Certified Valuation Analyst CVA Discount Rates and Cost of Capital 2

Question 1

To convert a levered beta to an unlevered beta (asset beta), the analyst uses the:

Accepted Answer

Hamada equation

Answer

The Hamada equation strips out the effect of financial leverage to derive the unlevered (asset) beta, which can then be re-levered for the subject company's capital structure.

Question 2

In the WACC formula, the cost of debt is adjusted by multiplying by (1 - tax rate) because:

Accepted Answer

Interest expense is tax-deductible, reducing the effective cost of debt financing

Answer

The after-tax cost of debt reflects the tax shield on interest payments, which reduces the true cost of debt capital to the company.

Question 3

The equity risk premium (ERP) used in CAPM and the build-up method represents:

Accepted Answer

The excess return investors expect above the risk-free rate for investing in equities

Answer

The ERP compensates equity investors for bearing market risk beyond the guaranteed return of risk-free Treasury securities.

Question 4

When a subject company has no publicly traded stock, an analyst estimates beta by:

Accepted Answer

Using unlevered betas of comparable publicly traded companies, then re-levering for the subject's capital structure

Answer

Private companies lack market price data, so analysts use guideline public company betas, strip leverage, and re-apply the subject's own capital structure.

Question 5

An increase in the subject company's long-term sustainable growth rate (g) in the Gordon Growth Model will:

Accepted Answer

Decrease the capitalization rate and increase value

Answer

Since the cap rate equals (discount rate − growth rate), a higher growth rate reduces the cap rate, which increases the capitalized value of the cash flow.

Certified Valuation Analyst Practice Test

Certified Valuation Analyst Practice Test

Certified Valuation Analyst CVA Discount Rates and Cost of Capital 2