Certified Valuation Analyst CVA Discount Rates and Cost of Capital

Question 1

In the build-up method for estimating cost of equity, which component is added to the risk-free rate to account for the size of the subject company?

Accepted Answer

Small company risk premium

Answer

The small company risk premium (size premium) compensates investors for the additional risk of investing in smaller companies relative to large-cap stocks.

Question 2

The Weighted Average Cost of Capital (WACC) is used in business valuation primarily when:

Accepted Answer

Valuing invested capital using a debt-free net cash flow stream

Answer

WACC discounts invested capital (debt-free) cash flows and is appropriate when the capital structure includes both debt and equity.

Question 3

Which risk-free rate is most commonly used in U.S. business valuations as the base for the build-up method?

Accepted Answer

Yield on 20-year U.S. Treasury bonds

Answer

The 20-year U.S. Treasury bond yield is the standard risk-free rate proxy in U.S. valuations because it matches long-term investment horizons.

Question 4

Beta in the Capital Asset Pricing Model (CAPM) measures:

Accepted Answer

Systematic (market) risk of an investment relative to the overall market

Answer

Beta measures systematic risk — how much a security's returns move in relation to overall market movements — and cannot be diversified away.

Question 5

When using Duff & Phelps size premium data, which decile has the highest size premium?

Accepted Answer

Decile 10 (smallest companies)

Answer

The smallest companies (Decile 10) carry the highest size premium because they are the most illiquid and risky relative to large-cap benchmarks.

Certified Valuation Analyst Practice Test

Certified Valuation Analyst Practice Test

Certified Valuation Analyst CVA Discount Rates and Cost of Capital