CFA Level II Equity Valuation Practice Questions
Question 1
Brightwater Utilities just paid an annual dividend of USD 2.00 per share, which is expected to grow at 4% a year indefinitely. An analyst estimates the required return on equity at 9%. What is the Gordon growth model value per share?
- A. USD 40.00
- B. USD 41.60
- C. USD 16.00
- D. USD 23.11
Show answer and explanation
Correct answer: B. USD 41.60
The Gordon growth model uses next year's dividend: V0 = D0(1+g)/(r-g) = 2.00 x 1.04 / (0.09 - 0.04) = 2.08 / 0.05 = USD 41.60. The model requires D1, so the just-paid dividend must be grown one period first.
- A. Divides the just-paid dividend by r - g, skipping the one-year growth step; that gives 40.00.
- B. Correct: D1 = 2.08 and r - g = 5%, so 2.08/0.05 = 41.60.
- C. Adds g to r in the denominator (13%) instead of subtracting, giving 2.08/0.13 = 16.00.
- D. Divides D1 by the required return alone (2.08/0.09), ignoring growth in the denominator.
Question 2
Tessera Foods paid a dividend of USD 1.50. Its dividend growth is currently 12% and is expected to decline linearly over eight years to a long-run rate of 4%. The required return is 10%. Using the H-model, what is the value per share?
- A. USD 26.00
- B. USD 42.00
- C. USD 34.00
- D. USD 33.00
Show answer and explanation
Correct answer: C. USD 34.00
H is the half-life of the decline: 8 / 2 = 4. V0 = D0[(1+gL) + H(gS - gL)]/(r - gL) = 1.50 x [1.04 + 4 x 0.08]/0.06 = 1.50 x 1.36/0.06 = USD 34.00.
- A. Ignores the above-normal growth term entirely and applies the Gordon model at 4%, giving 26.00.
- B. Uses the full eight-year decline for H instead of its half (1.50 x 1.68/0.06), giving 42.00.
- C. Correct: 1.50 x (1.04 + 0.32) / 0.06 = 34.00.
- D. Drops the (1+gL) growth in the first term (1.50 x 1.32/0.06), giving 33.00.
Question 3
Trellis Software will pay dividends of USD 1.00 in one year and USD 1.10 in two years. At the end of year two, the analyst expects EPS of USD 4.00 and a sale at a trailing P/E of 12. The required return is 10%. What is the present value per share?
- A. USD 40.58
- B. USD 45.55
- C. USD 50.10
- D. USD 41.49
Show answer and explanation
Correct answer: D. USD 41.49
Terminal price = 12 x 4.00 = 48.00. V0 = 1.00/1.10 + (1.10 + 48.00)/1.10^2 = 0.909 + 40.579 = USD 41.49. The terminal value is the expected price from the exit multiple, and it is received together with the year-two dividend, so both are discounted two periods.
- A. Leaves the year-two dividend out of the final cash flow (48/1.21 + 1.00/1.10).
- B. Discounts the year-two cash flow only one period, overstating value.
- C. Sums the cash flows without discounting (1.00 + 1.10 + 48.00 = 50.10).
- D. Correct: 0.909 + 49.10/1.21 = 41.49.
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Sable Networks has next-year EPS forecast of USD 3.00 and expected earnings growth of 12% a year. Its current P/E is 24. Peer companies trade at an average PEG ratio of 1.5, with growth expressed in percentage points. Using the peer PEG, what is the implied price per share?
- A. USD 72.00
- B. USD 54.00
- C. USD 36.00
- D. USD 4.50
Show answer and explanation
Correct answer: B. USD 54.00
Implied P/E = PEG x growth = 1.5 x 12 = 18. Implied price = 18 x EPS of 3.00 = USD 54.00. The company's own P/E of 24 corresponds to a PEG of 2.0, richer than peers.
- A. Uses the company's own P/E of 24, which is the current price rather than a peer-implied value.
- B. Correct: 1.5 x 12 = 18; 18 x 3.00 = 54.00.
- C. Multiplies growth by EPS (12 x 3.00) and skips the PEG ratio.
- D. Multiplies the PEG by EPS (1.5 x 3.00) and forgets to scale by growth.