The fundamental value of a business is the: O value of the forecasted future profits. O earnings per share. O stock price. O present value of the future profits it will earn.
The fundamental value of a business is the: O value of the forecasted future profits. O earnings per share. O stock price. O present value of the future profits it will earn.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:### Understanding the Fundamental Value of a Business
When evaluating the fundamental value of a business, it's important to consider various financial metrics and definitions. Here, we explore different potential definitions of a business's fundamental value and clarify which one is most accurate.
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#### Question: The fundamental value of a business is the:
- **Value of the forecasted future profits.**
- **Earnings per share.**
- **Stock price.**
- **Present value of the future profits it will earn.**
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Let's break down each of these answers:
1. **Value of the forecasted future profits:**
- This option considers the future potential earnings of the business. Forecasted profits are predictions made based on current trends and data.
2. **Earnings per share (EPS):**
- EPS is a financial metric indicating the portion of a company's profit allocated to each outstanding share of common stock. It's a commonly used indicator of a company's profitability but does not directly define the business's fundamental value.
3. **Stock price:**
- The stock price reflects the current market value of a company's shares. It is influenced by various factors, including market sentiment and external economic conditions, and may not always represent the intrinsic value of the business.
4. **Present value of the future profits it will earn:**
- This concept, also known as discounted cash flow (DCF) analysis, calculates the value of a business based on the present value of projected future cash flows. This method often provides a more accurate reflection of the business's fundamental value.
#### Conclusion:
The most precise definition of the fundamental value of a business is **the present value of the future profits it will earn**. This valuation method accounts for the time value of money, recognizing that future profits are worth less today due to potential risks and the opportunity cost of capital.
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Understanding this definition is crucial for making informed investment and financial decisions. By focusing on the present value of expected future profits, investors can gain a clearer picture of a business's true value.
Transcribed Image Text:### Financial Crises and Regulatory Measures
#### Understanding the 2007-2009 Financial Crisis
**Question:**
Even though deposit insurance existed, the United States experienced a major financial crisis from 2007 to 2009 because:
- There was a run on shadow banks, which were not covered by deposit insurance.
- There was excess competition from other countries.
- Banks refused to honor the deposit insurance scheme.
- The deposit insurance system failed during that time.
**Context:**
The financial crisis of 2007-2009 was a complex economic event rooted in multiple factors. Understanding the key reasons behind the crisis helps shed light on the limitations of existing financial safeguards and the role of different financial entities.
- **Shadow Banks:** These institutions operate outside the realm of traditional commercial banking regulation, often engaging in riskier financial activities. Since they were not covered by deposit insurance, when confidence waned, there was a rapid withdrawal of funds, leading to instability.
- **Excess Competition:** Although global competition affects economies, it was not a primary cause of the 2007-2009 crisis.
- **Banks and Deposit Insurance:** Traditional banks in the US generally honored the deposit insurance scheme, which was designed to protect depositors' funds up to a certain limit.
- **Failure of Deposit Insurance:** The system itself did not fail, but it was insufficient to address the liabilities of institutions operating outside its scope.
**Key Takeaway:**
The run on shadow banks, entities not protected by the deposit insurance scheme, played a significant role in the financial turmoil during this period. This highlights the need for broad financial regulatory measures encompassing various types of financial institutions.
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