The price may be understood as ‘the amount of money or other consideration asked for or given in exchange for something else’. The price is, therefore, an outcome of a transaction whereas the value may not necessarily require the arrival of a transaction. The value exists even if some assets become unable to generate cash flows today but can generate in future on the happening of some events.
For eg., A reserved oil may not have any value when the oil price is` 70 and the extraction cost of that oil is`110. However, when the price reaches ` 130 and is expected to prevail around this figure, it may have significant value. Another example reaffirms that price and value is not the same. A lawyer is having some questions regarding a professional assignment having remuneration of 2,50,000. He browses through some pages of a book at a bookshop and buys it for 40,000. He has an idea in his mind that the book is essential for earning professional remuneration of 2,50,000 and expected contribution from the book would be around 80,000. At this stage, the value/worth of that book is 80,000. However, after reading the book he feels that the book is not useful for this assignment. If an identical book cannot be coming back to the shop, its disposal worth would be negligible. The difference between price and value can be explained with the help of the behavior of the investors.
In theory, every decision maker believes rationally. A decision is called ‘rational’ when the objective of the decision maker is clear and he is well informed. Homogeneous expectations are characteristics of efficient markets. But it is clear from the researches in the area of behavioral finance that homogeneous expectations are characteristics of efficient markets. Market participants do work with asymmetric information and the expectations are different. As a result value and price don’t essentially need to be equal.
Valuation Knowing what a quality is worth and what determines that worth may be a necessity for intelligent decision making. Valuation is an essential prerequisite in choosing investments for a portfolio, in deciding on the appropriate price to pay or receive in a takeover, and in making investment, financing and dividend choices while running a business. The premise of valuation is that we are able to build affordable estimates valuable for many assets. The same elementary principles confirm the values of every kind of assets, real additionally as monetary. Some assets are easier to value than others because the details of valuation vary from asset to asset and therefore the uncertainty related to worth estimates is completely different for various assets. However, the core principles remain the same. The value of any asset must equal the present value of its future cash flows, discounted at a rate that reflects its inherent risk. Since neither the future cash flows for the appropriate discount rate can be known with certainty, valuation is always an estimation. Several evaluation methods are used to value a business but not a single method can be vouched to predict the exact price at which an entity can be sold. Valuing a business is a pivotal function while acquiring a company as the buyer will be willing to pay the price depending on the synergy value that will result when the companies are combined. The more the synergy value a particular acquisition can generate, the higher the maximum price an acquirer will be interested in paying. Valuation is used for stock selection, concluding market expectation, evaluating corporate events, setting up an opinion, evaluating business strategies, as communication among management, shareholders and analysts, appraisal, etc