NISM SERIES XV • CHAPTER 10

NISM Series XV Chapter 10 MCQs with Answers: Valuation Principles

Practise 20 multiple-choice questions on intrinsic value, discounted cash flow, FCFF, FCFE, WACC, valuation multiples, enterprise value, ROE, ROCE, SOTP and terminal value for the NISM Research Analyst Certification Examination.

Valuation is a central part of equity research. It helps analysts estimate the worth of a business by examining its future cash flows, earnings, assets, risk and growth prospects. Comparing estimated value with market price can help investors assess whether a security appears relatively expensive or inexpensive.

This practice set covers important concepts from Chapter 10: Valuation Principles, including discounted cash flow valuation, free cash flow, the cost of capital, relative valuation multiples, net asset value and sum-of-the-parts valuation.

20Practice MCQs

4Options per question

AnswersWith explanations

Study tip: Focus on the distinction between price and value, FCFF and FCFE, WACC and cost of equity, and enterprise value and equity value. Practise the valuation formulas until you can identify the correct discount rate and cash flow for each model.

Table of Contents

1. Fundamentals of Valuation and DCF (Q1–Q5)
2. WACC, Earnings Yield and Valuation Multiples (Q6–Q11)
3. ROE, ROCE and Asset-Based Valuation (Q12–Q14)
4. Relative Valuation, SOTP and Financial Analysis (Q15–Q19)
5. Terminal Value in DCF (Q20)
6. Quick Revision Notes and Formulas
7. Frequently Asked Questions

Part 1: Fundamentals of Valuation and DCF

Q1. According to value investor Seth Klarman, how are price and value distinguished in capital markets?

1. Price is determined by company assets, while value is set by market sentiment
2. Price is set by the most panicked seller, whereas value is determined by cash flows and assets
3. Price and value are always equal in efficient markets
4. Value is set by stock exchanges daily, whereas price is calculated by auditors

Show answer and explanation

Correct Answer: B — Price and value can differ.

The study guide uses this quote to illustrate the distinction between market price and underlying value. Price is the amount at which a security trades, while an analyst estimates value by examining factors such as cash flows, assets, risk and business prospects.

Q2. According to Warren Buffett, what are the two sources of value in a business identified in the study guide?

1. Dividends and Stock Splits
2. Earnings and Assets
3. Revenues and Liabilities
4. Goodwill and Market Capitalization

Show answer and explanation

Correct Answer: B — Earnings and Assets.

The study guide identifies earnings and assets as the two sources of business value. Earnings help indicate the business's capacity to generate profits and cash flows, while assets represent resources that support operations or may have independent economic value.

Q3. Under the Discounted Cash Flow (DCF) model, valuation is conceptually most appropriate when which three elements are known with certainty?

1. Historical revenue, price-to-earnings ratio and book value
2. Stream of future cash flows, timing of these cash flows and the expected discount rate
3. Dividend payout ratio, market capitalization and beta coefficient
4. Current market price, liquidation value and face value

Show answer and explanation

Correct Answer: B — Cash flows, timing and discount rate.

DCF valuation discounts expected future cash flows to their present value. The process depends on the amounts and timing of expected cash flows and the appropriate discount rate. In real-world valuation, these inputs are uncertain and must be estimated.

Q4. What is the fundamental difference between Free Cash Flow to Firm (FCFF) and Free Cash Flow to Equity (FCFE)?

1. FCFF represents cash available to equity holders only, while FCFE includes debt holders
2. FCFF is the cash flow available to all capital contributors, while FCFE is the residual cash flow available to equity holders after debt-related cash flows
3. FCFF is calculated after dividends, whereas FCFE is calculated before tax
4. FCFF applies only to banks, whereas FCFE applies to manufacturing firms

Show answer and explanation

Correct Answer: B — FCFF is for all capital providers; FCFE is for equity holders.

FCFF represents cash flow available to both debt and equity investors before payments to those capital providers. FCFE represents cash flow available to equity holders after operating needs, investment and net debt-related cash flows have been accounted for.

Q5. Which discount rate should be used to discount FCFF and FCFE, respectively?

1. Cost of Equity for FCFF; WACC for FCFE
2. Weighted Average Cost of Capital (WACC) for FCFF; Cost of Equity for FCFE
3. Bank Repo Rate for FCFF; Inflation Rate for FCFE
4. Yield to Maturity for both FCFF and FCFE

Show answer and explanation

Correct Answer: B — WACC for FCFF; Cost of Equity for FCFE.

FCFF is discounted using WACC because it represents cash flows available to debt and equity capital providers. FCFE is discounted using the cost of equity because it represents cash flows available to shareholders.

Part 2: WACC, Earnings Yield and Valuation Multiples

Q6. What is the correct mathematical formula for the Weighted Average Cost of Capital (WACC)?

