400 Q Guide

Explain the time value of money. Is it more more today than next year due to inflation?

No. The time value of money means you could invest money today and earn something additional with it by next year. Inflation also makes money less valuable over time, but the time value of money is about potential returns of an investment made today.

What does the "Discount Rate" mean?

The Discount Rate represents your opportunity cost or "targeted annualized return." In other words, if you don't invest in this company, how much could you earn over the long term by investing in other similar companies? The DR represents the potential returns and the risk of other, similar opportunities.

Why is the DR higher if the potential returns are higher? Shouldn't a company with higher potential returns have a lower DR making it more valuable?

The potential returns and the risk move together. If a stock could potentially go up by 10x, it's much riskier than a stock that only has the potential to increase by 2x.

What is WACC?

Weighted Average Cost of Capital, the most common DR used to value companies. To calculate it, multiply the % Equity in a company's capital structure by its cost, same with Debt (and PS and other long-term funding sources). WACC represents the average annualized return you'd expect to earn if you invested proportionally in the Debt AND Equity of a company and held them for a long time. (it's the rate the biz has to pay to YOU, the funder) From the company's POV, it's the average rate they pay to borrow money from banks and investors to fund its business.

How much would you pay for a company that generates $100 of cash flow every single year into eternity?

Growth value = 0% Company Value = FCF/(DR-CFGR) = FCF/DR so 100/10% = 1,000 if DR is 10%

A company generates $100 of CF today, and its CF is expected to grow at 5% per year for the long term. You could earn 10% per year by investing in other, similar companies. How would you pay for this company?

$100/(10%-5%) = $2,000.00

What does PV mean and what makes it change? How does it differ from NPV?

The Present Value of an asset or company equals its future cash flows discounted at the appropriate Discount Rate. Discount means you take that future cash flow and divide it by (1+DR)^(# years) assuming a constant DR in each period. PV tells you what a company or asset is worth today based on its potential future performance and return expectations. The PV increases if expected FCF grows or growth rate increases or DR decreases. NPV is subtracting the PV from the asking price of the company. If it's positive, you should buy because the company is worth more than its current price.

What does the internal rate of return (IRR) mean? How do you calculate it?

Technical terms: IRR = DR when NPV = 0 more (MOIC)^(1/n)-1 How much the company discounts at for you to break even, or the effective compounded rate of return on an investment.

What affects IRR? How are these different from those that affect PV?

Growth rate and FCF affect IRR. Not DR. Asking price does not affect IRR.

How do you use the IRR, Discount Rate, and Present Value to make investment decisions?

See if DR is higher or lower than IRR. If lower, good. If the asking price is lower than the PV when you plug in the Discount Rate, that's also good.

What are the three financial statements and why do we need them?

IS, CFS, and BS. We need them for different purposes. The IS lets us know how much a company is profiting over a set period of time. CFS lets us know how cash is flowing in and out of the company throughout a period of time. BS tells us what a company has in assets (its resources) and what it has in liabilities and equities (how it paid for those assets) at a point in time. You need all three to have a complete view of a company, because variables change and this gives a holistic overview, allowing you to estimate and forecast the CF more accurately.

How do the financial statements link together?

NI from IS flows straight into top of CFS. NI goes into equity to be given to shareholders on BS. Ending cash on CFS goes to assets on BS. Add back non-cash expenses from IS onto CFS. Items under CFI and CFF also show up on the Balance Sheet. Separate line items on CFS (D&A, CapEx) also show up on BS (Net PP&E).

What's the most important financial statement?

CFS because it directly tells you how much cash the company is generating and can be used for valuation. IS includes non-cash revenue, expenses, and taxes, and excludes cash spending on major items such as CapEx, so it doesn't not accurately represent a company's cash flow.

How might the financial statements of a company in the U.K. or Germany be different from those of a company based in the U.S.?

Income Statements and Balance Sheets tend to be similar across different regions, but companies that use IFRS often start the CFS with something other than NI: Operating Income, Pre-Tax Income, or if they are using the Direct Method, Cash Received and Cash Paid. IFRS-based companies also tend to place items in more "random" locations on the CFS, so you may need to rearrange it. Finally, the Operating Lease Expense is split into Interest and Depreciation on the IFRS while they are treating as a simple Rental Expense under US GAAP.

How do you know when a revenue or expense line item should appear on the Income Statement?

If it affects net income and corresponds completely to the period shown (based on delivery)

A company collects cash payments from customers for a monthly subscription service one year in advance. Why do companies do this, and what is the cash flow impact?

