CFM CFM Valuation & Performance Measurement 2 — Questions and Answers
Question 1: What is the discounted cash flow (DCF) method of valuation?
- Estimating an asset's intrinsic value by discounting projected future cash flows to present value (Correct answer)
- Comparing an asset's price to peer group multiples
- Valuing a company based on the replacement cost of its assets
- Calculating a company's value from its book equity
Correct answer: Estimating an asset's intrinsic value by discounting projected future cash flows to present value
DCF valuation sums the present value of all expected future free cash flows, discounted at an appropriate rate reflecting the investment's risk.
Question 2: What does the Price-to-Earnings (P/E) ratio indicate about a stock?
- How much investors are paying per dollar of current earnings (Correct answer)
- The total return generated by the stock over the past year
- The ratio of dividends paid to stock price
- The premium of market price over book value
Correct answer: How much investors are paying per dollar of current earnings
The P/E ratio reflects market expectations of future growth and profitability; a higher P/E suggests higher growth expectations or potential overvaluation.
Question 3: Why is EBITDA commonly used in company valuation?
- It approximates operating cash flow and allows comparison across firms with different capital structures and tax situations (Correct answer)
- It represents the total cash available for dividends
- It eliminates the need for revenue projections in valuation models
- It measures profitability after accounting for all financing costs
Correct answer: It approximates operating cash flow and allows comparison across firms with different capital structures and tax situations
EBITDA removes the effects of financing decisions, accounting choices, and tax environments, making it a useful proxy for operating performance across companies.
Question 4: How is enterprise value (EV) calculated?
- Market capitalization plus net debt (total debt minus cash) (Correct answer)
- Total assets minus total liabilities
- Market capitalization divided by earnings per share
- Total revenue multiplied by the P/E ratio
Correct answer: Market capitalization plus net debt (total debt minus cash)
EV represents the total value of a business to all capital providers (equity and debt holders), calculated as market cap + debt − cash and equivalents.
Question 5: What is the Gordon Growth Model (Dividend Discount Model) used for?
- Valuing a stock as the present value of perpetually growing dividends (Correct answer)
- Estimating future earnings growth based on historical dividends
- Calculating the cost of equity using dividend yield alone
- Measuring a stock's sensitivity to dividend policy changes
Correct answer: Valuing a stock as the present value of perpetually growing dividends
The Gordon Growth Model values a stock as D1 / (r − g), where D1 is next year's dividend, r is the required return, and g is the constant dividend growth rate.
Question 6: What is a comparable company analysis (comps) in equity valuation?
- Valuing a company by applying valuation multiples derived from similar publicly traded peers (Correct answer)
- Comparing a company's current price to its historical price-to-book range
- Analyzing a company's financial ratios against industry averages only
- Benchmarking a company's cost of capital against its sector median
Correct answer: Valuing a company by applying valuation multiples derived from similar publicly traded peers
Comps analysis derives a valuation range by applying relevant multiples (EV/EBITDA, P/E) from comparable public companies to the target company's financial metrics.
CFM CFM Valuation & Performance Measurement 2
What is the discounted cash flow (DCF) method of valuation?