Income Approach Methods Flashcards
6 cards from real Certified Valuation Analyst practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 6 Income Approach Methods flashcards as text
What is the capitalization of earnings method?
Answer: Dividing a single representative earnings figure by a capitalization rate to determine value
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.
What is a discounted cash flow (DCF) analysis?
Answer: Projecting future cash flows and discounting them back to present value using a required rate of return
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.
What is the weighted average cost of capital (WACC)?
Answer: The blended cost of a company's debt and equity financing, weighted by their proportions in the capital structure
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.
What is the build-up method for determining a discount rate?
Answer: Adding risk premiums (risk-free rate + equity risk premium + size premium + company-specific risk) to build a total required return
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.
What is the difference between a discount rate and a capitalization rate?
Answer: A discount rate applies to future cash flows; a capitalization rate is the discount rate minus the expected long-term growth rate
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.
Why are normalizing adjustments made to a company's financial statements in valuation?
Answer: To present the company's economic earning capacity by removing non-recurring, non-operating, and owner-specific items
Normalizing adjustments remove items that don't represent the company's ongoing economic earning capacity, such as excessive owner compensation, non-recurring expenses, related-party transactions, and non-operating assets/liabilities.
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