CFA Level 1 Exam Prep | Most Correct Statement | Test Prep

Most Correct Statement

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Question

Which of the following statements is most correct?

Answers

A. The CAPM approach is typically used to estimate a firm's flotation cost adjustment factor, and this factor is added to the DCF cost estimate.

B. These statements are all incorrect.

C. In practice (as opposed to in theory), the DCF method and the CAPM method usually produce exactly the same estimate for k(s).

D. The risk premium used in the bond-yield-plus-risk-premium method is the same as the one used in the CAPM method.

E. Under normal conditions, the CAPM (Capital Asset Pricing Model) approach to estimating a firm's cost of retained earnings gives a higher estimate than the DCF (Discounted Cash Flow) approach.

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Explanations

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A. B. C. D. E.

All are incorrect. Under the CAPM approach, it is at best difficult to obtain correct estimates of the inputs require to make it operational. The same could be said about the growth rate input under the DCF approach. The risk premium under the bond-yield-plus-risk premium approach is purely judgmental and results in a ballpark estimate.

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