Investment Banking - Finance Fundamentals

Gordon Growth Model (Perpetuity Growth)

Assumes the company grows at a stable, modest rate forever beyond the forecast period. You take the final year's free cash flow, grow it slightly, and divide by (WACC − g). It's theoretically grounded but sensitive to your growth rate assumption.

Exit Multiple Method

Assumes you "sell" the company at the end of the forecast period at whatever multiple similar companies are trading at today — typically EV/EBITDA. It's market-based and easier to defend, but anchored to current market conditions.

Unlevering Beta

βL ÷ (1 + (1 - Tax Rate) × (Debt/Equity))

Re-levering Beta

βL = βU × (1 + (1 - Tax Rate) × (Debt/Equity))

Hamada Equation

βL = βU × (1 + D/E)

Ending Retained Earnings Formula

Beginning Retained Earnings + Net Income – Dividends

When using Mid-Year Convention, how do you discount the TV differently depending on Gordon Growth vs Exit Multiple

Exit Multiple: Discount at the full year (n), not mid-year
Gordon Growth: Discount at mid-year (n − 0.5)

In the context of Beta dynamics, what does Business Risk represent?

The intrinsic risk of a company's operations and the volatility of its operating cash flows

How does Financial Risk contribute to the volatility of a company's stock price?

It introduces additional volatility caused by the company's choice to take on debt (leverage)

Why is the Beta found on platforms like Bloomberg or FactSet considered a 'Levered Beta'

Because it reflects the specific debt structure and financial risk of that peer company.

What is the primary purpose of 'unlevering' a peer's Beta before applying it to a target company

To isolate the pure business risk and ensure an 'apples-to-apples' comparison by removing the distortion of management's debt choices

How does carrying a high amount of debt affect a company's raw Beta reading

Debt inflates the risk reading, making the company appear riskier than its underlying business operations actually are

In the Hamada Equation, what does the variable 't' represent

The corporate tax rate

After finding the median Unlevered Beta of a peer set, what is the next step to determine the target's Cost of Equity (Ke​)

Re-lever the Beta using the target company's specific capital structure

Why is it considered a mistake to use the Coupon Rate as the Cost of Debt (Kd​) in WACC

The Coupon Rate is historical, whereas WACC requires the current rate at which the company could refinance today

What specific metric is the preferred input for the Cost of Debt (Kd​) in professional valuation

Yield to Maturity (YTM)

Which three factors are blended to calculate the Yield to Maturity (YTM) of a bond

The interest payments, the current market price, and the time remaining until maturity

How should you estimate the Cost of Debt (Kd​) for a private company with no tradable debt

Add the credit spread of comparable public peers (with similar credit profiles) to the Risk-Free Rate

What are the two mathematical components of Total Kd​ according to the credit spread approach

Cost of time (macro) + Cost of bankruptcy risk (micro)

In an Enterprise Value to Equity Value bridge, why are Net Operating Losses (NOLs) added to Enterprise Value

They are tax assets that provide value by reducing future cash outflows

Equity Investments (in the EV to Equity Bridge)

Stakes in other companies where ownership is less than 50% and results are unconsolidated.

Which category of assets includes real estate or divisions held for sale in an EV bridge?

Non-Core Assets.

Why is Minority Interest (Non-Controlling Interest) subtracted when moving from Enterprise Value to Equity Value?

To remove the portion of a consolidated subsidiary's value that is not owned by the parent company

In the EV bridge, what hybrid claim senior to common equity must be subtracted from Enterprise Value?

Preferred Stock

According to modern accounting standards (IFRS 16 / ASC 842), how are Capital Leases treated in an EV bridge?

They are treated as debt-like non-equity claims and subtracted from Enterprise Value

Explain the 'consolidation issue' regarding EBITDA and Minority Interest

Because 100% of a subsidiary's EBITDA is consolidated in the numerator, Enterprise Value must represent 100% of the capital base, requiring NCI to be adjusted in the bridge

What is a common misconception about the nature of Minority Interest in valuation?

That it is a form of debt, when it is actually an accounting consolidation adjustment

What are the two standard methods for calculating Terminal Value (TV)?

The Gordon Growth Method (Perpetuity Growth) and the Exit Multiple Method

How can you sanity check an EBITDA Exit Multiple used in a DCF?

By back-solving for the Implied Perpetuity Growth Rate to see if it is realistic relative to GDP

How do you back-solve for the Implied Growth Rate (g) from Terminal Value (TV)?

g=WACC−FCFn+1​/TV

Why can the terminal growth rate never be higher than the long-term GDP growth rate?

Because the company would eventually become larger than the entire economy

What is the typical range for a terminal growth rate in a mature economy?

2% to 3%, matching inflation or mature GDP growth

Stub Period

The time adjustment required when a valuation date does not align with the fiscal year-end

How does adjusting for a 'Stub Period' typically impact the Present Value (PV) of cash flows?

It increases the PV because the cash flows are received sooner than a full year from the valuation date

What does the Mid-Year Convention assume about the timing of a company's cash generation?

It assumes that cash is generated evenly throughout the year, rather than all at once at year-end

When using the Mid-Year Convention, what discount periods are used for years 1, 2, and 3?

0.5, 1.5, and 2.5

How is the Present Value (PV) adjusted for the Mid-Year Convention?

PV = CFn​/(1+WACC)^n−0.5

How does the Mid-Year Convention affect the final valuation compared to year-end discounting?

It increases the valuation because money received at month 6 is worth more than money received at month 12

When using the Mid-Year Convention with the Multiples Method, why is Terminal Value discounted by 'n' instead of 'n-0.5'?

Because the company is theoretically 'sold' at the very end of the final projection year

What is the reinvestment assumption built into the Internal Rate of Return (IRR) calculation?

It assumes that all interim cash flows are reinvested at the same rate as the IRR itself

Why might a professional use Modified IRR (MIRR) instead of standard IRR?

To set a more realistic reinvestment rate, such as the WACC, for interim cash flows

What is the fundamental difference between MOIC and IRR?

MOIC measures the absolute profit (cash-on-cash) regardless of time, while IRR measures the time value of that money

Why might a Private Equity firm view a 50% IRR deal as unfavorable if the capital was only deployed for 6 months?

The MOIC would be very low, meaning the absolute profit generated was small despite the high annualized return

Approximately what IRR does a 2.0x MOIC over 5 years generate?

15%

Approximately what IRR does a 2.0x MOIC over 3 years generate?

25%

Approximately what IRR does a 3.0x MOIC over 5 years generate?

25%

Approximately what IRR does a 3.0x MOIC over 3 years generate?

45%

What non-equity claim represents obligations to retired employees that are not fully funded?

Unfunded Pension Obligations

In the context of beta, why is a mining company naturally considered high risk?

Because its revenues swing wildly based on external factors like fuel prices and the broader economy (High Business Risk)

Walk me through Shareholder’s Equity Section

Common stock, additional paid-in capital (APIC), treasury stock, and retained earnings

Straight Line Annual Depreciation

(Asset Historical Cost − Salvage Value)/Useful Life Assumption

Which types of intangible assets are amortized?

Amortization is based on the same accounting concept as depreciation, except it applies to intangible assets rather than fixed tangible assets such as PP&E. Intangible assets include customer lists, copyrights, trademarks, and patents, which all have a finite useful life and thus amortized over its useful life.