 The most commonly used model to assess the value of a firm being a going concern is to see the firm from an investor's point of view. The investor buys the company's stock with the expectation of earning some returns in future in the form of dividends and the capital gain. Now how these returns are used in firm valuation for that purpose let's see an example. The example is about determining the expected holding period return or simply the expected return. For that purpose we assume that the investor's holding period is of 1 year and he expects to have dividend at the end of the year at $4. This means that is the expected dividend or dividend 1 or D1. The current share price or P0 is $48 and it is expected that at the end of the year's stock will be worth at $52 and that is termed as P1. Now to determine expected return on this one period investment we need to have two components. The first is the expected dividend and the second is the capital gain. To determine capital gain we need to deduct the opening price from the closing price and the difference will be divided over the opening price. So that will give us the value as capital gain. So we have to determine two values the dividend and the capital gain. So if we see we have dividend and capital gain of both then we need to divide these two items over the opening price and the resulting figure is 0.167 or 16.7%. So that is the return that this particular security is expected to give at the end of the year and so that is the expected return. Now if this is the expected return then what is the required rate of return and how it can be determined. Now the required rate of return is the return that is required by an investor over a security having some risks attached to that security. To determine this required rate of return or K there is a model that is used to determine this K that model is known as KPM or capital asset pricing model. KPM basically offers return estimates in line with the security's perceived risk. This means that any investor may require this return on any other investment of similar risk. For stock market prices set at equilibrium level expected return is considered as equal to the required rate of return. Now the KPM measures security risk in terms of beta. Now we can develop our relation between expected return and the required rate of return. If expected return is equal to required rate of return or K the stock is considered as fairly priced and if expected return is greater than K or the required rate of return then the stock is considered as the underpriced security and if the expected return is lesser than the required rate of return or K the stock is considered as an overpriced security. For understanding these relationships we have an example where our risk period is 6% and the difference between expected return on market portfolio and the risk period and the difference is termed as market risk premium or MRP that market risk premium is 5% the stock beta is 1.2 using these values into the KPM model we can determine the value of required rate of return or K and here we have the K of 12% so that is the required rate of return that any investor can require on this particular type of security now we see that our expected rate of return is 16.7% and that is greater than the required rate of return which is 12% so an investor can take a decision here and the decision is that it is better to add more of this stock into the portfolio held by that particular investor because the stock is underpriced what is the relationship between intrinsic value or V0 and the market price or P0 intrinsic value is the sum of present value of all the cash flows on a share or stock discounted at the cost of capital of the investor or its required rate of return which is termed as K so to determine the intrinsic value of any security the formula is to add the expected dividend and the expected price and divide this sum over the required rate of return or the K and that K is also termed as the capitalization rate in our example as we have dividend per share of $4 and expected price of $52 and we have the required rate of return of 12% now using this model the V0 or the intrinsic value or the fair market value of the stock is $50 now you see that the V0 is greater than P0 as P0 is $48 and the V0 or the intrinsic value is $50 so this stock is underpriced in the stock market by $2 so we can see that this particular stock is a positive alpha stock it offers better than a fair return relative to its risk and the investors will want to buy more of its more of this stock then they would following a passive strategy but what if the intrinsic value is lesser than the present stock stock value market value means that but if V0 is less than P0 then the stock will be considered as the overpriced security and in that particular case the investor should buy less of it this stock then under the passive strategy we know that in equilibrium market P0 will reflect the V0 estimates of all the market participants because any investors estimated intrinsic value or V0 differing from the current stock market stock price it must differ from the market consensus estimates whether they are the expected dividend expected price or the capitalization rate or opportunity cost or the required rate of return now that K is termed also as the market capitalization rate because this particular required rate of return or K which is the market capitalization rate this K represents the market consensus value of required rate of return