Equity Valuation Methods Flashcards
7 cards from real CFA practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Equity Valuation Methods flashcards as text
In a Gordon Growth Model, if the required return equals the dividend growth rate, the model produces:
Answer: An infinite stock value
The Gordon Growth Model denominator (r - g) equals zero when r = g, causing the formula to be undefined and theoretically producing infinite value.
Which of the following adjustments is required to convert EBIT to FCFF?
Answer: Add depreciation, subtract capital expenditures, subtract changes in working capital, then tax-effect EBIT
FCFF = EBIT(1-t) + Depreciation − CapEx − ΔWorking Capital, converting accrual operating income into cash available to all capital providers.
Which valuation multiple is most appropriate for comparing banks and financial institutions?
Answer: Price-to-book (P/B)
P/B is widely used for banks because their assets (loans, securities) are financial instruments that can be marked to market, making book value economically meaningful.
An analyst estimates that a firm's residual income will persist indefinitely at a constant level. The appropriate terminal value assumption is called:
Answer: Persistence factor model
When residual income is assumed to persist indefinitely at a constant level, the terminal value equals the perpetuity of residual income, which is a persistence factor approach.
In a comparable transactions analysis (precedent transactions), multiples are generally higher than comparable company multiples because:
Answer: Transaction multiples include a control premium paid by acquirers
Buyers in M&A typically pay a premium above trading price to gain control, resulting in acquisition multiples that are systematically higher than current market multiples.
Which of the following is a limitation of using the price-to-book (P/B) ratio for valuation?
Answer: P/B ignores off-balance-sheet assets like brand value and human capital
P/B misses intangible value not on the balance sheet, such as brands, patents, and talent, causing book value to significantly understate economic value for knowledge-intensive firms.
A firm's sustainable growth rate (SGR) is best estimated as:
Answer: Retention ratio × return on equity
SGR = b × ROE, where b is the earnings retention ratio (1 − payout ratio) and ROE is return on equity, representing growth achievable without external financing.