CFA Level I · CFA Level I Exam · Company Analysis: Past, Present, and Future
A company's cash flow forecast is 100 per year in perpetuity, discounted at 10%, giving a value of 1,000. The analyst judges that weak governance warrants a 2 percentage point higher discount rate, with no change in cash flows. The revised value is closest to:
The revised value is closest to 833. Raising the discount rate from 10% to 12% gives a perpetuity value of 100 divided by 0.12, or about 833. Subtracting the premium instead of adding it would wrongly give 1,250.
- A714
- B833Correct
- C1,250
Explanation
Perpetuity value = 100 / 0.12 = 833.3. The 714 figure results from using 14% (adding 4 points), and 1,250 results from subtracting 2 points (100/0.08).
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