CFA Asset Valuation 2 — Questions and Answers
Question 1: Which valuation approach estimates a firm's value by discounting its expected future free cash flows to the firm (FCFF) at the weighted average cost of capital?
- Dividend discount model
- Residual income model
- FCFF discounted cash flow model (Correct answer)
- Price-to-book ratio model
Correct answer: FCFF discounted cash flow model
The FCFF DCF model discounts cash flows available to all capital providers at the WACC to arrive at total firm value.
Question 2: A stock has a required return of 10% and pays a dividend of $2 next year that is expected to grow at 5% forever. Using the Gordon Growth Model, what is the intrinsic value?
- $20
- $40 (Correct answer)
- $22
- $50
Correct answer: $40
V = D1 / (r − g) = $2 / (0.10 − 0.05) = $40.
Question 3: In the enterprise value (EV) calculation, which of the following is subtracted from EV to derive equity value?
- Cash and cash equivalents
- Intangible assets
- Net debt (Correct answer)
- Deferred revenue
Correct answer: Net debt
Equity value = EV − net debt (total debt minus cash and equivalents).
Question 4: Which method is most appropriate for valuing a company that has negative earnings but positive operating cash flows?
- Price-to-earnings ratio
- EV/EBITDA multiple (Correct answer)
- Dividend discount model
- Price-to-book ratio
Correct answer: EV/EBITDA multiple
EV/EBITDA is useful when earnings are negative because EBITDA strips out non-cash and financing charges, often remaining positive.
Question 5: When using comparable company analysis, a valuation multiple is considered 'clean' primarily because it:
- Uses forecasted rather than historical numbers
- Adjusts for differences in capital structure
- Is calculated from market prices reflecting current expectations (Correct answer)
- Eliminates the need for a terminal value estimate
Correct answer: Is calculated from market prices reflecting current expectations
Market-derived multiples embed current investor expectations about growth and risk, making them timely and observable.
Question 6: A bond with a $1,000 par value pays a 6% annual coupon and matures in 5 years. If the market yield is 8%, what is the bond's approximate price?
- $920.15 (Correct answer)
- $1,000.00
- $1,079.85
- $856.44
Correct answer: $920.15
Discounting $60 annual coupons and $1,000 par at 8% for 5 years yields approximately $920.15.
Question 7: The justified P/E ratio based on fundamentals equals:
- (1 − b) / (k − g) (Correct answer)
- (1 + g) / (k + b)
- D0 / (k − g)
- EPS / (k − g)
Correct answer: (1 − b) / (k − g)
Justified P/E = payout ratio (1−b) divided by (required return k minus growth g), derived from the Gordon Growth Model.
CFA Asset Valuation 2
Which valuation approach estimates a firm's value by discounting its expected future free cash flows to the firm (FCFF) at the weighted average cost of capital?