Chartered Financial Analyst (CFA) Practice Exam Level 2

Which valuation approach is appropriate for a mature firm with steady operations?

1. Market Approach

2. Income Approach

3. Asset Approach

4. Reinvestment Approach

The correct answer is: Market Approach

The market approach is particularly suitable for valuing a mature firm with steady operations because this method relies on comparing the subject company to similar firms in the market. The rationale behind this is that established firms typically have stable earnings, predictable cash flows, and a history of financial performance that can be benchmarked against industry peers. In the market approach, valuation multiples (such as price-to-earnings or enterprise value-to-EBITDA) derived from comparable companies can provide insight into how the market values similar businesses. Since mature firms often operate in stable industries and face less uncertainty, these comparables help ascertain a reasonable valuation based on what similar firms have been sold for or how they are currently valued. While the income approach, which focuses on the present value of future cash flows, could also be applicable, it may require more assumptions about future growth rates and operating performance. Given that mature firms have steady operations, the reliance on market data tends to yield a more straightforward and reliable valuation. The asset approach usually focuses on the net asset value, which might be more relevant for firms with significant tangible assets or during liquidation scenarios rather than ongoing operations. The reinvestment approach, on the other hand, is typically used for firms in a growth stage, where