CFA Equity Valuation Methods 2

Question 1

In a two-stage dividend discount model, a company pays a $2.00 dividend growing at 15% for 5 years, then 4% forever. If the required return is 10%, what is the approximate intrinsic value?

Accepted Answer

$52.60

Answer

The two-stage DDM discounts each high-growth dividend plus the terminal value (Gordon Growth at year 5) back to the present at the required return of 10%.

Question 2

Which valuation approach is most appropriate when a company has negative earnings but positive operating cash flows?

Accepted Answer

EV/EBITDA multiple

Answer

EV/EBITDA is preferred when earnings are negative because EBITDA adds back depreciation and amortization, producing a positive metric for comparison.

Question 3

The justified P/E ratio based on fundamentals equals:

Accepted Answer

(1 - b) / (r - g)

Answer

The justified leading P/E = (1 - b) / (r - g), where b is the retention ratio, r is the required return, and g is the sustainable growth rate.

Question 4

In residual income valuation, the terminal value is often assumed to be zero because:

Accepted Answer

Competitive forces erode economic profits to zero over time

Answer

In competitive markets, excess returns above the cost of equity are competed away over time, driving residual income toward zero in the long run.

Question 5

An analyst uses the price-to-sales (P/S) ratio. Which company characteristic most limits the usefulness of P/S?

Accepted Answer

Negative net profit margins

Answer

P/S ignores profit margins, so a low P/S can appear attractive even if the company has persistently negative margins and is unlikely to become profitable.

CFA Practice Test

CFA Practice Test

CFA Equity Valuation Methods 2