Certified Valuation Analyst Income Approach Methods 3

Question 1

The Capital Asset Pricing Model (CAPM) is used in the income approach to estimate:

Accepted Answer

The cost of equity capital

Answer

CAPM estimates the required return on equity using the risk-free rate, beta, and equity risk premium.

Question 2

In CAPM, beta measures:

Accepted Answer

A company's systematic risk relative to the market

Answer

Beta quantifies how sensitive a security's returns are to overall market movements (systematic risk).

Question 3

The build-up method differs from CAPM primarily because it:

Accepted Answer

Does not rely on a beta coefficient

Answer

The build-up method sums risk premiums without using a beta, making it common for closely held companies.

Question 4

A size premium is typically added to the discount rate because:

Accepted Answer

Smaller companies generally carry higher risk than large public firms

Answer

Empirical data shows smaller firms exhibit higher returns and risk, justifying an added size premium.

Question 5

The company-specific risk premium accounts for:

Accepted Answer

Unsystematic risks unique to the subject company

Answer

This premium reflects firm-specific factors such as customer concentration or key-person dependence not captured elsewhere.

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