ExamFinch.com My Study

Study guide

10.4 Discounted Cash Flow & Relative Valuation Multiples

Practice this exam

Canadian Securities Course CSC

Track your progress as you read

Finished sections get a check mark.

1 Introduction & Exam Overview

About the CSC Exams

2 Chapter 1: The Canadian Investment Marketplace

1.1 The Canadian Securities Industry & the Investment Dealer's Role 1.2 Financial Intermediaries: Banks, Trusts, Credit Unions, Insurers & Pension Funds 1.3 Financial Market Trends 1.4 Investment Capital, Financial Instruments & Financial Markets 1.5 Canadian Exchanges, ATSs, Dark Pools & the Order Protection Rule 1.6 Canadian Securities Regulators, the CSA & CIRO 1.7 Investor Protection: OSFI, CIPF and CDIC 1.8 Ethics, Standards of Conduct & the Client Focused Reforms 1.9 Conflicts of Interest, Complaint Handling & Remediation

3 Chapter 2: The Economy

2.1 Economics Foundations & Measuring Economic Growth 2.2 The Business Cycle & Economic Indicators 2.3 Inflation & Interest Rates 2.4 The Labour Market & Unemployment 2.5 The Bank of Canada & the Inflation-Control Target 2.6 Implementing Monetary Policy: The Operating Band, Market Operations & Transmission 2.7 Fiscal Policy, Deficits & the Challenges of Government Policy 2.8 International Finance & Trade: The Balance of Payments and the Canadian Dollar

4 Chapter 3: Features and Types of Fixed-Income Securities

3.1 The Fixed-Income Marketplace, Bond Terminology & Security 3.2 Protective Covenants, Retirement Provisions & Extendible/Retractable Features 3.3 Government of Canada Securities: T-Bills, Marketable Bonds & RRBs 3.4 Provincial & Municipal Debt and Strip Bonds 3.5 Corporate Bonds, Credit Spreads & Bond Ratings 3.6 Money Market Instruments, Floating-Rate Notes & International Bonds 3.7 Other Fixed-Income Securities & Reading Bond Quotes

5 Chapter 4: Pricing and Trading of Fixed-Income Securities

4.1 Bond Pricing, Price–Yield Relationships & Accrued Interest 4.2 Yield Calculations & Return Measures 4.3 The Term Structure of Interest Rates & Yield Curve Theories 4.4 Fundamental Bond Pricing Properties: Volatility Rules, Duration & Convexity 4.5 Bond Market Trading & Bond Indexes

6 Chapter 5: Common and Preferred Shares

5.1 Common Shares: Ownership Rights, Voting & Restricted Shares 5.2 Dividends, DRIPs, Stock Splits & Consolidations 5.3 Preferred Shares: Features, Cumulative Dividends & Taxation 5.4 Preferred Share Variations: Convertible, Callable, Retractable, Floating & Rate-Reset 5.5 Fundamental Equity Metrics & Ratios 5.6 Stock Indexes & Averages

7 Chapter 6: Equity Transactions

6.1 Order Types, Execution & Market Mechanics 6.2 Margin Trading: Long Accounts & Borrowing 6.3 Short Selling & Short-Margin Requirements 6.4 Trading & Settlement Procedures: T+1, CDS & Confirmations

8 Chapter 7: Derivatives

7.1 Derivatives: Role, Underlying Assets & Users 7.2 Options Fundamentals: Calls, Puts & Moneyness 7.3 Option Strategies & Risk Management 7.4 Forward & Futures Contracts 7.5 Rights & Warrants

9 Chapter 8: Corporations and their Financial Statements

8.1 Corporate Structures & Corporate Governance 8.2 The Annual Report, Accounting Standards & the Auditor's Report 8.3 The Balance Sheet & Income Statement 8.4 The Cash Flow Statement & Earnings Quality 8.5 Public Company Disclosure, Investor Rights, Take-Over Bids & Insider Trading