A company collects cash payments for a monthly service long in advance if it has the market and pricing power to do so. Because of the time value of money, it's better to collect cash today rather than several months or a year into the future. This practice always boosts the company's cash flow and corresponds to Deferred Revenue. On the CFS, and increase in DR is a positive entry that boosts cash flow. (Deferred Revenue) allows company to expand. When they finally deliver the service and the cash is recognized as Revenue, DR declines, which appears as a negative entry on the CFS.

Why is AR an Asset but DR a liability?

Because in AR you've already delivered and in DR you have charged but are waiting to deliver. In accrual accounting, everything is based on delivery. AR is an asset because it's a future benefit to the company while DR is a future obligation.

What are Deferred Taxes and how do they affect the statements?

Things that the company has to pay but has not yet paid. Items such as Stock-Based Compensation and Asset Impairments are not deductible for cash-tax purposes until the second step (when an asset is sold at a loss or when employees exercise their options) and so you hold off on tax benefits. So these items initially create negative Deferred Taxes because the company pays more in Cash Taxes than its Income Statement suggest, but later they become deductible and Deferred Taxes turn positive. In my own words: it's when there's a discrepancy between what's recorded on your Income Statement and Cash Flow because of a difference between Book Taxes and Cash Taxes. Because some expenses SHOULD be tax-deductible but aren't until a second step happens (an asset is sold at a loss or an employee exercises their options), you pay more in cash than recorded on IS. You account for that by having a Deferred Tax Asset (you paid more than you should have) and once the second steps are taken you get rid of the asset.

A junior accountant in your department asks about the different ways to fund the company's operations via external sources and how they impact the financial statements. What do you say?

Raising equity through capital by issuing stocks -- doesn't affect core operations so IS doesn't change. CFF increases, and Equity side of BS increases. Raising debt through loans -- CFF increases, and Liabilities side of BS increases. Interest payments do show up on the IS and get taxed before producing NI.

Your firm recently acquired another company for $1,000 and created Goodwill of $400 and Other Intangible Assets of $200 on the Balance Sheet. A junior accountant in your department asks you why the company did this - how would you respond?

Because you paid a premium for that company, and you think that their IP or intangible assets like customer lists are worth that $200. The Goodwill is the additional price to make up the $1000 you paid extra than the value of the company itself. It's all to make sure the BS balances.

Explain lease accounting on the financial statements under IFRS 16 / ASC 842, including the differences between Operating Leases and Finance Leases.

IFRS: splits operating leases into depreciation and interest expenses. US GAAP: recognizes operating leases as just one rental expenses in operating expenses. US GAAP: since you take financial ownership technically they also split finance leases into depreciation and interest expenses Since finance leases under GAAP and IFRS leases are pushed into expenses under EBITDA, their EBITDA, EBIT, and Operating Cash Flow appears higher (IFRS treats the principal portion of the lease payment as a financing activity CFF rather than CFO)

What's the difference between Deferred Tax Assets and Deferred Tax Liabilities? How do Net Operating Losses (NOLs) factor in?

DTAs and DTLs relate to temporary differences between the book and tax bases of assets and liabilities. DTA represent potential future cash-tax savings for the company, while DTLs represent additional cash-tax payments in the future. DTLs often arise because of different Depreciation methods, such as when companies accelerate Depreciation for tax purposes, reducing their tax burdens in the near team but increasing it in the future. They may also be created in acquisitions. DTAs may arise when the company loses money in the current period and therefore accumulates a NOL. They are also created when the company deducts an expense for Book-Tax purposes but cannot deduct it for Cash-Tax purposes (eg Stock-Based Compensation) NOLs are a component of the DTA (approximately the Tax Rate * NOL Balance) NOLs are what the gov allows you to carry forward to subtract tax in the future from what company has to pay

How do you calculate FCF and what does it mean?

Unlevered FCF = NI + non-cash expenses - CapEx - changes in working capital (a way to group those liquid changes cause any changes = changes in cash flow) and then Levered = you pay back debt and stuff CFO (already adds back D&A and accounts for changes in working capital) - CapEx FCF is just how much cash you have in a period of time from your core business after paying for the cost of funding sources (such as interest on Debt) Positive FCF is a good sign and you can probably expand operations (acquiring other companies, hiring employees, re-investing in business, Dividends, Stock Repurchases) Negative FCF is a bad sign and you probably have to restructure or raise outside funding or cut expenses or grow tremendously to survive.

What is Working Capital? What does it mean if it's positive or negative?

Current operational (related to operations not structure) assets - current operational liabilities, and if it's positive that means you could sell of all your assets or liquify them to cover the operations of your business. It does depend on the specific case, though. If you have minimal inventory but a large deferred revenue that would be negative but it indicates high efficiency. Is WC is positive because of high receivables and difficulties collecting cash, that's bad.