1. WACC = (Ke × We) + [Kd × (1 − Tax Rate) × Wd]
2. WACC = (Ke / We) + (Kd / Wd)
3. WACC = EBITDA / Enterprise Value
4. WACC = Net Profit Margin × Asset Turnover

Show answer and explanation

Correct Answer: A — Weighted cost of equity plus after-tax weighted cost of debt.

The standard formula is:

WACC = (Ke × We) + [Kd × (1 − T) × Wd]

Here, Ke is the cost of equity, We is the weight of equity, Kd is the cost of debt, Wd is the weight of debt, and T is the applicable tax rate. The weights generally reflect the relevant capital structure used in the valuation.

Q7. How is Earnings Yield defined, and what is its relationship to the Price-to-Earnings (PE) ratio?

1. Earnings Yield = Current Price / EPS; it is identical to the PE ratio
2. Earnings Yield = EPS / Current Price; it is the inverse of the PE ratio
3. Earnings Yield = Dividend Per Share / Book Value; it is unrelated to the PE ratio
4. Earnings Yield = Net Sales / Market Capitalization; it is double the PE ratio

Show answer and explanation

Correct Answer: B — EPS divided by current share price.

Earnings Yield is calculated as EPS divided by the current share price, usually expressed as a percentage. The PE ratio is Price divided by EPS, so Earnings Yield is its reciprocal when the same earnings measure and price are used.

Q8. How is the Growth-Adjusted Price-to-Earnings (PEG) ratio calculated, and what might a PEG ratio below 1 indicate?

1. PEG = PE Ratio / Expected Growth Rate; a value below 1 may suggest the stock is inexpensive relative to expected growth
2. PEG = PE Ratio × Growth Rate; a value below 1 indicates high risk
3. PEG = Price / Sales; a value below 1 indicates bankruptcy risk
4. PEG = EPS / Growth Rate; a value below 1 suggests overvaluation

Show answer and explanation

Correct Answer: A — PE ratio divided by expected growth rate.

The PEG ratio compares a company's PE ratio with its expected earnings growth rate. A PEG below 1 is sometimes interpreted as indicating a relatively low valuation for the expected growth, but it is not a universal rule for undervaluation. Growth forecasts, risk and the method used to express growth all matter.

Q9. How is Enterprise Value (EV) calculated in the simplified formula used for valuation?

1. Market Capitalization − Total Debt + Cash
2. Market Value of Equity + Market Value of Debt − Cash and Cash Equivalents
3. Book Value of Equity + Retained Earnings
4. Net Sales + Operating Profit − Depreciation

Show answer and explanation

Correct Answer: B — Equity value plus debt, less cash.

A simplified Enterprise Value formula is:

EV = Market Capitalization + Market Value of Debt − Cash and Cash Equivalents

Depending on the valuation convention, analysts may also adjust for preferred stock, non-controlling interests and other relevant claims or non-operating assets.

Q10. Why is the Enterprise Value-to-EBIT (EV/EBIT) ratio often useful when comparing companies across an industry?

1. Because EV/EBIT ignores tax rates completely
2. Because it compares total firm value with operating earnings before interest, helping reduce differences caused by capital structure
3. Because EV/EBIT relies exclusively on historical cash flow statements
4. Because the PE ratio cannot be calculated for dividend-paying companies

Show answer and explanation

Correct Answer: B — It compares firm value with EBIT.

Enterprise Value represents the value attributable to the firm's capital providers, while EBIT is measured before interest expense. EV/EBIT can therefore help compare firms with different financing structures. It does not eliminate every difference in accounting policy, business risk or tax environment.

Q11. Under what circumstances do market participants commonly rely on the EV-to-Sales ratio?

1. When evaluating mature utility companies with high net profit margins only
2. As a comparative metric when a firm is making no operating profits
3. When calculating government bond yields
4. When determining the dividend payout ratio

Show answer and explanation

Correct Answer: B — When operating profits are absent or not meaningful.

EV/Sales compares enterprise value with revenue and can be useful when earnings or operating profits are negative or not meaningful. However, revenue alone does not reveal profitability, so analysts should also consider margins, cash burn and the path toward sustainable earnings.

Part 3: ROE, ROCE and Asset-Based Valuation

Q12. What is the formula for calculating Return on Equity (ROE) using balance-sheet variables?

1. Net Profits / Equity Capital or Net Worth
2. EBIT / Total Debt
3. Gross Profit / Current Liabilities
4. Dividends Paid / Market Capitalization

Show answer and explanation

Correct Answer: A — Net Profits divided by equity or net worth.

ROE measures the return generated on shareholders' equity. It is commonly calculated as Profit After Tax divided by average shareholders' equity, although the study guide presents net profits divided by equity capital or net worth.

