Relative Valuation in Finance

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What is the primary goal when selecting a set of peer firms for relative valuation?

To find firms with identical risk and cash flows
To identify firms with the same market capitalization
To select firms with similar industry and size (correct)
To choose firms with the same management team

What is the purpose of Step 2 in the relative valuation implementation process?

To calculate the EPS of the firm being analyzed
To compute the average valuation for the peer group (correct)
To select a group of peer firms
To apply the average valuation to the firm being analyzed

What is the implied stock price of Kenneth Cole if it is valued at the industry average P/E ratio of 29.84?

$43.25
$48.79
$51.51
$49.17 (correct)

What is the purpose of using different ratios, such as EV/EBITDA and EV/Revenue, in relative valuation?

To get a more accurate estimate of the firm's value (A) Signup and view all the answers

What is the benefit of using relative valuation in addition to the discounted cash flow model?

It provides a cross-check on the estimate of value from the discounted cash flow model (C) Signup and view all the answers

What is the assumption underlying the use of industry multiples in relative valuation?

That the firm's value is comparable to its peers along certain dimensions (A) Signup and view all the answers

What is a key limitation of using valuation multiples based on comparable firms?

It does not account for material differences between firms (B) Signup and view all the answers

What is a benefit of using the discounted cash flow method over the valuation multiple method?

It allows for the incorporation of specific information about cost of capital or future growth (B) Signup and view all the answers

What is the primary benefit of using a combination of valuation approaches?

It increases confidence in the valuation through consistent results (C) Signup and view all the answers

What is a potential pitfall of using valuation multiples based on comparable firms in a booming industry?

It cannot help determine whether an entire industry is overvalued (B) Signup and view all the answers

What is a factor that can affect the valuation multiple of a firm?

All of the above (D) Signup and view all the answers

What is the primary advantage of the discounted cash flow method over the valuation multiple method in terms of accuracy?

It allows for the incorporation of specific information about the firm's operations (B) Signup and view all the answers

What is the present value of the future cash flows to the owner of an asset?

The value of the asset's free cash flows (C) Signup and view all the answers

What is the primary cash flow that shareholders typically receive from a company?

Dividends (B) Signup and view all the answers

What is the discount rate used to discount the free cash flows to all investors in the enterprise valuation model?

The weighted average cost of capital (WACC) (A) Signup and view all the answers

What is the focus of the enterprise valuation model?

Valuing the company's free cash flows to all investors (A) Signup and view all the answers

Why is the enterprise valuation model a better approach than the dividend model?

Because it values the company's free cash flows to all investors, rather than just dividends (C) Signup and view all the answers

What is the benefit of using the enterprise valuation model over the dividend model, according to the text?

It is a more flexible model of valuation (C) Signup and view all the answers