What does the Change in Working Capital mean?

The Change in Working Capital tells you if the company needs to spend in advance of its growth or if it generates more cash flow as a result of its growth. If it's negative, that means you have to spend money before earning it. If it's positive, it means that you probably got money to spend. TLDR: does biz spend $ or earn $ first?

In its filings, a company states that EBITDA is a proxy for its CFO. The company's EBITDA has been positive growing at 20% for 3 years. However, the company recently ran low on cash and filed for bankruptcy. How???

EBITDA is typically based on a. company's Operating Income + D&A from the CFS. Although EBITDA can be a proxy for CFO, it is not a perfect representation of a company's cash flow. For example, it excludes CapEx, Acquisitions, Interest, Change in WC, and other non-recurring expenses. High numbers in any of these categories could have turned the cash flow negative and created this situation even if EBITDA looked okay.

How do you calculate ROIC and what does it tell you?

ROIC = NOPAT/Average Invested Capital. NOPAT is capital structure-neutral. Invested Capital = CSE + Debt + PS - Cash

ROIC tells you how efficiently a company uses all sources to generate after-tax profits from its CORE business.

Advantages and disadvantages of ROE, ROA, and ROIC for measuring company performance?

These metrics all measure how efficiently a company uses its Equity, Assets, or Invested Capital to generate after-tax profits, but the nuances differ. ROE and ROA are both affected by capital structure because they use Net Income in the numerator and Average Equity or Average Assets in the denominator. However, they're also closer to reality because Net Income is directly on a company's financial statements and affects Cash balance. NOPAT is hypothetical and doesn't appear on the statements, so ROIC is far removed the company's Cash position, even if it is company structure-neutral. Regarding ROE v ROA, ROA tends to be more useful for companies that depend heavily on their Assets to generate NI (eg banks and insurance firms) while ROE is more of a general-purpose metric that could apply to many industries.

A company hires a new employee for a total cost of $100,000 per year. Walk me through how the financial statements change, assuming a 25% tax rate.

$100K operating expense, $75K NI decrease flows into CFS cash down -> assets down $75K equity also down $75K (NI down)

Walk through a $10 decrease in Depreciation, assuming a 25% tax rate.

COGS +$10, NI down $7.5 flows into CFS but add back depreciation (non-cash expense) => +$2.5 +2.5 cash, -10 depreciation on asset side, balances with -7.5 (NI) on equity side

A company's CEO has decided to sell all its assets, starting with a factory recorded at a book value of $100 on its Balance Sheet. If this factory sells for $140, how do the statements change?

IS: You made $40 profit from the sale so you put that in revenue, increasing NI by $30 at a 25% tax rate CFS: +$30, +$140 from sale, -$40 realized gain to avoid double counting (CFO accounted for) => +$130 BS: +$130 on cash -$100 on factory => +$30, +$30 on equity (NI) balance

Walk me through the financial statements when a customer orders a product for $100 and receives it but hasn't yet paid for it. Then, walk me through the cash collection, combining it with the first step. Ignore COGS and other delivery costs for simplicity.

IS: +$100 post-tax +$75 CFS: +$75, -$100 (Accounts Receivable) BS: -$25 from cash, +$100 AR, +$75 NI balance

When AR is collected from previous problem…

IS: no change, still $75 CFS: +$75, -$100, +$100 => +$75 BS: +$75 on both sides

A company hires a marketing agency to run an online advertising campaign for its services. The marketing agency charges $10,000 for this initial campaign, delivers it, and invoices the company, which has 60 days to pay. Walk me through the statements.

IS: -10K -7.5K post tax CFS: -7.5K +10K BS: 2.5K, 10K-7.5K

Now, walk me through what happens ONLY in Step 2, when the company finally makes payment after 60 days. Also, explain intuitively what happens from start to finish.

IS: no change, still -7.5K CFS: -7.5K BS: -7.5K, -7.5K BALANCE You had a liability of 10K for a bit there in between but after you paid it went back down to 0 and you just lost 7.5K of the marketing payment

Your friend's e-commerce company orders $200 of products from its main supplier. A month later, it sells these products for $500. Walk me through each step of this process SEPARATELY.

1. IS: no changes (yet to be operated) CFS: -200 BS: -200, +200

2. IS: +300, +225 post tax CFS: +225, -300, +500 = 425 BS: +425, -$200 = $225 = $225

In here, inventory went up and cash went down in exchange. Then we profited from our inventory and our cash went up but assets down.

