LINCOLN INTERNATIONAL PREP

Flashcards covering key valuation methodologies, financial metrics, and statement analysis from the lecture notes.

What are the three commonly used valuation methodologies?

The three commonly used valuation methodologies are the discounted cash flow analysis, comparable company analysis, and precedent transaction analysis.

How does the discounted cash flow (DCF) method value a company?

The discounted cash flow method values a company by considering its projected cash value, either by discounting or adjusting to its present value.

How does comparable company analysis (CCA) value a company?

Comparable company analysis values a company by comparing it to other businesses of similar size and operating in similar industries using criteria such as margins and profitability, growth rate, and geography.

What is precedent transaction analysis?

Precedent transaction analysis is a valuation methodology that determines a company's implied value by evaluating recent acquisition prices under similar circumstances.

What is enterprise value (EV)?

Enterprise value is the total value of a company, including the current share price and the cost to pay off the debt, giving an in-depth insight into a company's overall financial situation.

What is equity value?

Equity value is the value of a company's ownership after it has paid off all its debts, representing the value that remains for the investors.

How do you incorporate intangible assets when performing a valuation analysis?

First, identify and specify the intangible assets, then evaluate their impact on the company's financial performance. Next, calculate their net asset value and record it on the company's balance sheet, along with the difference from the overall business valuation.

How are pitch books prepared?

First, determine the client's requirements and objectives. Then, research relevant tax laws, regulations, and the company's financial information for tax-related issues or opportunities. Organize this information clearly with concise language and visual aids, following a standard template including a title page, executive summary, bank introduction, market overview, valuation, transaction strategy, and summary.

What is Discounted Cash Flow (DCF)?

DCF is a valuation method that estimates the value of an investment using its expected future cash flows.

What is Weighted Average Cost of Capital (WACC)?

WACC is a company's average after-tax cost of capital from all sources, including common stock, preferred stock, bonds, and other forms of debt, and is used as the discount rate in DCF models.

What is CAPM, and what is it used for in valuation?

CAPM (Capital Asset Pricing Model) is used to calculate the cost of equity, which is an input in the WACC formula.

What is the formula for Enterprise Value (EV)?

EV = Equity Value + Debt + Preferred Stock + Noncontrolling Interest − Cash.

Why is Enterprise Value important when comparing companies?

EV represents the total value of a firm, including both equity and debt holders, and is important when comparing companies with different capital structures.

What is Terminal Value in a DCF?

Terminal Value represents the value of a business beyond the forecasted period in a DCF model.

How do you calculate Beta for a private company?

For a private company, find comparable public companies, unlever their betas to remove capital structure effects, and then re-lever the beta using the private company's capital structure.

What is the core assumption of comparable company analysis (CCA)?

Comparable company analysis operates under the assumption that similar companies will have similar valuation multiples, such as EV/EBITDA.

What factors can cause two companies with the same EBITDA to have different valuations?

Two companies with the same EBITDA can have different valuations due to factors like growth potential (higher projected cash flow growth), leverage (higher debt increases risk), and overall risk profile.

Walk me through a DCF analysis.

First, project the company’s free cash flows (FCFs) over 5-10 years. Discount these FCFs to their present value using the company's WACC. Calculate the terminal value. Add the present value of the projected cash flows and the terminal value to determine the company’s overall valuation (Enterprise Value).

How do you arrive at the Terminal Value in a DCF?

The terminal value can be arrived at using two methods: the Gordon Growth Model (GGM) by projecting FCFs beyond the discrete forecast period or the Exit Multiple Method by applying a multiple (e.g., EV/EBITDA) to the last year's EBITDA. This value is then discounted back to the present.

How do you convert Equity Value to Enterprise Value?

You add debt and subtract cash from equity value to get enterprise value.

Why is distinguishing between Equity Value and Enterprise Value important?

EV represents the company's value independent of its capital structure, while equity value is just the value of shareholders' stake.

When are Revenue multiples and EBITDA multiples typically used?

Revenue multiples are often used for companies without positive EBITDA (e.g., small tech startups), while EBITDA multiples are preferred for more established companies with stable earnings.

What is a zero-coupon bond?

A zero-coupon bond is a bond that doesn’t pay interest (coupon) but is sold at a discount and matures at its face value; the difference between the purchase price and the face value is the bondholder's return.

