Chartered Financial Analyst (CFA) Practice Exam Level 2

What discounts are used in private equity valuation?

1. Discount for Lack of Insights and Discount for Lack of Historical Data

2. Discount for Lack of Control and Discount for Lack of Marketability

3. Discount for Lack of Experience and Discount for Lack of Resources

4. Discount for Lack of Growth and Discount for Lack of Revenue

The correct answer is: Discount for Lack of Control and Discount for Lack of Marketability

In private equity valuation, the appropriate discounts to use generally reflect the unique nature of investing in private companies, which often lack the same level of transparency, liquidity, and control as publicly traded firms. The specific discounts employed, such as the Discount for Lack of Control and Discount for Lack of Marketability, address these concerns effectively. The Discount for Lack of Control acknowledges that minority investors in private companies usually do not have the power to influence company decisions. This lack of control can significantly affect an investor's willingness to pay for a stake in the company, as they bear additional risk without the ability to guide management or operations. The Discount for Lack of Marketability is crucial as it reflects the difficulty of selling shares in privately held companies compared to publicly traded ones. Private equity investments often require a long holding period, making it harder for investors to exit their investment or realize its value. This discount takes into account the time and effort involved in potentially finding a market for the investment, which can ultimately depress the valuation. Understanding these discounts is essential for accurately assessing the value of private equity investments and aligning expectations with the inherent risks associated with them. The other choices listed do not align with the commonly accepted practices in private equity valuation, focusing instead on aspects that are less relevant