10 Chapter 9: Financing and Listing Securities

9.1 Government & Corporate Financing: Underwriting and Syndicates 9.2 The Prospectus Process, Stabilization & Purchaser Rights 9.3 The Exempt Market & Private Placements 9.4 The Listing Process: TSX, TSXV & Capital Pool Companies 9.5 Continuous Disclosure, Material Changes & Insider Reporting

11 Chapter 10: Investment Analysis

10.1 Methods of Equity Analysis & Macroeconomic Analysis 10.2 Fundamental Industry Analysis 10.3 Company Analysis: Competitive Advantages, Governance & the Dividend Discount Model 10.4 Discounted Cash Flow & Relative Valuation Multiples 10.5 Financial Statement Ratio Analysis 10.6 Assessing Preferred Share Investment Quality 10.7 Technical Analysis: Charts, Trends & Patterns 10.8 Technical Indicators, Volume, Breadth & Sentiment

12 Chapter 11: Portfolio Analysis

11.1 Measuring Investment Return 11.2 Measuring Risk: Types of Risk, Standard Deviation & Downside Measures 11.3 Portfolio Risk & Return: Correlation and Diversification 11.4 Beta, the Capital Asset Pricing Model & the Security Market Line 11.5 Portfolio Manager Styles: Equity & Fixed Income 11.6 The Portfolio Management Process: Objectives, Constraints & the IPS 11.7 Asset Mix, Monitoring, Performance Evaluation & Rebalancing

13 Chapter 12: Alternative Investments, Other Managed, and Structured Products

12.1 Alternative Investments: Structures, Fees & Liquid Alternatives 12.2 Alternative Strategies, Performance Measurement & Due Diligence 12.3 Segregated Funds, Labour-Sponsored Funds & Listed Private Equity 12.4 Income Trusts, REITs & Closed-End Funds 12.5 Structured Products: PPNs & Market-Linked GICs 12.6 Split Shares & Asset-Backed Securities

14 Chapter 13: Mutual Funds

13.1 Managed Products & Mutual Fund Structure 13.2 Pricing Mutual Fund Units: NAVPS & Forward Pricing 13.3 Mutual Fund Fees, Sales Charges & Unit Series 13.4 Mutual Fund Regulation, Fund Facts & Account Opening 13.5 Types of Mutual Funds & Fund Management Styles 13.6 Redemptions, Withdrawal Plans & Measuring Fund Performance

15 Chapter 14: Exchange-Traded Funds (ETFs)

14.1 ETF Origins, Structure, Tax Efficiency & ETF Facts 14.2 ETF Creation, Redemption & Arbitrage 14.3 Types of ETFs & Advanced Strategies 14.4 Comparing ETFs, Mutual Funds & Individual Securities

16 Chapter 15: Working with the Institutional Client

15.1 The Institutional Marketplace & Institutional Clients 15.2 Institutional Investment Guidelines, Styles & Restrictions 15.3 Buy Side & Sell Side: Trading Desks, Revenue, Clearing & Best Execution 15.4 Block Trading, Dark Pools & Algorithmic Trading

17 Chapter 16: Fee-Based Accounts and Working with the Retail Client

16.1 Fee-Based Accounts: Managed & Non-Managed Models 16.2 Fee Transparency, CRM2 & Total Cost Reporting, and MWRR vs. TWRR 16.3 The Financial Planning Approach & the Life Cycle 16.4 Behavioral Finance, Sequence-of-Returns Risk & Client Coaching 16.5 Estate Planning Basics

18 Chapter 17: Canadian Taxation

17.1 The Canadian Taxation System 17.2 Taxation of Investment Income 17.3 Capital Gains, Losses & The Superficial Loss Rule 17.4 Registered vs Non-Registered Tax-Advantaged Accounts 17.5 Tax Planning Strategies, Pension Plans & the RDSP

10.4 Discounted Cash Flow & Relative Valuation Multiples

Key Takeaways Explain This Topic AI

Free cash flow to the firm is discounted at WACC to give enterprise value; free cash flow to equity is discounted at the cost of equity.

Equity value = enterprise value − debt − preferred shares + cash.

