Investment Banking and Valuation Technical Concepts

Flashcards covering core accounting, valuation, DCF modeling, merger models, LBO mechanics, and corporate finance interview concepts.

Operating Working Capital

A financial metric defined as $(\text{Current Assets} - \text{Cash \& Cash Equivalents}) - (\text{Current Liabilities} - \text{Debt})$. It measures working capital requirements while explicitly excluding financing items like cash and debt.

Deferred Revenue

A liability recorded on the Balance Sheet when a company collects cash upfront from a customer for goods or services that have not yet been delivered or performed under accrual accounting.

Treasury Stock Method

A methodology used to calculate fully diluted share count assuming that any option proceeds received by the company from the exercise of in-the-money options are fully used to repurchase shares at the current market price.

Noncontrolling Interest

Formerly known as Minority Interest, an equity line item on the Balance Sheet reflecting the portion of a majority-owned subsidiary ($>50\%$) not owned by the parent firm. It is added to Enterprise Value so that both the numerator and denominator reflect $100\%$ of the consolidated subsidiary.

Goodwill

An asset that acts as an accounting plug in an acquisition, calculated by subtracting the book value of the target from the equity purchase price, representing intangible value such as brand, customer relationships, and intellectual property.

Goodwill Impairment

A non-cash accounting charge on the Income Statement that occurs when an acquirer reassesses an acquired business's intangible assets and determines they are worth significantly less than originally estimated.

Deferred Tax Liability (DTL)

A liability on the Balance Sheet that arises when tax expense recognized on the GAAP Income Statement is higher than the tax actually paid in cash to authorities in the current period, frequently created during asset write-ups in M&A.

Deferred Tax Asset (DTA)

An asset on the Balance Sheet that arises when a company pays more taxes in cash than it expenses on its GAAP Income Statement, often created by asset write-downs or deductible Net Operating Losses.

Capital Lease

A long-term lease that transfers ownership rights of an asset to the lessee; it is capitalized on the Balance Sheet as debt, incurs interest expense, and depreciates over its useful life.

Operating Lease

A short-term lease for property or equipment where the lessee acquires no ownership rights, treated as a routine operating expense on the Income Statement rather than capitalized as debt.

Unlevered Free Cash Flow (UFCF)

The cash flow generated by a company's operations that is available to all providers of capital (debt and equity), calculated as $\text{EBIT} \times (1 - \text{Tax Rate}) + \text{D\&A} - \text{CapEx} - \Delta\text{NWC}$.

Levered Free Cash Flow (LFCF)

The cash flow generated by a company that is available strictly to equity holders, calculated after subtracting mandatory debt repayments and tax-adjusted interest expense.

Weighted Average Cost of Capital (WACC)

The required return on capital across all investors, calculated as $\text{Cost of Equity} \times (\%\,\text{Equity}) + \text{Cost of Debt} \times (\%\,\text{Debt}) \times (1 - \text{Tax Rate}) + \text{Cost of Preferred} \times (\%\,\text{Preferred})$.

Capital Asset Pricing Model (CAPM)

The model used to determine a company's Cost of Equity ($K_e$), defined by the formula $K_e = \text{Risk-Free Rate} + \beta \times \text{Equity Risk Premium}$.

Gordon Growth Method

A formula used to determine Terminal Value in a DCF based on assuming cash flows grow into perpetuity at a constant rate: $\text{Terminal Value} = \frac{\text{Final Year FCF} \times (1 + g)}{\text{Discount Rate} - g}$.

Mid-Year Convention

A DCF discounting methodology that accounts for cash flow entering evenly throughout the year rather than at year-end by applying discount intervals of $0.5, 1.5, 2.5, \dots$ instead of $1.0, 2.0, 3.0, \dots$.

Accretive Acquisition

An M&A transaction where the combined pro-forma Earnings Per Share (EPS) of the acquirer is greater than the acquirer's standalone EPS prior to the acquisition.

Dilutive Acquisition

An M&A transaction where the combined pro-forma Earnings Per Share (EPS) of the acquirer is lower than the acquirer's standalone EPS prior to the transaction.

All-Stock P/E Rule of Thumb

A quick M&A heuristic stating that in an all-stock transaction, the acquisition is accretive if the buyer's $\text{P}/\text{E}$ multiple is higher than the seller's $\text{P}/\text{E}$ multiple, and dilutive if the buyer's $\text{P}/\text{E}$ multiple is lower.

