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

Topic Test Level 2 – Equity , Valentine Case

  • This topic has 1 reply, 2 voices, and was last updated Mar-19 by ec_test.
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    • rogileiza

      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.

    • ec_test

      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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