A Software-as-a-Service (SaaS) company bills customers upfront for an entire year of service and collects the cash before the contract begins. Walk me through the process for a $250 contract with a $50 delivery cost between January 1 and December 31 of the year. COMBINE the cash collection and revenue recognition.

Jan: IS: no change nothing has been delivered CFS: +250 BS: +250 but also +250 liabilities Throughout the year, slowly move toward: IS: +250 as you earn what you promised to deliver, -50 COGS, +150 NI CFS: +150, -250 => +150 BS: +150, +150 The company had deferred revenue but it went down to 0 by end of year and earned the 150 for services.

A company with 1000 shares issues 500 new shares worth $1.00 on January 1 to fund its business. Then, it decides to issue Dividends per Share of $0.10 to all its shareholders at the end of the year. Walk me through both steps SEPARATELY on the statements.

Jan: IS: no change CFS: +$500 BS: +$500, +$500

Dec: IS: no change CFS: -$150 => +$350 BS: +$350, +$350

A company issues $200 of Debt at a 10% interest rate. Walk me through the entire first year on the statements, including the initial issuance and the full interest payment. COMBINE both steps.

1. IS: no change CFS: +$200 BS: +$200, +$200
2. IS: -$20 interest, -$15 NI CFS: +$185 BS: +$185, +$185

How does this change if, in addition to the 10% interest rate, the Debt now has a 20% principal repayment each year? Combine both steps and assume the principal repayment occurs on December 31.

1. IS: no change CFS: +$200 BS: $200 on both
2. IS: -$20, -$15 NI CFS: -$40, -$15 => $145 BS: $145, $145 BALANCE

A company that follows U.S. GAAP signs a 10-year Operating Lease on January 1. It will pay $160 in Rent each year.

Assuming a 5% Discount Rate, walk me through the financial statements over this entire year. For simplicity, you may "round" and assume the Present Value of the lease payments equals $1,200.

When you sign the 10-year lease, GAAP forces you to put the entire 10-year value on your BS on Day 1. The PV is $1,200. ROU Asset of $1200 and a Lease Liability of $1200. When you pay $160 rent, since DR = $60 that's your interest. $100 goes toward paying principal debt.

At start: IS: -$160 => -$120 CFS: -$120 BS: -$120 +1,100 and -$120 +1,100 BALANCE

Now run through same scenario but with IFRS rather than GAAP

$1200/10 =$120.00 (straight line depreciation) and an initial interest expense of $1200 * 5% =$60.00 So lease principal repayment = $160 - $60 =$100.00 IS: -120 and -60 so that's -135 CFS: -135, +120, +1200 liability and -1200 asset and then -100 => -115 BS: -115 +1080 -120 = -135 -1100 BALANCE

A company buys a factory for $200 using $200 of Debt. What happens INITIALLY on the statements?

No changes on IS CFS: +200, -$200 BS: +200 on both sides

One year passes. The company pays 10% interest on its Debt, and it depreciates 10% of the factory. It also repays 5% of the Debt principal. What happens on the statements in this first year?

$20 on interest, $20 depreciation repay $10 principal IS: -$40 => -$30 CFS: -$30, +$20, -$10 => -$20 BS: -$20 -$20, -$30, -$10

At the end of the first year, the company sells its factories for $220 and uses the proceeds to repay its remaining debt principal, after realizing there is little demand for its products.

Walk through this step separately from the previous two.

Assume that the net PP&E balance is $180 because of changes in the previous step.

IS: +$30 NI CFS: +$30, +$220, -$40, -$190 => +$20 BS: +$20, -$180 = +$30, -$190 BALANCE

Walmart purchases $200 of Inventory "on credit," sells it for $400, and records an additional $100 in Operating Expenses to support the sale. Walk me through ONLY Step 1 of this process with the Inventory purchase.

IS: no changes CFS: +$200 BS: +$200, +$200

Step 2 (sale and delivery of the products and the supplier payments)

IS: +$200, -$100, +$75 NI CFS: +$75, +$200, -$200 => +$75 (because inventory is operations we don't subtract from CFO) BS: +$75 -$200 +75 -$200 BALANCE

What do Equity Value and Enterprise Value MEAN?

EV is the value of the company's CORE BUSINESS OPERATIONS (Net Operating Assets) to ALL INVESTORS (Equity, Debt, Preferred, maybe others) EqVal is the value of EVERYTHING a company has (net assets) that's available to Equity investors (common shareholders)

That sounds complicated. What do these concepts mean in plain English? Can you give a real-life analogy?