Section 338(h)(10) Election

A tax election in an M&A transaction that is legally structured as a stock purchase but treated as an asset purchase for tax purposes, allowing the buyer to obtain a stepped-up basis in the target's assets.

Exchange Ratio

A deal structure in stock-financed M&A transactions where the buyer ties the consideration to a fixed ratio of buyer shares issued per seller share (e.g., $1.5$ shares of buyer stock for each share of target stock).

Earnout

A form of contingent deferred compensation in an M&A deal where the buyer agrees to pay additional funds in future years only if the target satisfies predefined performance milestones.

Dividend Recapitalization

A transaction in which a private equity portfolio company issues new debt solely to fund a special dividend distribution to the private equity sponsor, returning capital and improving IRR.

Payment-In-Kind (PIK) Debt

A debt instrument that does not require cash interest payments; instead, the interest expense accrues directly to the loan principal balance over time and is treated as a non-cash add-back on the Cash Flow Statement.

Maintenance Covenant

A debt covenant typical of bank debt that mandates the borrower continuously maintain specific financial performance ratios, such as a maximum $\text{Total Debt} / \text{EBITDA}$ or minimum interest coverage.

Incurrence Covenant

A debt covenant typical of high-yield debt that prohibits a borrower from undertaking specific strategic actions (such as taking on more debt, selling assets, or making large acquisitions) unless certain conditions are met.

Section 382 Limitation

An Internal Revenue Code limitation that restricts the annual deduction of acquired Net Operating Losses (NOLs) to the fair market value of the target company multiplied by the highest adjusted long-term tax-exempt rate over the preceding 3 months.

Days Sales Outstanding (DSO)

A working capital efficiency metric measuring the average number of days it takes for a company to collect cash from credit sales, calculated as $\frac{\text{Accounts Receivable}}{\text{Credit Sales}} \times 365$.

Days Sales of Inventory (DIO)

A metric that indicates the average number of days a company holds inventory before selling it, calculated as $\frac{\text{Inventory}}{\text{COGS}} \times 365$.

Days Payable Outstanding (DPO)

A metric that indicates the average number of days a company takes to pay its trade payables to suppliers, calculated as $\frac{\text{Accounts Payable}}{\text{COGS}} \times 365$.

Operating Leverage

A measure of the proportion of fixed costs versus variable costs in a company's operations; firms with high operating leverage experience larger percentage swings in operating income for a given percentage change in revenue.

LTV / CAC Ratio

A SaaS valuation and operating metric that compares the customer lifetime value ($\text{LTV}$) to the customer acquisition cost ($\text{CAC}$), where a value of $2$ to $4$ is considered healthy and approximately $3$ is viewed as the optimal target.

Dividend Discount Model (DDM)

An intrinsic valuation methodology for banks and financial institutions that discounts projected future dividend distributions at the Cost of Equity ($K_e$), adding the discounted terminal value calculated from a $\text{P}/\text{BV}$ or $\text{P}/\text{TBV}$ multiple.

Residual Income Model

Also called an Excess Returns Model, an intrinsic valuation framework for banks that sums current Book Value and the present value of future excess returns, where excess return equals $(\text{ROE} \times \text{Book Value}) - (K_e \times \text{Book Value})$.

Sum-of-the-Parts Valuation

A valuation technique used for diversified conglomerates that values each business division separately using tailored public comparables and precedent transactions, subsequently summing each division's value to calculate total Enterprise Value.

Liquidation Valuation

A distressed valuation methodology that assesses the net proceeds realized if all company assets are sold off piecemeal and liabilities are paid off, determining whether equity holders receive any residual value.

Revolver

A senior secured bank debt facility functioning like a corporate credit card that is drawn down when mandatory debt repayments exceed available cash flow, and repaid first when excess cash flow is generated.

Fabless Semiconductor Model

A semiconductor manufacturing business model where the company designs chips and intellectual property in-house but outsources the physical wafer fabrication to independent third-party foundries.

Special Purpose Acquisition Company (SPAC)

A publicly listed shell corporation created with the sole objective of raising capital via an IPO to acquire an unspecified private target company, enabling the target to go public without a traditional underwriting process.

Rule of 72

A financial shortcut used to estimate the number of years required to double an investment or financial metric, calculated by dividing $72$ by the annual growth or return rate.