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CFA Level I · CFA Level I Exam · Introduction to Equity Valuation

An analyst building a forecast for a cyclical manufacturer wants to reflect uncertainty about the economy. The most appropriate approach is to:

Scenario analysis is most appropriate: the analyst prepares forecasts under several economic conditions and weights them by probability. This captures the cyclical company's sensitivity to the economy, whereas extrapolating one year's growth or using an unadjusted industry margin ignores the cycle.

  1. Ause only the most recent year's growth rate as the forecast
  2. Bprepare forecasts under several scenarios with assigned probabilitiesCorrect
  3. Capply the industry's average margin without adjusting for the cycle

Explanation

Scenario analysis builds forecasts for different economic conditions, such as expansion and recession, and weights them by probability, which suits a cyclical company. Extrapolating one year's growth or applying an unadjusted industry margin ignores cyclicality and gives a single-point estimate.

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