What long-term ratios do creditors typically look at?

Creditors look at the Debt Ratio (Total debt/total assets) and Debt-to-Equity Ratio (D/E), where a lower D/E ratio indicates lower financial risk.

What short-term ratios do creditors typically look at?

Creditors look at liquidity ratios like the Current Ratio and Quick Ratio, which focus on the company’s ability to cover short-term obligations, and EV/EBITDA to assess overall financial health.

What is EBITDA?

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a measure of a company's core profitability, excluding the effects of financing and accounting decisions.

What is EV/EBITDA?

EV/EBITDA (Enterprise Value to EBITDA) is a widely used valuation multiple that compares the value of the business (enterprise value) to its earnings before interest, taxes, depreciation, and amortization.

What is the EV/EBITDA multiple, and why is it a common metric for valuing companies?

The EV/EBITDA multiple compares a company’s Enterprise Value (EV) to its EBITDA. It’s commonly used because it helps compare companies with different capital structures by removing the effects of financing and accounting decisions, making it particularly useful for industry comparisons.

How does a $100 increase in CapEx affect the three financial statements in year 0?

IS: No effect. CF: Cash outflow of $100 from investing, Net change in cash - $100. BS: Cash down $100 (Assets), PP&E up $100 (Assets), so Assets remain balanced, and the balance sheet balances.

How does $5 of depreciation (with 20% tax rate) affect the three financial statements?

IS: Pre-tax income down $5, Net Income down $4 (after 20% tax, 5 * 0.8 = 4). CF: Net Income down $4, add back non-cash depreciation of $5, so Net cash from operations is up $1. BS: Cash up $1 (Assets), PP&E down $5 (Assets), Retained Earnings down $4 (Equity), so Assets go down $4 and Equity goes down $4, balancing the sheet.

How does $100 of new debt, immediately used for an investment (as per notes), affect the three financial statements?

IS: No effect. CF: Cash from investing down $100 (for asset purchase), Cash from financing up $100 (for debt issuance), Net change in cash is $0. BS: Property, Plant & Equipment (PP&E) up $100 (Assets), Debt up $100 (Liabilities), balancing the sheet.

How does $10 of interest expense and $10 of depreciation (with a 40% tax rate) affect the three financial statements?

IS: Pre-tax income down $20 ($10 interest + $10 depreciation), Net income down $12 (after 40% tax, $20 * 0.6 = $12). CF: Net income down $12, add back non-cash depreciation of $10, Net change in cash is down $2. BS: Cash down $2 (Assets), PP&E down $10 (Assets), Retained Earnings down $12 (Equity). Assets down $12, Equity down $12, balancing the sheet.

How does $10 of interest expense (with a 40% tax rate) affect the three financial statements?

IS: Pre-tax income down $10, Net income down $6 (after 40% tax, $10 * 0.6 = $6). CF: Net income down $6, no non-cash add-back, Net change in cash is down $6. BS: Cash down $6 (Assets), Retained Earnings down $6 (Equity), balancing the sheet.

What is the P/E Ratio?

The P/E Ratio (Price-to-Earnings) compares a company’s stock price to its earnings per share (EPS), indicating how much investors are willing to pay for each dollar of earnings.

How does $10 of PIK (Payment-in-Kind) interest (with a 40% tax rate) affect the three financial statements?

IS: Pre-tax income down $10, Net income down $6 (after 40% tax). CF: Net income down $6, add back non-cash PIK interest of $10, Net change in cash is up $4. BS: Cash up $4 (Assets), Liabilities up $10 (PIK interest is added to debt), Retained Earnings down $6 (Equity). Assets up $4, Liabilities up $10 and Equity down $6, balancing the sheet.

How does $10 of depreciation (with a 40% tax rate) affect the three financial statements?

IS: Pre-tax income down $10, Net income down $6 (after 40% tax). CF: Net income down $6, add back non-cash depreciation of $10, Net change in cash is up $4. BS: Cash up $4 (Assets), PP&E down $10 (Assets), Retained Earnings down $6 (Equity). Assets down $6, Equity down $6, balancing the sheet.

How does a $10 increase in deferred revenue affect the three financial statements?

IS: No initial changes. CF: Cash inflow of $10 from operating activities (unearned revenue), Net change in cash is up $10. BS: Cash up $10 (Assets), Deferred Revenue up $10 (Liabilities), balancing the sheet.

