FSA Final_V1

What is the P/E and P/B ratio of a company with share price €40, EPS €2, BVPS €16?

P/E = 20, P/B = 2.5

How do you calculate market capitalization?

Market Cap = Share Price × Shares Outstanding

What is the total return from a €100 share that ends at €108 and pays €2 dividend?

Total Return = (108 + 2 - 100)/100 = 10%

What is cost of equity using CAPM if Rf = 3%, β = 1.2, Rm = 10%?

Re = 3% + 1.2(7%) = 11.4%

How do you calculate WACC with 60% equity (10%) and 40% debt (5%, tax 30%)?

WACC = 0.6×10% + 0.4×5%×(1–0.3) = 7.4%

What is DDM valuation with D1 = €2.08, r = 11%, g = 4%?

P = D1 / (r – g) = €29.71

What is the PV of cash flows: €100 (Y1), €110 (Y2), €120 (Y3), at 8%?

PV ≈ €288.87

How do you find equity value from EV and net debt?

Equity = EV – Net Debt

Name two strengths and two weaknesses of using P/E ratio

Pros: fast, benchmarkable; Cons: distorted by accounting, not usable with losses

How do you calculate terminal value using Gordon Growth?

TV = FCF_(T+1) / (r – g)

What’s the per-share equity value if DCF = €1,225m, net debt = €200m, 50m shares?

Equity = €1,025m; Per Share ≈ €20.51

How do you apply the Residual Income Model for 5 years of earnings?

Value = BV + PV(RI1–5) + PV(Terminal RI)

Why might market value exceed model value (e.g. CRH case)?

Market expects faster long-term growth or higher terminal ROCE

When is DDM, DCF, or RIM most appropriate?

DDM = stable dividends, DCF = stable FCF, RIM = clean earnings + limited dividends

What is the formula for CAPM?

Re = Rf + β(Rm – Rf)

What is the WACC formula?

WACC = E/V × Re + D/V × Rd × (1 – Tax)

What is the formula for terminal value?

TV = FCF_(T+1) / (r – g)

What is the residual income formula?

RI = NI – (COE × BV)

What is the residual income valuation formula?

Value = BV + PV(RI)

What is intrinsic value?

Value based on fundamentals, not market sentiment

What does beta measure?

Systematic risk — how sensitive a stock is to the market

What does abnormal return (alpha) represent?

Actual return – expected return (from CAPM)

What is the difference between FCFF and FCFE?

FCFF includes debt payments; FCFE = FCFF – Interest × (1–tax) – Net debt repayments

What are the 3 steps in using RIM properly?

Forecast NI → compute RI → discount RI and add to BV

What happens if ROCE = COE in RIM?

No residual value is created — value = book value

Why do analysts often prefer DCF or RIM over DDM?

DDM relies on subjective dividends; RIM/DCF model internal generation of value

How do you handle terminal value in RIM?

Use RI_(T+1) × (1 + g) / (r – g) and discount to present

What is “cum-dividend” earnings in RIM?

NI assumes dividends reinvested — simplifies RI calculation

Why can multiples be misleading across firms?

Different accounting, capital structure, tax treatment distort comparability

What makes a DCF highly sensitive and unreliable?

Terminal value assumptions, discount rate selection, and FCF forecasting errors

What is adjusted beta?

Adjusted β = 2/3 × Raw β + 1/3 × 1 (mean reversion toward market β = 1)

What does irrational exuberance imply for valuation?

Markets often overvalue stocks due to hype/emotion rather than fundamentals

What does Keynes’ beauty contest mean for investor behavior?

Investors buy what they think others think others will value—not based on intrinsic value

What are red flag assumptions in valuation models?

Over-optimistic growth rate, ignoring reinvestment needs, misapplying discount rate

What is the Efficient Market Hypothesis (EMH)?

Theory that stock prices always reflect all public (and possibly private) info

What are the three levels of EMH?

Weak (past prices), Semi-strong (public info), Strong (all info incl. insider)

Question (Term)

Answer (Definition)

What is the formula for Free Cash Flow to the Firm (FCFF)?

FCFF = EBIT × (1 – tax) + Depreciation – CAPEX – Change in Working Capital

What makes forecasting free cash flow difficult?

Requires multiple assumptions: revenue growth, margin stability, reinvestment needs, and working capital changes

What’s the difference between alpha and beta investing?

Beta: return driven by market risk exposure; Alpha: return from security selection or skill beyond market movement

Why might DCF be unreliable for high-growth or early-stage firms?

FCF may be negative or erratic due to high reinvestment; terminal value dominates; better to use RIM or multiples

When is the Residual Income Model preferred over DCF?

When earnings are more stable than cash flows or when cash flows are negative/unreliable

What is working capital and why does it matter in valuation?

Working Capital = Current Assets – Current Liabilities; changes affect operating cash flow and FCFF estimates

How can aggressive terminal value assumptions distort DCF results?

Overestimating growth or underestimating WACC inflates terminal value, which often drives >70% of firm value

Why must you subtract net debt from firm value in a DCF?

DCF gives enterprise value; to find equity value, subtract net debt to isolate value attributable to shareholders

What are the two approaches to estimating terminal value in DCF?

(1) Perpetuity Growth Model, (2) Exit Multiple Method (e.g., EV/EBITDA)

What is the Exit Multiple Method for terminal value?

TV = EBITDA in final year × assumed industry EV/EBITDA multiple (based on comps)