If you buy a house for $500K with a $100K down payment, $500K is the Enterprise Value, and $100K is the Equity Value. Enterprise Value does not change when the capital structure changes, so if you use $250K for the down payment, the Equity Value is now $250K, but the Enterprise Value is still $500K.

Why do you need both Equity Value and Enterprise Value? Can't you just value companies using one of them?

Need them for different valuations and analyses

What's the difference between Current Enterprise Value and Implied Enterprise Value?

Current EV is if you calculate based on current share price, Implied is if you go with valuation and determine what you think it should be worth (eg list price of a house is 500K but you did research and think its more like 450K)

What is the difference between Basic Equity Value and Diluted Equity Value?

Basic: Common Shares Outstanding * Current Share Price Diluted (more accurate measurement of what the company's Net Assets are worth to common shareholders): includes dilutive securities such as options, warrants, restricted stock units (RSUs) and convertible bonds = Diluted Shares Outstanding * Current Price

Dilutive securities incentivize employees to stay

Use Treasury Stock Method to factor in options and warrants and If Converted for convertible bonds

Let's say you have a company's Diluted Equity Value. How do you move from Equity Value to Enterprise Value?

EqVal - Cash + Debt + PS + NCI OR subtract non-operating assets and add Liability and Equity lines that represent other investor groups (beyond common shareholders)

Why do you subtract Equity Investments and add Noncontrolling Interests in the Enterprise Value calculation?

Because Equity Investments are not core operational assets and Noncontrolling Interests represent an investor group

Can you explain the proper treatment of pensions in Enterprise Value?

Only Defined-Benefit Pension plans factor in. You should add the unfunded or underfunded portion in the TEV bridge because the employees represent another investor group if promised future payments. (If contributions into the pension plan are tax-deductible, multiple unfunded portion by (1-TR) in TEV bridge

Should you add Operating Leases in the Enterprise Value calculation? What about Finance Leases?

Match with multiples for comparability.

Can you give examples of company actions that affect Equity Value but NOT Enterprise Value, Enterprise Value but NOT Equity Value, and BOTH Enterprise Value and Equity Value?

This "compound question" tests how well you understand these concepts beyond simple definitions. There are many possible answers, but a few simple ones include: • Affects Equity Value But Not Enterprise Value: A company issues $100 of Stock and lets it sit in Cash on its Balance Sheet (Net Operating Assets are unchanged). • Affects Enterprise Value But Not Equity Value: A company issues $100 of Debt and uses it to buy a factory, boosting its Net PP&E (Net Operating Assets increase by $100). • Affects Both Equity Value and Enterprise Value: A company issues $100 of Stock and uses it to buy a factory, boosting its Net PP&E (Net Operating Assets increase by $100, and Common Shareholders' Equity is also up by $100).

Could Equity Value ever be negative? What about Enterprise Value?

EqVal can't mathematically, EV could if you have a bunch of cash (busted biotech firms that trade at a discount to their cash)

You are comparing Companies A and B. Each operates in the same industry with the same revenue, EBITDA, and other financial metrics.

Company A is financed with 100% Equity, and Company B is financed with 50% Equity and 50% Debt.

In theory, their Enterprise Values should be the same. Will they be the same in real life?

No, debt is still riskier.

[FOR Equity Value and Enterprise Value Calculations: ALWAYS JUST LOOK AT WHETHER COMMON SHAREHOLDER EQUITY CHANGES AND WHETHER NET OPERATING ASSETS CHANGES] A company issues $200 in Common Shares. How do Equity Value and Enterprise Value change?

EV: no change EqVal: +$200

This same company decides to use the $200 in Common Stock proceeds to acquire another business for $100 instead. How does everything change?

EV: +$100 EqVal: +$200 (stock issuance step)

What if the company uses that same $100 from the $200 of new Common Stock to acquire an Asset rather than an entire company?

Depends on if the Asset is operating. If it is a core asset then no change to EV, if operating then: EV: +$100 EqVal: +$200

A company issues $100 in Debt to purchase a new factory. How do EqVal and EV change?

EV: +$100 EqVal: no change

A company issues $100 of CS and $100 of PS and lets the proceeds sit in Cash. How do EqVal and EV change?

EV: no change EqVal: +$100 (PS DOES NOT AFFECT CSE)

This same company now issues $10 in Common Dividends and $10 in Preferred Dividends. What happens in JUST THIS STEP?

EqVal: -$20 (BOTH COMMON AND PREFERRED DVIDENDS FLOW INTO CSE ON BALANCE SHEET :(. ) EV: no change

A company issues $150 of Debt and $50 of CS to acquire $175 of PP&E and $25 of Short-Term Investments. How do EqVal and EV change?

