. This earning, when compared with existing assets, especially intangible assets, is very complicated to measure valuations of intangible assets.
The second disadvantage of the asset-based valuation method is that this process becomes complex for some businesses due to lack of objectivity and accurate measurement of actual worth.
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