How does a $10 decrease in deferred revenue (when services are rendered) affect the three financial statements?

IS: Revenue up $10, Pre-tax income up $10, Net income up $6 (after 40% tax). CF: Net income up $6, cash outflow from change in deferred revenue (as it's recognized, not received as cash in this period) of $10, Net change in cash is down $4. BS: Cash down $4 (Assets), Deferred Revenue down $10 (Liabilities), Retained Earnings up $6 (Equity). Assets down $4, Liabilities down $10 and Equity up $6, balancing the sheet.

What are the key components of the Income Statement (IS)?

The IS shows a company’s profitability over a specific period, including revenue, COGS, SG&A, R&D, EBIT, interest expense, EBT, income tax, and net income.

What are the key components of the Balance Sheet (BS)?

The BS shows financial position at a specific point in time, including Current Assets (cash, accounts receivable, inventory), Noncurrent Assets (PP&E), Current Liabilities (accounts payable, short-term debt), Noncurrent Liabilities (deferred taxes, long-term debt, lease obligation), and Shareholder Equity (common stock, APIC, preferred stock, treasury stock, retained earnings).

What are the key components of the Cash Flow Statement (CFS)?

The CFS summarizes cash inflows and outflows over a period, categorized into Operating Activities (start with net income, add back non-cash expenses like D&A and stock-based compensation, changes in NWC), Investing Activities (long-term investments, CapEx, acquisitions/divestitures), and Financing Activities (issuing debt/equity, share repurchases, debt repayment, dividends).

How do the three financial statements link together?

The Income Statement's Net Income flows into the top line of the Cash Flow Statement and into Retained Earnings on the Balance Sheet. The Cash Flow Statement's ending cash balance is reflected as Cash on the Balance Sheet. Changes in Balance Sheet items (like PP&E, Debt, and SE) are affected by investing and financing activities in the Cash Flow Statement, and working capital changes also appear in operating cash flow.

Explain the difference between straight-line and accelerated depreciation.

Straight-line depreciation expenses an equal amount of an asset's cost over its useful life, while accelerated depreciation expenses a larger portion of the asset's cost in the earlier years of its life.

What is Working Capital?

Working Capital is the capital of a business used in its day-to-day trading operations, calculated as current assets minus current liabilities.

What is the formula for WACC?

WACC = (E/V * Re) + ((D/V * Rd) * (1 – T)), where E is equity market value, D is debt market value, V is E+D, Re is cost of equity, Rd is cost of debt, and T is corporate tax rate.

How is the Cost of Debt typically determined?

The cost of debt is readily observable in the market as the yield on debt with equivalent risk.

How is the Cost of Equity typically estimated?

The cost of equity is typically estimated using the Capital Asset Pricing Model (CAPM), which links the expected return of equity to its sensitivity to the overall market.

Explain why having debt can reduce WACC, but also increase it at high levels.

Debt typically has a lower cost than equity and provides a tax shield (interest is tax-deductible), which initially lowers WACC. However, high levels of debt introduce significant financial risk, which can increase the cost of both debt and equity, ultimately leading to a higher overall WACC.

What is Equity Value (in terms of market cap)?

Equity Value is the market capitalization of a company, calculated as shares outstanding multiplied by the share price.

What does Enterprise Value reflect?

Enterprise Value reflects the total cost to acquire a company, representing the value to all shareholders, debt holders, and other capital providers.

Under what circumstances does Noncontrolling Interest appear in the Enterprise Value formula?

Noncontrolling interest appears when a company owns over 50% of another company and thus needs to report 100% of the majority-owned subsidiary’s financial performance where the portion not owned is the noncontrolling interest.

How is Preferred Stock treated in the EV formula, and why?

Preferred Stock is added to Equity Value in the EV formula because it pays a fixed dividend and has a higher claim to assets than common stock, making it more similar to debt from a capital structure perspective.

Why is Cash subtracted in the Enterprise Value formula?

Cash is considered a non-operating asset; a buyer essentially gets the seller's cash upon acquisition, effectively paying less for the operational business hence it is subtracted.

What is the formula for CAPM?

CAPM = Risk-Free Rate + Beta * Equity Risk Premium.

What is the Equity Risk Premium?

Equity Risk Premium = (Expected Market Return - Risk-Free Rate).