EqVal: +$50 EV: +$175 (PP&E counts as an Operating Asset) apparently STI are counted as Cash :/

A company issues $50 of Debt to buy a new factory. However, AFTER this purchase, its Enterprise Value increases by $100 rather than $50. Your co-worker claims it is because the company issued Debt to make this purchase, and Debt increases Enterprise Value. Is he correct?

The factory is worth $100, considering market value. No. The purchase method does not matter when determining how Enterprise Value changes. All that matters is how the Net Operating Assets change. The most likely explanation here is that the book value of this factory is $50, but its market value is $100 because market participants believe the Present Value of its future cash flows is closer to $100. Therefore, Enterprise Value increases by $100 rather than $50. The company effectively got a discount on a new asset.

A company purchases $100 of Inventory using Cash. How do EV and EqVal change?

EV: +$100 EqVal: no changes

Now assume the Inventory is sold for $200 and walk me through the entire process from beginning to end and how it affects EqVal and EV

When the inventory is sold for $200, COGS is $100, at a 25% tax rate, NI is at +$75. That flows directly into CSE, so EqVal is +$75. EV: -$100 in NOA => overall no change

A company has 200 outstanding shares at a current price of $10. It also has 50 options at an exercise price of $8 each. What is its Diluted Equity Value?

Outstanding price = $2000. 50*$8 =$400.00 Instead of letting the shareholders suffer diluted value, the company buys back stocks. $400 / $10 = 40 200+50-40 = 210 stocks are out at $10 each $2100 is the Diluted Equity Value TREASURY STOCK METHOD: a company will use any cash it receives from option exercises to buy back its own stock and minimize the dilutive impact on existing shareholders

A company has 10,000 shares outstanding and a current share price of $20. It also has 100 options at an exercise price of $10, 50 RSUs, and 100 convertible bonds at a conversion price of $10 and a par value of $100. What is the Diluted Equity Value?

10,000 * $20 = $200,000.00 ($200K) Exercise the options, $1000 / $20 = 50 Treat 50 RSUs as common shares => $1000 Convert the bonds, since conversion price is less than share price: PAR VALUE / CONVERSION PRICE = new shares per bond. $100/10 = 10 shares per bond. We have 100 bonds. 10 * 100 = 1000. 1000 shares ADD THEM ALL UP = 50 + 50 + 1000 = 1100 1,100 + 10000 =11,100 11,100*20 =222,000

Public companies already have Market Caps and Share Prices. Why do you need to "value them" at all? You already know how much they're worth.

Those reflect Current Value according to the market as a whole--but the market can be wrong. You value companies to see if the market's views are correct and whether a company's value might change based on your views.

What are the advantages and disadvantages of the 3 main methodologies?

Public Comps are useful because they're based on real market data, are quick to calculate and explain, and do not depend on far-in-the-future assumptions. BUT there may not be truly comparable companies, the analysis will be less accurate for volatile or thinly traded companies, and it may undervalue companies' long-term potential. Precedent Transactions are useful because they're based on the real prices that companies have paid for other companies, and they may better reflect industry trends than Public Comps. BUT the data is often spotty and misleading, there may not be truly comparable transactions, and specific deal terms and market conditions might distort the multiples. DCF Analysis is the most correct methodology according to finance theory, it's less subject to market fluctuations, and it better reflects company-specific factors and long-term trends. Intrinsic value, taking data from finance sheets of the actual company. BUT it's also very dependent on far-in-the-future assumptions, and there's disagreement over the proper calculations for key figures like the Cost of Equity and WACC.

Which of the 3 main methodologies will produce the highest Values?

Depends on industry, time period, and assumptions. Precedent Transactions often produces higher Implied Values than Public Comps because of the control premium -- the extra amount that buyers must pay to acquire sellers. A DCF depends on the long-term assumptions being used.

Which one should be worth more: $500 million EBITDA healthcare company or a $500 million EBITDA industrials company?

The industrials company sees massive CapEx and Depreciation expenses. Probably the healthcare company is worth more, as its cash flow is higher.

Can you walk me through how you use Public Comps and Precedent Transactions in a valuation?

First, you select the companies and transactions based on industry, size, and geography (and time for the transactions). Then, you determine the appropriate metrics and multiples for each set (revenue, rev growth, EBITDA, EBITDA margins, and revenue and EBITDA multiples) and calculate them for all the companies and transactions. Next, you calculate the minimum, 25th percentile, median, 75th percentile, and maximum for each valuation multiple in the set. Finally, you apply these numbers to the financial metrics of the company you're analyzing to estimate its Implied Value.

