Certified Valuation Analyst Income Approach Methods

Question 1

What is the capitalization of earnings method?

Accepted Answer

Dividing a single representative earnings figure by a capitalization rate to determine value

Answer

The capitalization of earnings method converts a single, representative level of earnings (typically normalized) into value by dividing it by a capitalization rate, assuming stable, predictable earnings will continue indefinitely.

Question 2

What is a discounted cash flow (DCF) analysis?

Accepted Answer

Projecting future cash flows and discounting them back to present value using a required rate of return

Answer

DCF projects the company's expected future free cash flows over a discrete period, then discounts them to present value using a discount rate that reflects the risk of those cash flows, plus a terminal value for the period beyond the projection.

Question 3

What is the weighted average cost of capital (WACC)?

Accepted Answer

The blended cost of a company's debt and equity financing, weighted by their proportions in the capital structure

Answer

WACC calculates the overall required return by weighting the cost of equity and after-tax cost of debt by their respective proportions in the company's capital structure, serving as the discount rate in DCF valuations.

Question 4

What is the build-up method for determining a discount rate?

Accepted Answer

Adding risk premiums (risk-free rate + equity risk premium + size premium + company-specific risk) to build a total required return

Answer

The build-up method constructs a discount rate by starting with the risk-free rate and adding successive premiums for equity risk, size, industry, and company-specific factors to reflect the total risk of the investment.

Question 5

What is the difference between a discount rate and a capitalization rate?

Accepted Answer

A discount rate applies to future cash flows; a capitalization rate is the discount rate minus the expected long-term growth rate

Answer

The discount rate reflects the total required return on an investment, while the capitalization rate equals the discount rate minus the expected sustainable long-term growth rate, converting a single-period income stream into value.

Certified Valuation Analyst Practice Test

Certified Valuation Analyst Practice Test

Certified Valuation Analyst Income Approach Methods