Q13. How is Return on Capital Employed (ROCE) calculated?

1. PAT / Net Worth
2. EBIT / Total Capital Employed (Debt + Net Worth)
3. Net Sales / Fixed Assets
4. Operating Cash Flow / Current Assets

Show answer and explanation

Correct Answer: B — EBIT divided by Capital Employed.

ROCE measures operating earnings relative to the capital employed in a business. The supplied study guide describes capital employed as debt plus net worth. Analysts should use a consistent definition of capital employed when comparing companies.

Q14. In which types of businesses is the Net Asset Value (NAV) approach primarily used for valuation?

1. Fast-Moving Consumer Goods (FMCG) and Information Technology
2. Extremely asset-oriented businesses such as Real Estate, Shipping and Aviation
3. Software-as-a-Service (SaaS) startups exclusively
4. Retail broking firms exclusively

Show answer and explanation

Correct Answer: B — Asset-heavy businesses.

The NAV approach estimates value using the value of assets minus liabilities, with adjustments as appropriate. It can be particularly relevant for asset-heavy businesses such as real estate and shipping, although the best valuation method depends on the company's characteristics.

Part 4: Relative Valuation, SOTP and Financial Analysis

Q15. What are Trading Multiples and Transaction Multiples in relative valuation?

1. Ratios derived from central bank interest rates
2. Ratios derived from public stock market prices or comparable mergers and acquisitions deals
3. Technical moving averages used by day traders
4. Regulatory limits imposed on IPO pricing

Show answer and explanation

Correct Answer: B — Public market comparisons and transaction comparisons.

Trading multiples are derived from the market prices of publicly traded comparable companies. Transaction multiples are based on comparable M&A transactions. Both methods rely on selecting relevant comparables and using consistent financial metrics.

Q16. What is Sum-of-the-Parts (SOTP) Valuation?

1. Adding the P/E ratios of all companies listed on an index
2. Valuing each distinct business segment of a conglomerate separately and summing them to estimate total company value
3. Summing historical dividend payments over a 10-year period
4. Calculating the total market capitalization of the top 10 shareholders

Show answer and explanation

Correct Answer: B — Valuing separate business segments individually.

SOTP is useful for companies with multiple businesses that may have different growth rates, risk profiles and valuation methods. The analyst estimates the value of each segment and combines them, making suitable adjustments for debt, corporate costs and other claims to arrive at an equity or enterprise value estimate.

Q17. Why can the Price-to-Earnings (PE) ratio be deceptive for heavily leveraged firms?

1. High debt reduces interest payments, inflating net profit
2. Net earnings reflect interest costs and the PE ratio does not directly account for total debt liabilities
3. Leveraged firms are exempt from calculating EPS
4. PE ratio applies only to companies with zero debt

Show answer and explanation

Correct Answer: B — PE does not directly account for debt in its numerator.

The PE ratio compares equity market value with earnings attributable to shareholders. Different debt levels affect interest expense and net earnings, so PE alone may not provide a complete comparison. EV-based multiples can offer additional perspective by considering both equity and debt claims.

Q18. Why should research analysts focus on consolidated financial statements rather than standalone numbers when a company has subsidiaries?

1. Standalone numbers include international tax exemptions
2. Consolidated numbers capture the financial performance and liabilities of the parent company and its subsidiaries as a group
3. SEBI forbids publishing standalone financial statements
4. Consolidated statements exclude long-term corporate debt

Show answer and explanation

Correct Answer: B — They show the group as a whole.

Consolidated statements combine the parent company and controlled subsidiaries under applicable accounting standards. They help analysts assess the broader group's operations, assets, liabilities and performance. Standalone statements can still be useful for understanding the parent company's own financial position and obligations.

Q19. How can a company increase its Return on Equity (ROE) without improving its underlying operating performance?

1. By reducing selling prices in every situation
2. By increasing financial leverage, which can reduce the relative equity base while keeping assets and operations similar
3. By issuing bonus shares to existing shareholders
4. By increasing cash holdings on the balance sheet in every situation

Show answer and explanation

Correct Answer: B — Increasing financial leverage.

Additional debt can increase ROE when the equity base falls relative to earnings or when leverage amplifies returns. However, leverage also increases financial risk and interest obligations. ROCE can provide a complementary view of operating returns relative to the broader capital employed.

Part 5: Terminal Value in DCF

Q20. In a DCF valuation model, how is Terminal Value calculated at the end of a high-growth projection period using the perpetual growth method?

1. By multiplying the final year's cash flow by the historical inflation rate
2. By multiplying cash flow for the last projection year by (1 + g) and dividing by (Discount Rate − g)
3. By taking the current market price and dividing by historical EPS
4. By adding total current assets to non-current liabilities

Show answer and explanation

Correct Answer: B — The perpetual growth method.