1. Find comps
2. Get appropriate multiples and metrics
3. Calculate the minimum, 25, median, 75, and maximum of each valuation multiple in set
4. Apply to your company

Can you give a few examples of how you might screen for similar companies or transactions?

Geography, industry, size, and time for precedent transactions Eg. European legacy airlines with over 1 billion euro EBITDA American transactions over past 5 years in fast-casual restaurants of over $500M

How do you decide which metrics and multiples you use?

You usually look at a sales-based metric and its corresponding multiple and 1-2 profitability-based metrics and their multiples. For example, Revenue (sales), EBITDA (profit), and Net Income (profit) => TEV/Revenue, TEV/EBITDA, P/E

You do this because you want to value a company in relation to how much it sells and how much it KEEPS from its sales.

Why do you look at BOTH historical and projected metrics in these methodologies?

Historical metrics are useful because they're based on what happened in real life, but they can also be deceptive if there were non-recurring items or if the company made acquisitions or divestitures. Projected metrics are useful because they assume the company will operate in a steady state without acquisitions, divestitures, and non-recurring items. But also…that's speculative and based on predictions.

When calculating the forward multiples for the comparable companies, should you use each company's Current EqVal or Current EV, or should you project them them to get the Year 1 or Year 2 values?

ALWAYS use current EqVal or EV. You shouldn't try and guess what your company will be worth in the future, just try and guess the future cash flow. So basically: How much am I paying today for $1 of this company's future earnings???

How do you interpret Public Comps? What does it mean if the median multiples are above or below the ones of the company you're valuing?

Above: you have an overvalued company Below: you have an undervalued company in market If the margins and growth rates are similar.

What is a Liquidation Valuation, and when is it useful and not so useful?

Estimate the value of a company by estimating the market values of all Assets and adding them up and them subtracting Liabilities. DUH it gives Implied EqVal because you're valuing its Net Assets not just Net Operating Assets. This method is for DISTRESSED companies because it tells you how much they might be worth if they liquidate and how much different lender groups might receive. It's useful for healthy, growing companies because it undervalues them significantly, assets like Net PP&E are always worth more to concerning situation companies.

How does a Dividend Discount Model (DDM) differ from a DCF?

In a DDM, rather than projecting FCF you project Dividends (usually by per-share figure or percentage of Net Income) To calculate the Terminal Value, you used an Equity Value-based multiple such as P/E, and you discount it to Present Value using the Cost of Equity. Calculates Implied Equity Value, and you divide it by the diluted share count to get the company's Implied Share Price. Essential in industries such as commercial banks and insurance, useful in regular dividend industries (utilities), and not so useful for most others.

Why might you use an M&A Premiums analysis to value a company?

Applies only to public companies because you look at similar public acquisitions and calculate the premium paid by the buyers. (percentage-wise premium) Can't indicate that a company is undervalued

What are the advantages and disadvantages of a Sum-of-the-Parts Valuation?

Works well for conglomerates that have very different divisions (retail vs. transportation vs. digital media segments) The divisions operate in different industries so valuing the company as a whole is not helpful, since no other public companies are comparable. You make a DCF for each part. BUT that takes time, and you might not have enough information.

How do you set up an LBO valuation (IT'S A FLOOR VALUATION), and when is it useful?

You set up an LBO valuation by creating an LBO model in which a private equity firm acquires a company using Debt and Equity, holds it for several years, and then exits for a certain multiple of EBITDA. Most PE firms target an IRR in a specific range, so you work backward and determine the maximum price the PE firm could pay to achieve a targeted IRR. This methodology is really useful for screening LBO candidates and also helps a company understand what PE firms vs. normal companies might pay for it.

What is a valuation multiple? Explain the theory and give a real-life analogy.

A valuation multiple is a company's value based on its CF, CFGR, and DR. Company Value = CF / (DR - CFGR) Compare how expensive and cheap similar houses of different sizes are

You're valuing a mid-sized manufacturing company. This company's TEV / EBITDA multiple is 15x, but the median TEV / EBITDA for the comparable companies is 10x. What's the most likely explanation?

The market expects the company's cash flow to grow faster than other comparable companies. DR is probably not differing significantly.

Walk me through how you calculate EBIT and EBITDA for a public company.

EBITDA = Revenue - COGS/SG&A EBIT = Revenue - COGS/SG&A - D&A

EBIT = Operating Income (Income Statement) and then add back any non-recurring charges that have reduced OI. EBITDA = EBIT + D&A

How do you decide whether to use Equity Value or Enterprise Value in valuation multiples?

If the financial metric in the denominator deducts Net Interest Expense, the numerator has to match.

