Chartered Financial Analyst (CFA) Practice Exam Level 2

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What is the method of calculating the asset approach valuation?

Based on market trends alone
Based on tangible assets and future cash flows
Based on company earnings and dividends
Based on historical data and projections

The correct answer is: Based on tangible assets and future cash flows

The asset approach valuation method focuses on the value of a company's tangible assets, assessing their worth at a given point in time. This methodology typically involves identifying all of the company's physical assets, such as real estate, machinery, inventory, and any other tangible items, and then calculating their current values. The strength of this approach lies in its emphasis on the actual assets owned by a company rather than future profitability or cash flows. By valuing tangible assets, this method provides a clear picture of the organization's net asset value, which can be particularly useful for companies with significant physical holdings or in liquidation scenarios. This approach may also incorporate consideration of future cash flows but primarily centers on the existing assets' worth at the time of valuation. Evaluating future cash flows typically aligns more closely with income-based valuation methods, which focus on earnings and dividends, while market trends or historical projections are less relevant within the strict asset valuation framework. Thus, it's clear that when applying the asset approach, it's essential to derive value from the tangible assets specifically.