LOS a: Distinguish between the method of comparables and the method based on forecasted fundamentals as approaches to using price multiples in valuation, and discuss the economic rationales for each approach.

Q1. 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)   fundamental data.

C)   historical P/E multiples.

Q2. 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.

C)   it is very easy to find comparable firms that have the same business mix and risk and growth profiles.

Q3. Which of the following statements about the method of forecasted fundamentals in price multiple valuation is TRUE? It:

A)   values an asset relative to a benchmark value of the multiple.

B)   relates multiples to company fundamentals using a discounted cash flow (DCF) model.

C)   relies on the Law of One Price.

Q4. Which of the following statements about the method of comparables in price multiple valuation is TRUE? It:

A)   relates multiples to company fundamentals using a discounted cash flow (DCF) model.

B)   values an asset relative to a benchmark value of the multiple.

C)   assumes that cash flows are related to fundamentals.

Q5. 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.

C)   Free cash flow to the firm.

LOS a: Distinguish between the method of comparables and the method based on forecasted fundamentals as approaches to using price multiples in valuation, and discuss the economic rationales for each approach. fficeffice" />

Q1. 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)   fundamental data.

C)   historical P/E multiples.

Correct answer is B)

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.

Q2. 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.

C)   it is very easy to find comparable firms that have the same business mix and risk and growth profiles.

Correct answer is B)

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.

Q3. Which of the following statements about the method of forecasted fundamentals in price multiple valuation is TRUE? It:

A)   values an asset relative to a benchmark value of the multiple.

B)   relates multiples to company fundamentals using a discounted cash flow (DCF) model.

C)   relies on the Law of One Price.

Correct answer is B)

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.

Q4. Which of the following statements about the method of comparables in price multiple valuation is TRUE? It:

A)   relates multiples to company fundamentals using a discounted cash flow (DCF) model.

B)   values an asset relative to a benchmark value of the multiple.

C)   assumes that cash flows are related to fundamentals.

Correct answer is B)

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.

Q5. 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.

C)   Free cash flow to the firm.

Correct answer is B)

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.