EV/EBITDA is not affected by capital structure or depreciation policy, so it suits capital-intensive industries.

Price-to-book is the main multiple for banks and insurers; price-to-sales is used when earnings are negative.

Last updated: October 2026

The dividend discount model suits steady dividend payers, but many companies pay little or no dividend. This section covers discounted cash flow valuation using free cash flow and WACC, the bridge from enterprise value to equity value, and the relative valuation multiples analysts use to compare companies.

Discounted Cash Flow (DCF) & Enterprise Valuation

While the Dividend Discount Model is useful for dividend-paying companies, many firms pay no dividends, reinvesting all operating cash into business expansion. To value these enterprises, analysts use Discounted Cash Flow (DCF) modeling, which measures the cash generated by core operations regardless of dividend payout policies. Discounted Cash Flow Valuation Architecture

  • ├── 1. Project Free Cash Flow to Firm (FCFF) over 5 to 10 year explicit forecast horizon
  • ├── 2. Calculate Weighted Average Cost of Capital (WACC) as the discount rate
  • ├── 3. Discount explicit FCFF to present value
  • ├── 4. Estimate Terminal Value (TV) using Gordon Growth or Exit Multiple method
  • ├── 5. Sum PV of explicit cash flows + PV of Terminal Value = ENTERPRISE VALUE (EV)
  • └── 6. EV to Equity Bridge: Enterprise Value - Total Debt + Cash = COMMON EQUITY VALUE
  • 1. Free Cash Flow to Firm (FCFF) vs. Free Cash Flow to Equity (FCFE)

Free Cash Flow to Firm (FCFF): Represents the discretionary cash flow generated by operations that is available to all capital providers —including both bondholders (debt) and common shareholders (equity)—after funding operational expenses, working capital investments, and capital expenditures (CapEx): FCFF = EBIT × ( 1 − t ) + D&A − CapEx − Δ Non-Cash Working Capital \text{FCFF} = \text{EBIT} \times (1 - t) + \text{D\&A} - \text{CapEx} - \Delta\text{Non-Cash Working Capital} FCFF = EBIT × ( 1 − t ) + D&A − CapEx − Δ Non-Cash Working Capital Where t t t is the corporate income tax rate, and D&A \text{D\&A} D&A is depreciation and amortization. Discount Rate: FCFF must be discounted at the Weighted Average Cost of Capital (WACC) , reflecting the blended required return of both debt and equity holders.

Free Cash Flow to Equity (FCFE): Represents the cash flow remaining exclusively for common equity holders after meeting all operating expenses, tax liabilities, reinvestment needs, and net debt principal payments: FCFE = Cash Flow from Operations (CFO) − CapEx + Net Debt Issued (Repaid) \text{FCFE} = \text{Cash Flow from Operations (CFO)} - \text{CapEx} + \text{Net Debt Issued (Repaid)} FCFE = Cash Flow from Operations (CFO) − CapEx + Net Debt Issued (Repaid) Discount Rate: FCFE is discounted at the Cost of Equity ( k e k_e k e ​ ) to derive equity value directly.

2. The Weighted Average Cost of Capital (WACC)

WACC measures a corporation's overall cost of capital, weighting each capital component by its proportion in the firm's capital structure:

WACC = ( E V × k e ) + ( D V × k d × ( 1 − t ) ) \text{WACC} = \left(\frac{E}{V} \times k_e\right) + \left(\frac{D}{V} \times k_d \times (1 - t)\right) WACC = ( V E ​ × k e ​ ) + ( V D ​ × k d ​ × ( 1 − t ) )

Where:

  • E E E = Market value of common equity
  • D D D = Market value of total debt
  • V = E + D V = E + D V = E + D = Total enterprise capital base

k e k_e k e ​ = Cost of equity (calculated via the Capital Asset Pricing Model: k e = R f + β [ E ( R m ) − R f ] k_e = R_f + \beta [E(R_m) - R_f] k e ​ = R f ​ + β [ E ( R m ​ ) − R f ​ ] )

k d k_d k d ​ = Pre-tax cost of debt (yield to maturity on corporate debt)

t t t = Corporate marginal income tax rate (reflecting the interest tax shield , since interest payments are tax-deductible)