What are two common formulas for Terminal Value?

Terminal Value = [Free Cash Flow (FCF) * (1+g)] / (WACC - g) (Gordon Growth Model) or Terminal Value = Last Year's EBITDA * Terminal Multiple (Exit Multiple Method).

How do you calculate beta for a private company?

Find comparable public companies ('comps'), find their average levered beta, unlever these betas using the average debt-to-equity ratio of the comps, then re-lever the unlevered beta using the private company's specific debt-to-equity ratio.

When walking through a DCF, what are the key steps to get from Revenue to Free Cash Flow (FCF)?

Start with Revenue, subtract COGS to get Gross Profit. Subtract all operating costs (SG&A, R&D) to arrive at EBIT. Account for taxes (using (1-T)) to get NOPAT. Add back Depreciation and Amortization. Subtract Capital Expenditures (CapEx). Subtract the change in Net Working Capital (NWC). This results in Free Cash Flow.

What are the pros and cons of Precedent Transaction Analysis?

Pros: It provides a valuation with a control premium, useful when comparable public acquisition data is available. Cons: Influenced by temporary market conditions, difficult to find perfectly comparable transactions, market sentiment can significantly impact implied valuations.

What are the pros and cons of Comparable Company Analysis (Comps)?

Pros: Uses current market data ('how they are trading right now'), a larger pool of companies often available, reliable if many comparable companies exist (median can be accurate). Cons: No two companies are perfectly alike, challenging to find true comps, companies can have different product lines or segments.

What are the pros and cons of Discounted Cash Flow (DCF) Analysis?

Pros: If confident in assumptions, it's a sound method valuing individual cash streams, not affected by temporary market conditions. Cons: Highly sensitive to assumptions (can produce wildly different valuations), forecasting future performance is subjective (especially terminal value), not suitable for companies with unpredictable or negative cash flows (e.g., biopharma).

What are the pros and cons of Leveraged Buyout (LBO) Analysis?

Pros: Establishes a 'floor' valuation by determining what a financial buyer (sponsor) would pay, providing a realistic valuation that doesn't rely on synergies. Cons: Ignoring synergies can underestimate valuation for strategic buyers, valuation is very sensitive to operating and financing cost assumptions, and prevailing financing market conditions.

List the five key steps to arrive at an Equity Value per Share based on a DCF analysis.

1) Project FCFs for 5-10 years. 2) Discount these FCFs to their Present Value (PV) using WACC. 3) Calculate Terminal Value (via Gordon Growth or Exit Multiple Method) and discount it back to PV. 4) Add the PV of projected FCFs and PV of Terminal Value to find Enterprise Value. 5) Subtract net debt (Debt - Cash) from Enterprise Value to find Equity Value, then divide by shares outstanding for share price.

What are the main steps in performing a Leveraged Buyout (LBO) analysis?

1) Determine purchase price (Entry Valuation). 2) Create Sources and Uses table, detailing how the deal is funded (debt, equity). 3) Project the target company's financial statements and calculate Free Cash Flows (FCFs). 4) Use FCFs to pay down debt. 5) Determine exit price and calculate the Internal Rate of Return (IRR) and Multiple of Invested Capital (MOIC).

What are three primary ways to increase the Internal Rate of Return (IRR) in an LBO?

1) How much the PE firm pays: Buying at a lower entry multiple or selling at a higher exit multiple. 2) How the PE firm pays: Maximize the debt load without bankrupting the company, as more debt generally means higher IRR. 3) How the company performs: Generate more free cash flow to pay down debt, which increases the equity upon exit.

Explain the difference between MOIC and IRR.

MOIC (Multiple of Invested Capital) tells you how an investment's value has grown on an absolute basis, while IRR (Internal Rate of Return) tells you how that investment has generated returns on an annualized basis, considering the time value of money.

What qualities make a company an attractive target for a Leveraged Buyout (LBO)?

Attractive LBO targets typically have stable, predictable cash flows, are potentially undervalued, have strong management teams, offer cost-cutting opportunities, require low CapEx, and possess a strong collateral base.

In a scenario implying an Enterprise Value derived from $10 million EBITDA and a 10x multiple, if total debt is $150 million, what is the implied worth for debt and equity based on the example values provided?

The implied worth is $100 million for debt and $0 for equity.