ACCA Financial Management (F9) Certification Practice Exam

What does the fundamental theory of share values suggest about realistic share prices?

1. They are based on historical data alone

2. They should equal the intrinsic value only during bear markets

3. They are derived from predicted future dividends

4. They are random and unpredictable

The correct answer is: They are derived from predicted future dividends

The fundamental theory of share values posits that the price of a share should reflect its intrinsic value, which is primarily determined by the present value of expected future cash flows, specifically dividends. This theory emphasizes that investors make decisions based on their expectations of how much cash (in the form of dividends) they will receive in the future, discounted back to their present value using an appropriate discount rate. Consequently, when evaluating a share's realistic market price, one should consider the anticipated future dividends, as these are what ultimately generate returns for shareholders. This approach builds on the premise that in an efficient market, where all available information is reflected in share prices, the intrinsic value derived from future dividends will align with what investors are willing to pay. Therefore, option C accurately encapsulates this critical aspect of share valuation by emphasizing the importance of predicted future dividends in determining realistic share prices.