ACCA Financial Management (F9) Certification Practice Exam

What type of valuation does the earnings yield method represent?

1. Asset-based valuation

2. Income-based valuation

3. Market-based valuation

4. Expense-based valuation

The correct answer is: Income-based valuation

The earnings yield method is classified as an income-based valuation approach because it focuses on the earnings generated by an investment relative to its price. This method essentially looks at the earnings potential of a company and allows investors to assess how much income they can expect to generate from each dollar invested in the company's shares. In applying the earnings yield method, one calculates the earnings yield by taking the earnings per share (EPS) and dividing it by the market price per share. This metric provides insight into the return that investors can expect from their investment based on the company’s current earnings. Income-based valuation methods, including the earnings yield, are essential in determining the value of a company based on its ability to generate future income. By focusing on earnings, investors can better understand how different investment opportunities compare in terms of profitability and forecast future cash flows. This contrasts with asset-based valuations, which focus on the underlying assets of a company, or market-based valuations, which rely on market comparables.