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
Which statement best describes the relationship between a company's WACC and its intrinsic value under the FCFF model?
Answer: Higher WACC leads to lower intrinsic value because future cash flows are discounted more heavily
A higher WACC increases the discount rate in the denominator of the FCFF model, reducing the present value of all future free cash flows and thus intrinsic value.
When using the EV/EBITDA multiple, an analyst should be most cautious about comparing companies with significantly different:
Answer: Capital expenditure requirements and depreciation levels
EBITDA excludes capital expenditures, so firms with high maintenance CapEx needs look artificially cheap on EV/EBITDA compared to asset-light peers.
In reverse DCF analysis, the analyst primarily seeks to determine:
Answer: The growth rate implied by the current stock price given an assumed discount rate
Reverse DCF solves for the growth rate embedded in today's market price, helping analysts judge whether that implied growth is reasonable or overly optimistic.
A company's forward P/E is 18× and the industry average forward P/E is 14×. Which factor would most justify the premium?
Answer: Higher expected earnings growth relative to peers
A premium P/E is typically justified by superior earnings growth prospects, as the market pays more per dollar of current earnings for faster-growing companies.
When comparing a trailing P/E to a forward P/E, a forward P/E is generally preferred by analysts because:
Answer: Historical earnings are subject to restatement and can be negative during recessions
Forward P/E uses analyst estimates of future earnings, making it more relevant for valuation, while trailing earnings may be distorted by one-time items or cyclical troughs.
In a private company valuation, analysts typically apply a discount for lack of marketability (DLOM) because:
Answer: Private equity stakes cannot be easily sold in a liquid public market
DLOM compensates investors for the inability to quickly liquidate a private stake, reflecting the illiquidity premium required above comparable public market valuations.
Which of the following statements about the residual income model is most accurate?
Answer: Value equals book value plus the present value of all future residual income
In the residual income model, intrinsic value = book value per share + PV of all future residual income, where residual income = net income − equity charge (cost of equity × book value).