In the context of the valuation of companies, what does the Law of One Price state?

The Law of One Price is a fundamental principle in finance that asserts that in an efficient market, identical goods or securities must have the same price when accounting for risk and time. In the context of valuation, this means that similar cash flows, which are expected to occur under similar conditions, should be valued in a similar manner. Therefore, this principle supports the concept that assets or investments that generate equivalent cash flows will have equivalent valuations.

This concept is crucial for investors and analysts since it underpins the methodology used in asset pricing and valuation models. For instance, if two companies are expected to generate the same cash flows but are priced differently, it could indicate either a mispricing in one or both of the markets or differing risk profiles that investors need to account for.

The other options misinterpret the implications of the Law of One Price; it does not concern itself with the requirement of positive returns, nor does it suggest that valuations are independent of market conditions or that cash flows should remain unadjusted for risk. Thus, the focus on similar cash flows leading to similar valuations aligns perfectly with the essence of the Law of One Price in valuation practices.