CFA CFA Level 2 Topic Test Level 2 – Equity , Valentine Case

Topic Test Level 2 – Equity , Valentine Case

  • Author
    • Avatar of rogileizarogileiza
        • CFA Level 2

        If you are already doing the practice topic tests for level 2, I need your help to clarify something. I disagree with the answers for questions 2 and 3 for topic test on equity, the Valentine case. It seems to me the answers mixes up the formulas for trailing, and forward P/E ratios. If you agree with the answers for this topic test, would you please explain why the formulas used are correct? Thanks.

      • Avatar of ec_testec_test
          • CFA Charterholder

          Hi @rogileiza

          I understand that the formulas to get the justified trailing and leading multiples are counter intuitive. You’d think that the leading multiples would have the (1+g) and the trailing would not have the growth factor. However, it is backwards. Below are the derivations using the GGM:

          justified trailing P0/E0=(1-b)(1+g)/(r-g)
          justified leading P0/E1=(1-b)/(r-g)

          Using the Gordon Growth Model: 

          justified trailing
          P0=D0(1+g)/(r-g) using the GGM – then divide everything by E0

          P0/E0=(D0/E0)(1+g)/(r-g) – D0/E0 = Dividend payout = (1-b) at time=0

          Then – P0/E0=(1-b)(1+g)/(r-g)

          leading trailing 
          P0=D1/(r-g) using the GGM – then divide everything by E1

          P0/E1= (D1/E1)/(r-g)  – D1/E1 = dividend payout at time=1

          Then – P0/E1=(1-b)/(r-g)


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