12.3: Valuation Premise
So, the HPR is not acceptable because it does not include the critical notion of time value of money. In general, we will find that the (dollar-) valuation of any asset will adhere to the following rule:
The value of an (financial) asset is equal to
the future cash flows the asset is expected to produce,
each of which cash flow is discounted to its present value
and then all such present values are aggregated to
a single value.
This says that in valuing an asset, we must first identify its future cash flows, and then discount each of those cash flows at an appropriate discount rate, and aggregate the figures into a sum, which shall be the asset’s valuation or price.
We will also find that, in a certain sense, the dollar value and the discount rate are interchangeable; in fact, we will note that the discount rate, in a large sense, is the “true” price of the asset.
These premises are basic to finance.