The formula is:

Terminal Value = FCF in final projection year × (1 + g) / (r − g)

Here, g is the perpetual growth rate and r is the appropriate discount rate. The formula assumes stable perpetual growth and requires r to be greater than g. For FCFF, use WACC as the discount rate; for FCFE, use the cost of equity.

Quick Revision Notes: Valuation Formulas

Concept	Formula / Key Point
Price vs. Value	Market price is observable; intrinsic value is estimated from fundamentals and assumptions.
DCF Valuation	Present value of expected future cash flows discounted at an appropriate rate.
FCFF	Cash flow available to both debt and equity capital providers.
FCFE	Cash flow available to equity holders after operating needs, investment and net debt-related cash flows.
FCFF Discount Rate	Weighted Average Cost of Capital (WACC).
FCFE Discount Rate	Cost of Equity.
WACC	(Ke × We) + [Kd × (1 − T) × Wd].
Earnings Yield	EPS / Current Share Price; reciprocal of PE when the same earnings measure is used.
PEG Ratio	PE Ratio / Expected Earnings Growth Rate, using a consistent growth convention.
Enterprise Value	Market Capitalization + Debt − Cash and Cash Equivalents, with possible additional adjustments.
EV/EBIT	Enterprise Value / EBIT.
EV/Sales	Enterprise Value / Revenue.
ROE	Net Profit / Shareholders' Equity.
ROCE	EBIT / Capital Employed.
NAV Valuation	Value of relevant assets minus liabilities, subject to appropriate adjustments.
Trading Multiples	Valuation ratios derived from publicly traded comparable companies.
Transaction Multiples	Valuation ratios derived from comparable M&A transactions.
SOTP	Value each business segment separately and combine the segment values with appropriate adjustments.
Terminal Value	FCF in final projection year × (1 + g) / (r − g), using a consistent cash flow and discount rate.

Exam reminder: Valuation outputs depend on assumptions about future cash flows, growth and risk. Keep cash flows and discount rates consistent: FCFF with WACC, and FCFE with the cost of equity. A valuation estimate is not a guaranteed future market price.

Frequently Asked Questions (FAQs)

1. What is covered in NISM Series XV Chapter 10?

Chapter 10 covers valuation principles such as intrinsic value, DCF valuation, FCFF, FCFE, WACC, valuation multiples, ROE, ROCE, NAV and Sum-of-the-Parts valuation.

2. What is the difference between FCFF and FCFE?

FCFF represents cash available to both debt and equity providers, while FCFE represents cash available to equity shareholders after operating requirements, investment and net debt-related cash flows.

3. Why is WACC used to discount FCFF?

FCFF is available to both debt and equity capital providers. WACC reflects the weighted required returns of those providers, so it is the appropriate discount rate for valuing the firm's operating cash flows under the standard FCFF framework.

4. What is the difference between Enterprise Value and Market Capitalization?

Market capitalization is the market value of a company's equity. Enterprise Value starts with equity market value, adds debt and other relevant claims where applicable, and subtracts cash and cash equivalents under the chosen valuation convention.

5. What does a PEG ratio below 1 mean?

A PEG below 1 is sometimes considered a sign that a company's PE ratio is low relative to its expected earnings growth. It is not a definitive signal of undervaluation because growth forecasts and business risks may be uncertain.

6. Are these official NISM examination questions?

These are practice questions based on the supplied Chapter 10 study-guide content. They are intended for revision and should not be represented as official NISM examination questions.

Conclusion

Valuation principles help research analysts estimate what a business may be worth based on cash flows, earnings, assets and risk. DCF models focus on expected cash flows, while relative valuation uses comparable market or transaction multiples. Asset-based and SOTP methods can be useful when a company's assets or distinct business segments are central to its value.

Revise these 20 MCQs, practise the formulas and remember to match each cash flow with the correct discount rate before moving to the next chapter.

Continue Your NISM Series XV Preparation

Explore the previous chapters and continue preparing for the Research Analyst Certification Examination.

• Chapter 1: Practice MCQs
• Chapter 2: Practice MCQs with Answers
• Chapter 3: Practice MCQs
• Chapter 4: Fundamentals of Research
• Chapter 5: Economic Analysis
• Chapter 6: Industry Analysis
• Chapter 7: Company Analysis – Qualitative Dimensions
• Chapter 8: Company Analysis – Quantitative Dimensions
• Chapter 9: Corporate Actions
• All NISM Series XV Research Analyst MCQs

Disclaimer: This article is intended for educational and examination-preparation purposes only. These practice questions are based on the supplied study-guide content and are not official NISM examination questions. Valuation formulas may vary by convention and purpose. This content is not investment advice; always verify concepts with the latest official NISM study material.