Level 1 — RecognitionValuation Methods

Valuation Methods

⏱ 20 minutes30 marksprintable — key stays hidden on paper

Chapter: 2.6 Valuation Methods Level: 1 — Recognition (MCQ, Matching, True/False with Justification) Time Limit: 20 minutes Total Marks: 30

Section A — Multiple Choice (1 mark each)

Q1. The intrinsic value of a stock is best described as:

A) Its current trading price on the exchange
B) The value based on fundamentals and expected cash flows
C) The 52-week high price
D) The book value on the balance sheet

Q2. In a Discounted Cash Flow (DCF) model, future cash flows are:

A) Compounded forward to a future value
B) Discounted back to present value
C) Added together without adjustment
D) Multiplied by the P/E ratio

Q3. WACC stands for:

A) Weighted Average Cost of Capital
B) Working Asset Capital Cost
C) Weighted Annual Cash Cost
D) Whole Average Company Cost

Q4. The Gordon Growth (constant-growth DDM) formula for value is:

A) $V = D_1 \times (r - g)$
B) $V = \dfrac{D_1}{r - g}$
C) $V = \dfrac{D_1}{r + g}$
D) $V = D_1 \times r \times g$

Q5. Terminal value in a DCF represents:

A) The value of cash flows during the explicit forecast period only
B) The value of all cash flows beyond the explicit forecast period
C) The initial investment amount
D) The company's total debt

Q6. Relative valuation typically uses:

A) Discounted future free cash flows
B) Multiples such as P/E, EV/EBITDA compared to peers
C) The dividend discount model exclusively
D) Reverse DCF assumptions

Q7. The margin of safety is:

A) The gap between market price and intrinsic value that protects against error
B) The company's cash reserves
C) The dividend yield
D) The difference between revenue and costs

Q8. A reverse DCF is used to:

A) Compute intrinsic value from scratch
B) Infer the growth assumptions implied by the current market price
C) Discount dividends only
D) Calculate WACC

Q9. Sum-of-the-parts (SOTP) valuation is most appropriate for:

A) A single-product startup
B) A diversified conglomerate with distinct business segments
C) A company with no revenue
D) A pure dividend-paying utility

Q10. In the cost of equity via CAPM, a higher beta implies:

A) A lower required return
B) A higher required return
C) No change in required return
D) A guaranteed dividend

Section B — Matching (1 mark each, Q11–Q16)

Match each term (Q11–Q16) to its correct description (I–VI).

Term	Description
Q11. Scenario analysis	I. Discount rate blending cost of debt and equity
Q12. WACC	II. Testing valuation under bull/base/bear cases
Q13. Terminal growth rate	III. Value derived from expected future dividends
Q14. DDM	IV. Long-run perpetual growth, usually near GDP/inflation
Q15. Sensitivity analysis	V. Buying below intrinsic value for protection
Q16. Margin of safety	VI. Changing one input to see impact on value

Section C — True/False WITH Justification (2 marks each: 1 mark T/F, 1 mark reason)

Q17. "Market price and intrinsic value are always equal." — True or False? Justify.

Q18. "In the Gordon Growth Model, the growth rate $g$ must be less than the discount rate $r$ for a finite value." — True or False? Justify.

Q19. "A lower discount rate (WACC) results in a lower DCF valuation, all else equal." — True or False? Justify.

Q20. "A larger margin of safety generally reduces investment risk." — True or False? Justify.

Answer keyMark scheme & solutions

Section A (1 mark each)

Q1 — B. Intrinsic value is fundamentals-based (expected cash flows), independent of the quoted market price. (1)

Q2 — B. DCF discounts future cash flows back to present value using a discount rate — the core of time value of money. (1)

Q3 — A. WACC = Weighted Average Cost of Capital, blending debt and equity costs by their capital weights. (1)

Q4 — B. $V = \dfrac{D_1}{r-g}$ is the constant-growth DDM/Gordon Growth formula. (1)

Q5 — B. Terminal value captures all cash flows beyond the explicit forecast horizon (perpetuity or exit multiple). (1)

Q6 — B. Relative valuation compares multiples (P/E, EV/EBITDA) against peers. (1)

Q7 — A. Margin of safety = buffer between price paid and intrinsic value, protecting against estimation error. (1)

Q8 — B. Reverse DCF back-solves the growth/assumptions the current price implies. (1)

Q9 — B. SOTP values each segment separately and sums them — ideal for diversified conglomerates. (1)

Q10 — B. CAPM: $r_e = r_f + \beta(r_m - r_f)$ ; higher $\beta$ → higher required return. (1)

Section B — Matching (1 mark each)

Q11 → II (scenario analysis = bull/base/bear cases)
Q12 → I (WACC = blended discount rate)
Q13 → IV (terminal growth ≈ long-run GDP/inflation)
Q14 → III (DDM = value from dividends)
Q15 → VI (sensitivity = change one input)
Q16 → V (margin of safety = buy below intrinsic value)

(6 marks total)

Section C — True/False with Justification (2 marks each)

Q17 — FALSE (1). Market price fluctuates with sentiment, supply/demand and short-term factors, so it frequently deviates from intrinsic value; the gap is what value investors exploit. (1)

Q18 — TRUE (1). If $g \ge r$ , the denominator $(r-g)$ is zero or negative, giving an infinite/undefined value; the geometric series only converges when $g < r$ . (1)

Q19 — FALSE (1). A lower discount rate makes future cash flows worth more today, so valuation increases, all else equal. (1)

Q20 — TRUE (1). Buying well below intrinsic value cushions against forecasting errors and adverse events, lowering downside risk. (1)

[
  {"claim":"Gordon Growth: V = D1/(r-g) with D1=2, r=0.10, g=0.04 gives 33.33...","code":"D1=2; r=Rational(10,100); g=Rational(4,100); V=D1/(r-g); result = abs(float(V)-33.3333333)<1e-4"},
  {"claim":"Lower discount rate raises PV: PV of 100 in 5 yrs at 8% > at 12%","code":"pv8=100/(1+Rational(8,100))**5; pv12=100/(1+Rational(12,100))**5; result = float(pv8) > float(pv12)"},
  {"claim":"CAPM higher beta gives higher required return: rf=0.03, mrp=0.05, beta 1.5 vs 0.8","code":"rf=Rational(3,100); mrp=Rational(5,100); r_high=rf+Rational(15,10)*mrp; r_low=rf+Rational(8,10)*mrp; result = float(r_high) > float(r_low)"},
  {"claim":"Gordon model diverges when g>=r (denominator non-positive)","code":"r=Rational(8,100); g=Rational(8,100); result = (r-g)==0"}
]