A company has $100 in Revenue, a 15% EBIT margin, and D&A that is 5% of its Revenue. The company's Equity Value is $100, and it has $20 of Cash, $40 of Debt, and $30 in Lease Liabilities. What is its TEV / EBITDA multiple?

D&A = $5 EBIT = $15 $15 + $5 = $20 EBITDA = $20 EqVal = $100 - $20 + $40 =$120.00 120/20 = 6 <- If we are treating Lease Liabilities as Finance or Operating Leases? If we are using GAAP?

For clarity, the company I just described followed U.S. GAAP, and the Lease Liabilities were for Operating Leases. Now, imagine that this company followed IFRS rather than U.S. GAAP. How would the EBIT margin and D&A percentages change, and how would the TEV / EBITDA change?

The D&A percentage would be higher because D&A under IFRS includes Lease Depreciation. And EBITDA margin would be higher under IFRS because it would add back the entire Operating Lease Expense so that EBITDA would be higher than $15 ASDHSAIUHDOIAJDSCOIJIAOSDMAS ?J@REWQHEP@ I!(U#TUYWGEFHOJAPKO{DIWrutgy4uWFEHDCJASLX

What are the advantages and disadvantages of TEV / EBITDA vs. TEV / EBIT vs. P / E?

TEV/EBITDA is better when you want to ignore the company's CapEx and capital structure completely. --> normalizes companies and is more useful in industries where CapEx is not a huge value driver. TEV/EBIT is better when you want to ignore capital structure but partially factor in CapEx (via the Depreciation, which comes from CapEx in previous years) <-- better when you want the implied values to have some relation to CapEx. The P/E multiple is affected by different tax rates, capital structures, non-core business activities, and more, so it is less useful for normalization purposes than the others (though it has the advantage of being widely understood). More specific to specific industries such as banks and insurance firms that use EqVal as the leading valuation metric.

A company is currently trading at 10x TEV / EBITDA. It wants to sell an Operating Asset for 2x the Asset's EBITDA. Will that transaction increase or decrease the company's Enterprise Value and its TEV / EBITDA multiple?

EV will go down, EBITDA will go down because you sold your asset and that's losing out on the ongoing profits. Since Asset's multiple was lower than the entire company's multiple, TEV/EBITDA actually increases.

What happens to the company's Equity Value and P / E multiple in this scenario?

No change (unless Gain or Loss) Most likely, P/E increases because 2x < 10x but it matters the capital structure of the asset and stuff that affects the math. No guarantee.

How do you calculate and use Unlevered FCF and Levered FCF?

ULFCF: NOPAT + D&A - CapEx - Changes in Operating Capital LFCF: NI + D&A - CapEx - Changes in Operating Capital (useful in specialized contexts and industries such as equity REITs)

If a company is valued mostly based on its cash flow, why do you also use metrics such as EBIT and EBITDA that may not represent its true cash flow?

For convenience and comparability. FCF takes more time to calculate and requires you to review the full CFS and make adjustments. The individual items within FCF vary widely for different companies. As a result, EBIT and EBITDA are better for comparability and normalization (based on IS and one line of CFS)

Give an example of a company change that affects UFCF but not EBITDA.

Higher than normal change in working capital (large inventory purchase) and CapEx additional spending

Company A has a P / E multiple of 15x, with a Net Income of $120 and a TEV / EBITDA multiple of 15x. Its EBITDA is $150. Company B has the same 15x P / E multiple but a Net Income of $100, a TEV / EBITDA of 10x, and an EBITDA of $200. Which one has a higher Net Debt balance?

Equity value = number of shares * price = 15 * 120 = 1800, and EV = 2250 Equity value = 15 * 100 = 1500 and EV = 2000 Company A's net debt is 2250 - 1800 = 450 Company B's net debt is 2000 - 1500 = 500 Company B has a higher Net Debt balance.

A company's Operating Income is $100, and it has a $500 Debt balance at a 4% interest rate. It also has Cash of $100, currently earning 0% interest. If the company's Equity Value is $600, its P / E multiple is 12x, and its tax rate is 25%, what can you conclude about its Enterprise Value?

$20 interest EqVal = $600 P/E multiple is 12 that means Net Income is $50 If Operating Income is $100 that means $50 is the NI after Interest and Taxes.

$600 - $100 (Cash) + $500 = $1000 assuming no Preferred Stock

but I guess there is Preferred Stock because…

$100 Operating Income - $20 Interest Expense = $80 Then after tax that's $60 in net income

$10 discrepancy is probably because of preferred stock. So maybe the company has $10 in Preferred Dividends.

But anyways that just means ultimately EV > $1000