3. The Enterprise Value to Equity Value Bridge

Discounting projected FCFF plus the terminal value yields Enterprise Value (EV) —the total economic value of the operating business. To derive the intrinsic value attributable to common shareholders, analysts apply the Enterprise Value Bridge :

Common Equity Value = Enterprise Value − Total Debt − Preferred Shares + Cash and Cash Equivalents \text{Common Equity Value} = \text{Enterprise Value} - \text{Total Debt} - \text{Preferred Shares} + \text{Cash and Cash Equivalents} Common Equity Value = Enterprise Value − Total Debt − Preferred Shares + Cash and Cash Equivalents

Intrinsic Price Per Share = Common Equity Value Diluted Common Shares Outstanding \text{Intrinsic Price Per Share} = \frac{\text{Common Equity Value}}{\text{Diluted Common Shares Outstanding}} Intrinsic Price Per Share = Diluted Common Shares Outstanding Common Equity Value ​

Relative Valuation Multiples

Relative valuation compares a company's market valuation multiples to those of direct industry peers, sector benchmarks, or the firm's own historical averages. While DCF models provide absolute intrinsic value, relative valuation evaluates how the market is currently pricing comparable companies.

1. Price-to-Earnings (P/E) Ratio

The most widely referenced equity valuation multiple:

P/E Ratio = Market Price Per Share Earnings Per Share (EPS) \text{P/E Ratio} = \frac{\text{Market Price Per Share}}{\text{Earnings Per Share (EPS)}} P/E Ratio = Earnings Per Share (EPS) Market Price Per Share ​

Trailing P/E: Uses diluted EPS reported over the trailing four quarters (last 12 months). Reflects audited historical facts but can be backward-looking.

Forward P/E: Uses consensus estimated EPS over the next 12 months or upcoming fiscal year. Reflects forward earnings expectations, though analyst estimates are subject to revision.

The PEG Ratio (Price/Earnings to Growth): Adjusts the P/E ratio for the company's projected earnings growth rate: PEG Ratio = P/E Ratio Annual EPS Growth Rate (%) \text{PEG Ratio} = \frac{\text{P/E Ratio}}{\text{Annual EPS Growth Rate (\%)}} PEG Ratio = Annual EPS Growth Rate (%) P/E Ratio ​ Interpretation: A PEG ratio equal to 1.0 indicates that a stock's valuation matches its earnings growth. A PEG ratio below 1.0 suggests potential undervaluation, whereas a PEG above 2.0 suggests overvaluation.

2. Enterprise Value to EBITDA (EV/EBITDA)

Enterprise Value to EBITDA compares the total operating value of an enterprise to its operating cash flow before interest, taxes, depreciation, and amortization:

Enterprise Value (EV) = Market Capitalization + Total Debt + Preferred Equity − Cash and Cash Equivalents \text{Enterprise Value (EV)} = \text{Market Capitalization} + \text{Total Debt} + \text{Preferred Equity} - \text{Cash and Cash Equivalents} Enterprise Value (EV) = Market Capitalization + Total Debt + Preferred Equity − Cash and Cash Equivalents

EV/EBITDA Multiple = Enterprise Value EBITDA \text{EV/EBITDA Multiple} = \frac{\text{Enterprise Value}}{\text{EBITDA}} EV/EBITDA Multiple = EBITDA Enterprise Value ​

Why EV/EBITDA is Preferred for Capital-Intensive Sectors: The EV/EBITDA multiple is capital-structure neutral . Unlike the P/E ratio, EV/EBITDA is not distorted by whether a company finances its assets through debt or equity, nor is it affected by differences in depreciation schedules or corporate income tax rates. This makes it an essential metric for capital-intensive Canadian sectors such as oil and gas exploration, pipeline infrastructure, mining, telecommunications, and cable networks .

