The Valuation Principle

Cost Benefit Analysis

A process that involves evaluating the benefits generated compared to the costs incurred creating those benefits.

Value Creation

Occurs when the benefits exceed the costs of an investment or decision.

Competitive Market Prices

Markets where goods are bought and sold at the same price, influenced by supply and demand.

Valuation Principle

Values of assets to individuals and firms are determined by their competitive market prices.

Present Value

The current value of a future cash flow, discounted at the relevant interest rate.

Net Present Value (NPV)

The difference between the present value of a project's benefits and the present value of its costs.

NPV Rule

Select the investment alternative with the highest NPV to maximize value.

Time Value of Money

The difference in value between money today and money in the future.

Arbitrage

The simultaneous purchase and sale of an asset to profit from a difference in the price.

Law of One Price

In frictionless markets, perfect substitutes must have identical prices.