1. A 2. C 3. A or B, hmm… real valuation model. I’ll go with B. 4. B

CBBC

Yes, CBBC. Can you explain why the answer for 3) is B? I don’t fully understand the answer from Schweser…

Post the explainations

1, C A real valuation approach estimates value using real cash flows that are discounted at the real required return. Using a real valuation approach will create realistic capital spending forecasts and the terminal value of the company will be calculated correctly – therefore components 2 and 4 will be calculated correctly. However, a real valuation approach will incorrectly calculate cash taxes, which are based on nominal financial statements, as well as net working capital. Components 1 and 3 will be calculated incorrectly. 2, B Both Antilles and Luke make incorrect statements. Although Antilles is accurate that companies respond differently to country risks, this is an argument for adjusting cash flows – not the discount rate. A general discount rate cannot be applied to every company within a country because every company has different operating characteristics. These different operating characteristics are best captured by adjusting forecasted cash flows. Luke is also incorrect. Country risks are examples of unsystematic risks that are diversifiable, and therefore should not be included in the cost of capital. Again, adjusting cash flows is a better way to reflect the impact of country risk. 3, B For an average systematic risk stock the real expected return using the CAPM model would be estimated as 4 + 1(5) = 9% Since the historical real returns for companies in Quijinn have averaged 12% the country risk premium should be close to 12 - 9 = 3% 4, C Better cash flow estimates for an emerging market company can be determined by using probability-weighted scenario analysis. This involves assigning probability estimates to the economic/operating states that the company is likely to encounter and making adjustments to its cash flows. Scenario analysis is an important tool in understanding the effects of different macroeconomic variables on the cash flows of an emerging market company. Scenario analysis involves assigning probabilities to various operating environments an emerging market company is likely to encounter.

Country risk premium = Expected Return - (Real GDP + Market Risk Premium) CRP = 12% - (4% + 5%) CRP = 12%- 9% CRP = 3%

Can I find this formula in the notes? Are the Real GDP and Market Risk Premium of country Quijinn? I thought it might be from global market or something.

Yes. Its based on the global market index. Based on the analyst forecasts: Real GDP =4% (given) Market Risk Premium = 5% (in the CFAI text, it recommends that analysts use an MRP of 4.5%-5.5% So real returns for the average company based on the global market index are 4% + 5% = 9% However, companies in Quijinn have earned 12% historically. This implies that companies in Quijinn require an additional premium over the global market. This premium is estimated as 12%-9% = 3%. I understand this 3% as the additional premium over the global market index and GDP growth. Read page 275-276 of the CFAI text books. I think they explain it pretty well.

Page 269, Book 4, CFAI: “Use the cost of capital to discount the cash flows in a probability-weighted scenario approach. Do not add any risk premium, because you would be double-counting risk.” Why is this?

CLT2 Wrote: ------------------------------------------------------- > Country risk premium = Expected Return - (Real GDP > + Market Risk Premium) > > CRP = 12% - (4% + 5%) > > CRP = 12%- 9% > > > CRP = 3% Is this Formula correct: Country risk premium = Expected Return - (Real GDP + Beta*Market Risk Premium)

^ yea, actually that’s how they solved it in QBank and they assumed beta = 1, so eventually it became the one stated by CLT2.