Certified Valuation Analyst (CVA) Practice Exam

Which three build-up models are based on the addition of a weighted average risk premium to the risk-free rate?

1. Capital asset pricing model, Black-Scholes model, and Gordon growth model

2. Black/green, value-netex, and RRCM

3. Discounted cash flow, economic profit, and capital asset pricing model

4. Dividends discount model, internal rate of return, and net present value

The correct answer is: Black/green, value-netex, and RRCM

The correct choice identifies build-up models that incorporate a weighted average risk premium to the risk-free rate. In various financial models used for valuation, constructing an appropriate discount rate is critical for accurately assessing the value of an investment. Build-up models are methodologies that typically estimate the required return on investment by starting with the risk-free rate and adding different risk premiums to account for specific risks associated with the investment. For example, these risk premiums may include equity risk premiums, size premiums, or industry-specific premiums. The three models mentioned in the correct answer are known to apply this systematic approach of aggregating various risk premiums. Specifically, they allow for different factors to be weighed according to the investor's perception of risk related to the investment being analyzed. This forms a comprehensive understanding of the total risk involved, which enhances the reliability of the investment's perceived value. On the other hand, the other options either reference models that do not focus on adding risk premiums to the risk-free rate or do not specifically employ the typical build-up model structure. Hence, the choice highlights the essential nature of how weighted averages of risk premiums factor into specific valuation strategies.