3. Price-to-Book (P/B) Ratio

Price-to-Book (P/B) = Market Price Per Share Book Value of Equity Per Share = Market Capitalization Common Shareholders’ Equity \text{Price-to-Book (P/B)} = \frac{\text{Market Price Per Share}}{\text{Book Value of Equity Per Share}} = \frac{\text{Market Capitalization}}{\text{Common Shareholders' Equity}} Price-to-Book (P/B) = Book Value of Equity Per Share Market Price Per Share ​ = Common Shareholders’ Equity Market Capitalization ​

Primary Application in Canada: The P/B ratio is the primary valuation metric for Canadian chartered banks, life insurance companies, and asset managers . Financial institutions hold balance sheets composed primarily of liquid financial assets (mortgages, government bonds, commercial loans) that are regularly marked near fair market value under IFRS.

Analytical Benchmark: A Canadian bank with a sustained Return on Equity (ROE) above its cost of equity trades at a premium to book value ( P / B > 1.0 P/B > 1.0 P / B > 1.0 ). If ROE falls below the cost of capital, the bank typically trades at a discount ( P / B < 1.0 P/B < 1.0 P / B < 1.0 ).

4. Price-to-Sales (P/S) Ratio

Price-to-Sales (P/S) = Market Price Per Share Revenue Per Share \text{Price-to-Sales (P/S)} = \frac{\text{Market Price Per Share}}{\text{Revenue Per Share}} Price-to-Sales (P/S) = Revenue Per Share Market Price Per Share ​

Application: Used for emerging growth companies (such as early-stage tech or biotech) that generate significant revenue growth but have not yet achieved net profitability (where P/E is undefined due to negative earnings), or for cyclical companies experiencing temporary operating losses during an economic trough.

Comparative Matrix: Equity Valuation Multiples

Valuation Multiple Calculation Formula Ideal Sector Applications Primary Advantages Core Limitations

Price-to-Earnings (P/E) Share Price EPS \frac{\text{Share Price}}{\text{EPS}} EPS Share Price ​ Consumer goods, mature technology, healthcare Intuitive, ubiquitous, directly links price to shareholder profits Meaningless with negative earnings; distorted by leverage and non-cash charges

EV / EBITDA Enterprise Value EBITDA \frac{\text{Enterprise Value}}{\text{EBITDA}} EBITDA Enterprise Value ​ Energy, pipelines, mining, telecommunications, utilities Neutral to debt leverage; independent of accounting depreciation policies Ignores ongoing capital expenditure requirements needed to replace aging assets

Price-to-Book (P/B) Share Price Book Value per Share \frac{\text{Share Price}}{\text{Book Value per Share}} Book Value per Share Share Price ​ Chartered banks, lifecos, investment dealers, REITs Stable historical baseline; balance sheet marked near fair value under IFRS Distorted by asset write-downs, share buybacks, and unrecorded intangible assets

Price-to-Sales (P/S) Share Price Sales per Share \frac{\text{Share Price}}{\text{Sales per Share}} Sales per Share Share Price ​ Unprofitable tech startups, cyclical firms in a trough Cannot be distorted by accounting accruals; always positive Ignores cost structure, debt burdens, and operating margin differences

Worked Comparative Multiples Table: Canadian Telecom Peers

  • Canadian Telecom Peer Share Price Forward P/E EV / EBITDA P / B Multiple Dividend Yield
  • Telco Alpha $52.00 14.2x 7.1x 2.1x 5.8%
  • Telco Beta $44.00 12.0x 6.2x 1.6x 6.4%
  • Telco Gamma $68.00 18.5x 8.8x 2.8x 4.2%
  • Peer Group Average — 14.9x 7.4x 2.2x 5.5%

Comparative Analysis: Telco Beta trades at a discount to the peer group on both Forward P/E (12.0x vs. 14.9x average) and EV/EBITDA (6.2x vs. 7.4x average), while offering the highest dividend yield (6.4%). An analyst would investigate whether this valuation discount reflects a temporary market mispricing (presenting a buying opportunity) or underlying structural weaknesses such as higher debt leverage, slower subscriber growth, or network underinvestment.