CFA Level II Exam · Equity Valuation: Applications and Processes
Equity Valuation Process and Value Definitions for CFA Level II
Updated 7 October 2026 · Fact-checked
Equity valuation estimates a security's intrinsic value and compares it with market price to judge mispricing. You must know the value definitions (intrinsic, going concern, liquidation, fair market, investment value) and the process: understand the business, forecast, choose a model, convert forecasts to value, then apply the result in a recommendation.
Understand Equity Valuation Process and Value Definitions
Equity valuation is the estimation of what a share is worth. The main use is to find mispriced securities. If you think value is higher than price, the stock looks undervalued. If lower, it looks overvalued.
Intrinsic value is the value of an asset given a hypothetical complete understanding of its investment characteristics. Nobody knows it exactly. Analysts estimate it, so their estimate can differ from the true value. Market price is simply what the asset trades at. If you believe markets are efficient, price is a good estimate of intrinsic value. If not, the gap is your opportunity, and it exists only if your estimate is better than the market's.
The vignette may also ask which value definition fits a situation. Going concern value assumes the company continues to operate. Liquidation value assumes the company is closed and its assets are sold, either in an orderly sale (more time, higher value) or a forced sale (less time, lower value), after paying liabilities. Use going concern for healthy firms. Liquidation value fits a firm in distress or being wound up, and it is often a floor for value.
Fair market value is the price at which a willing, informed buyer and seller would transact, neither under compulsion, in a hypothetical market. It is a market-participant view. Investment value is the value to a specific buyer, based on that buyer's own requirements and expectations, including synergies. So investment value can differ between buyers, while fair market value does not depend on one buyer.
The valuation process has steps: (1) understand the business, including industry and competitive position, (2) forecast company performance, (3) select the right valuation model, (4) convert forecasts to a valuation, (5) apply the valuation conclusion by making a recommendation or decision. Analysts also communicate results with clear, supported reasoning.
Key formulas to remember
- Mispricing test
- Intrinsic value estimate > market price → undervalued; < market price → overvalued
- The conclusion is only as good as your estimate; it is not certain.
- Fair market value
- Price between a willing, informed buyer and seller, neither compelled
- Independent of a particular buyer's synergies.
- Investment value
- Value to a specific buyer given its requirements and expectations
- Can exceed fair market value when the buyer expects synergies.
- Liquidation value
- Proceeds from asset sales − liabilities
- Orderly sale gives a higher value than forced sale.
How to solve Equity Valuation Process and Value Definitions questions
Use this approach for any question on value definitions or the valuation process.
- 1Read the vignette and underline the situation: healthy firm, distress, takeover, or routine investing.
- 2Decide whether the business will keep operating. If yes, going concern; if being closed, liquidation value.
- 3Ask whose perspective is used. A market-wide, hypothetical buyer means fair market value; a specific buyer with its own synergies means investment value.
- 4For liquidation, check the time available. Ample time suggests orderly; urgency suggests forced.
- 5For process questions, match the described action to the step: understanding, forecasting, model selection, conversion, or application.
- 6For mispricing questions, compare your estimate with price and remember the estimate may be wrong.
- 7Pick the option that fits the exact wording and conditions.
Quickest way: Keyword matching
When to use it: When you have little time and the question asks which definition or process step applies.
- Spot the cue word: continues operating, closed, hypothetical market, specific buyer, synergies, forecast, model.
- Map it: continues → going concern; closed → liquidation; hypothetical willing parties → fair market; specific buyer or synergies → investment value.
- Eliminate options that change the perspective or the operating assumption.
- Choose and move on.
Common mistakes in Equity Valuation Process and Value Definitions
Treating intrinsic value as a known fact
Textbook examples produce a single clean number.
Fix: Remember intrinsic value is an estimate. Different analysts can reach different values.
Assuming market price always equals intrinsic value
Confusing efficient market belief with certainty.
Fix: Price equals intrinsic value only if markets are efficient. Mispricing can exist, and you must justify why.
Mixing up fair market value and investment value
Both are described as what a buyer would pay.
Fix: Fair market value is hypothetical and buyer-neutral. Investment value is specific to one buyer and may include synergies.
Using going concern value for a firm being wound up
Going concern is the default assumption in most models.
Fix: If the vignette says the firm will close or is distressed, use liquidation value.
Ignoring orderly versus forced sale
Liquidation is treated as one concept.
Fix: Forced sales produce lower proceeds. Check the time pressure in the vignette.
Worked examples
Example 1
Vignette: Northwind Foods is profitable and plans to keep operating. Its analyst estimates a share value of $48 using a discounted cash flow model. The share trades at $42. A rival, Sunbeam, would pay $55 per share because it expects cost savings from combining operations. Q1: What type of value is the $48 estimate? Q2: What does the $55 represent? Q3: What does the analyst conclude about the stock?
Show the solution
- Q1: Northwind will keep operating and the $48 is the analyst's estimate of value from fundamentals, so it is an estimate of intrinsic value on a going concern basis.
- Q2: $55 depends on one buyer's expected cost savings, so it is investment value, not fair market value.
- Q3: Estimate $48 is above price $42, so the stock appears undervalued, provided the estimate is reliable.
Answer: Q1: Going concern intrinsic value. Q2: Investment value to Sunbeam. Q3: Undervalued relative to the analyst's estimate.
Example 2
Vignette: Delta Print is insolvent. Its creditors must sell its assets within two weeks. An analyst notes that with six months, the assets would sell for about $9 million; in two weeks, about $6 million. Liabilities are $5 million. Q1: Which value concept applies? Q2: What equity value results from the two-week sale? Q3: Which process step did the analyst perform in choosing this concept?
Show the solution
- Q1: The firm is being closed, so liquidation value applies, and the short deadline makes it a forced sale.
- Q2: Forced sale proceeds $6 million − liabilities $5 million = $1 million.
- Q3: Choosing the concept that fits the firm's situation is selecting the appropriate valuation approach, which follows understanding the business.
Answer: Q1: Forced liquidation value. Q2: $1 million. Q3: Selecting the appropriate valuation model or approach.
Exam tips
- Underline whether the firm will continue operating; that alone separates going concern from liquidation.
- Look for the word 'specific' or 'synergies' to signal investment value.
- When a question says a security is mispriced, check whether the estimate comes from a model you trust.
- Learn the five process steps in order so you can place any described action.
Equity Valuation Process and Value Definitions in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Equity Valuation Process and Value Definitions: frequently asked questions
What is the difference between intrinsic value and market price?
Intrinsic value is an estimate of what an asset is worth based on its fundamentals. Market price is what it trades at. If you think the estimate is better than the market's view, a gap signals mispricing.
What is the difference between going concern value and liquidation value?
Going concern value assumes the firm keeps operating. Liquidation value assumes it is closed and assets are sold to pay liabilities. Forced sales give lower values than orderly ones.
How is fair market value different from investment value?
Fair market value is the price between a willing, informed buyer and seller in a hypothetical market. Investment value is worth to one particular buyer, including its own expectations and synergies.
What are the steps in the equity valuation process?
Understand the business, forecast performance, select the right model, convert forecasts into a valuation, and apply the conclusion in a recommendation or decision.