- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Valuation
- Learning Module 20. Equity Valuation: Applications and Processes
- Subject 4. Absolute and Relative Valuation Models
CFA Practice Question
Which of the following statements is (are) true with respect to the types of valuation models that may be used to value a security?
II. The dividend discount model would be considered as one type of an absolute valuation model.
III. Relative valuation models attempt to determine whether a stock price is overvalued or undervalued relative to its intrinsic value.
IV. Valuation models should price in a control premium if the individual conducting the model is a majority shareholder.
I. A going concern valuation model assumes that a stock price is equal to its net asset value per share.
II. The dividend discount model would be considered as one type of an absolute valuation model.
III. Relative valuation models attempt to determine whether a stock price is overvalued or undervalued relative to its intrinsic value.
IV. Valuation models should price in a control premium if the individual conducting the model is a majority shareholder.
Correct Answer: II and IV
I is incorrect because a going concern valuation model assumes that the value of a stock is more dependent upon its future earnings potential as opposed to its net asset value per share.
III is incorrect because relative valuation models attempt to determine whether a stock price is overvalued or undervalued relative to another stock or industry benchmark. Intrinsic value is primarily determined using absolute valuation models.
User Contributed Comments 6
| User | Comment |
|---|---|
| matthew9 | why IV is correct ? |
| Swetha | I guess it's because any valuation model should take into account minority/majority interest to arrive at the correct intrinsic value. |
| thekapila | IV is correct to value the intrinsic value of stock for majority stockholder. As he has to pay premium to get control over company which is the price for that power. |
| jmcarr02 | But a major shareholder also has market impact when he transacts his shares which hinders his capacity to get the best price for his shares. This factor should also be considered and it probably has a counter-effect on his control premium. |
| MonkeySee | Generally if you have ownership control barring an emergency need for cash, liquidity of your asset is not the prime concern. Therefore, hinderance of his liquidity is more then compensated by his control premium. Finally if and when he decides to sell, he is also selling the onwership premium on top of the value of the stake. |
| davidt87 | IV is just retarded |