Chartered Financial Analyst (CFA) Practice Exam Level 2

Which component is necessary to calculate the implied required rate of return?

1. Sales Price

2. Net Investment

3. Future Cash Flows

4. Cash Flow from Operations

The correct answer is: Future Cash Flows

To determine the implied required rate of return, future cash flows are essential. This is because the implied required rate of return is derived from the expectations of future cash flows discounted back to their present value. The process typically involves estimating the future cash flows that an investment is expected to generate and then understanding how those cash flows relate to the current price of the investment. By comparing the present value of expected cash flows to the current market price, investors can assess whether an investment appears undervalued or overvalued and deduce the implied rate of return necessary for the investment to be deemed attractive given its risk profile. While other components such as the sales price, net investment, and cash flow from operations can provide relevant information in the broader context of financial analysis, they do not specifically serve the purpose of calculating the implied required rate of return. The focus on future cash flows allows investors to align their expectations of risk and return based on projected financial performance.