CFA Level 2: Market-Based Valuation of Price and Enterprise Value

CFA Level 2 - Equity Session 12-Reading 44 Market-Based Valuation: Price and Enterprise Value Multiples - LOS a (Practice Questions, Sample Questions) 1. An analyst begins an equity analysis of Company A by estimating future cash flows, discounting them back to the present, and dividing the result by the outstanding number of shares. This analyst is most likely using the: A) the method of comparables. B) the method of forecasted fundamentals. (Explanation — This analysis is comparing forecasted discounted cash flows (DCF) to a fundamental variable (shares). This suggests the method for forecasted fundamentals.) C) technical analysis 2. An analyst begins an equity analysis of Company A by noting the following ratios from three companies in the same industry: EPS PE Company A $1.60 10.0 Company B $2.10 12.5 Company C $5.80 13.0 This analyst is most likely using: A) the method of forecasted fundamentals. B) technical analysis. C) the method of comparables (Explanation — The analysis is comparing ratios of three companies in the same industry. The Law of One Price states that similar assets should have comparable prices.) 3. The value of a firm, calculated using the discounted cash flow (DCF) method, will be closest to the valuation using P/E multiples when P/E multiples are estimated using: A) P/E multiples of comparable firms. B) historical P/E multiples. C) fundamental data (Explanation — In the DCF valuation method, an analyst makes specific assumptions about each variable, such as growth, risk, payout, etc. The valuation using P/E multiples will be closest to the one obtained using the DCF approach when fundamental data -- for growth, risk, payout, etc. -- is used to estimate P/E multiples.) 4. P/E multiples are often computed using the average of the multiples of comparable firms, because: A) it provides the most accurate results. B) it is conceptually very straightforward. (Explanation — The use of comparable firms is quite common, because it is conceptually very straightforward. Also, it does not require the analyst to make specific assumptions regarding growth, risk, and other variables. However, it is often difficult to find comparable firms, since even within the same industry different firms can have different business mixes and risk and growth profiles. C) it is very easy to find comparable firms that have the same business mix and risk and growth profiles. 5. Which of the following statements about the method of forecasted fundamentals in price multiple valuation is most accurate? A) It relates multiples to company fundamentals using a discounted cash flow (DCF) model. (Explanation — The method of forecasted fundamentals relates multiples to company fundamentals using a DCF method. It does not explicitly rely on the Law of One Price. Further, it does not typically focus on benchmarks) B) It values an asset relative to a benchmark value of the multiple. C) It relies on the Law of One Price. 6. Which of the following statements about the method of comparables in price multiple valuation is CORRECT? A) It values an asset relative to a benchmark value of the multiple. (Explanation — The method of comparables involves using a price multiple to evaluate whether an asset is valued properly relative to a benchmark value of the multiple. It makes no explicit assumptions about fundamentals and does not rely on a DCF model.) B) It relates multiples to company fundamentals using a discounted cash flow (DCF) model. C) It assumes that cash flows are related to fundamentals. 7. Which of the following valuation approaches is based on the rationale that stock values differ due to differences in the expected values of variables such as sales, earnings, or related growth rates? A) Method of comparables. B) Method of forecasted fundamentals. (Explanation — The method of forecasted fundamentals is based on the rationale that stock values differ due to differences in the expected values of fundamentals such as sales, earnings, or related growth rates.) C) Free cash flow to the firm