Free CFA Level II Equity Valuation Practice Questions
Equity valuation on the CFA Level II exam covers discounted cash flow models (DDM, FCFE, FCFF), relative valuation multiples, residual income models, and private company valuation techniques. Weighted 10-15% (CFA Institute).
Sample Questions
Question 1
Easy
The clean surplus relation requires that:
Solution
B is correct.
The clean surplus relation states:
where is book value, is earnings (net income), and is dividends. This means all changes in book value flow through the income statement — there are no 'dirty surplus' items that bypass income. The clean surplus relation requires that all changes in equity (other than transactions with owners like dividends) are captured in net income.
The clean surplus relation states:
where is book value, is earnings (net income), and is dividends. This means all changes in book value flow through the income statement — there are no 'dirty surplus' items that bypass income. The clean surplus relation requires that all changes in equity (other than transactions with owners like dividends) are captured in net income.
Question 2
Medium
Based on the vignette, what is Pinnacle Retail's justified P/S ratio?
Solution
C is correct.
The justified trailing price-to-sales ratio derived from the Gordon Growth Model is:
Using the vignette data with net profit margin = 8%, payout ratio = 50%, sustainable growth rate = 6%, and required return = 10%:
The justified P/S ratio links profitability (margin), capital allocation (payout), growth, and risk (required return) into a single metric.
The justified trailing price-to-sales ratio derived from the Gordon Growth Model is:
Using the vignette data with net profit margin = 8%, payout ratio = 50%, sustainable growth rate = 6%, and required return = 10%:
The justified P/S ratio links profitability (margin), capital allocation (payout), growth, and risk (required return) into a single metric.
Question 3
Hard
Based on the vignette, what is IronBridge Construction's estimated equity value using the excess earnings method?
Solution
B is correct (3.65 million). The excess earnings method for private companies:
Determine required earnings on identifiable tangible and intangible assets.
- Working capital: 800,000 × 6% = 48,000
- Fixed assets: 1,200,000 × 10% = 120,000
- Total required earnings on identifiable assets: 168,000
Calculate excess earnings (intangible value proxy):
- Normalized earnings: 500,000
- Excess earnings: 500,000 - 168,000 = 332,000
Capitalize excess earnings at the intangible asset rate:
- Capitalized intangible value: 332,000 / 16% = 2,075,000
Add tangible asset values:
- Total equity value: 800,000 + 1,200,000 + 2,075,000 - 425,000 (liabilities) = 3,650,000
The excess earnings method separately values tangible assets and intangible/goodwill value.
Determine required earnings on identifiable tangible and intangible assets.
- Working capital: 800,000 × 6% = 48,000
- Fixed assets: 1,200,000 × 10% = 120,000
- Total required earnings on identifiable assets: 168,000
Calculate excess earnings (intangible value proxy):
- Normalized earnings: 500,000
- Excess earnings: 500,000 - 168,000 = 332,000
Capitalize excess earnings at the intangible asset rate:
- Capitalized intangible value: 332,000 / 16% = 2,075,000
Add tangible asset values:
- Total equity value: 800,000 + 1,200,000 + 2,075,000 - 425,000 (liabilities) = 3,650,000
The excess earnings method separately values tangible assets and intangible/goodwill value.