400Q 2025

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

Money depriciates with time.

3 things

1. you can invest money today

2. inflation will decrease the purchasing power of the money

3. if you lend someone money there is a risk that they may not return it back to you

For these reasons if you lock up your money elsewhere you expect to be compensated.

What does the discount rate mean?

The discount rate is the rate of return that the investor requires. It should also be the rate that the investor expects they can find else where for the same amount of risk.

Why is the discount rate higher if the potential returns are higher? Shouldn’t a company with higher potential retuyrns have a lower discount rate, makling it more valubale?

Having a higher discount rate implies that there is a greater risk or range of outcomes assoicated with an investment, so therefore the PV of the investment should be lower due to the uncertainty.

What is WACC

Weighted average cost of capital represents the cost of capital across both debt and equity

so you wopuld take % of equity in cap structure times the cost of equity and add taht with the % of debt in the cap strucutre and multiply that with the after tax cost of debt

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

So this is PV of a perpetuity. So at $100, w/ a discount rate of 10%, this comapny would be worth $1000.

A company generates $100 of cash flow today and its cash flow is expected to grow at 5% per year for the long term.

You can earn 10% per year by investing in other similar companies. How much would you pay for this company?

So this is a growing perputituity. Since cash flows begin today you can use the formula C + C / (r-g)

so we would have $100 + $100 / (1 - 0.5) = $2100 so the company is worth $2100

What does “Present Value” mean, and what makes it change? Hoed oes it differ from net present value?

Present value in the context of investing usually means what would some future cash flows be worth today. You would use a discount rate to modify the future cash flows to know what they would be worth today

It differs from net present value because in investing you want to know if the present value of your investment is greater that your initial / upfront investment

so NPV = PV of FCF - initial investment

What does the intenral rate of return IRR mean? How do you calculate it.

The internal rate of return (IRR) is the discount rate that makes an investment’s NPV equal to zero. If you invest $10 today, discounting the future cash flows at the IRR gives them a present value of $10.

For a bond, YTM equals IRR. It is the single discount rate that makes the present value of all future coupon payments and the principal repayment equal to the price you pay for the bond.

In other words, given the amounts and timing of those payments, what discount rate makes them worth your initial investment in today’s money?

What affects the IRR?

1) the timing of the cash flows 2) the size of the cash flows 3) the initial investment size

So you should be comparing the discount rate to IRR.

How do you use the IRR, Discount rate, and present valye to make investment decisions?

You compare an investment’s IRR with your required rate of return, which you use as the discount rate. If IRR exceeds that rate, the investment has a positive NPV, meaning its future cash flows are worth more in today’s money than your initial investment.

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

1. income statement, shows the profitablity of a company over some period of time

2. cash flow statement, shows a companies ability to generate postive cash flows in the 3 sections CFO, CFI, CFF

3. Balance sheet, shows the financial health and status of a company typically at the end of a period. Broken down into A, L, E

How do the financial statements link together?

1. Starting with the income statement, rev - expenses to arrive at net income

2. NI will flow into both RE on the balance sheet as well as CFO starts with NI, and makes adjusments for non-cash expenses, changes in NWC, and gain/loss/impairments releated to assets

3. The cash flow statement is connected to the balance sheet in the sense that it reconciles the net change in cash, and the balance sheet relfects the cash position at the end of the period

4. The cash flow statement is also connect to the balance sheet in the sense that reading the CFI section will show you the capital expenditures for a company during the year

5. The cash flow statement will also tell you about debt, equity issuances as well as dividends issuance

What's the most important financial statement?

Cash flow statement is argueably the most important, the buisness cannot operate without cash. Investors will not invest if the company is not liquid / cannot be cash flow postive in the future. So it is very fundamental that you know how much cash the company is burning and producing.

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.

Two examples that come to mind would be inventory and leases

So inventory IFRS prohibits LIFO accounting, it can overstate profit by reducing COGS in an inflationary enviornment. But U.S. GAAP allows both.

For leases, U.S. GAAP will record operating leases expense as a single operating cost. Under IFRS leases are treated closer to debt, with both depricaition and interest expense.

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

revenue recognition principle

Expense matching principle

So revenue is recorded in the same year that the co provided the good/service

Expenses are should be included on the income statement alongside the revenue that they helped generate

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?

Companies do this so that they can have cash on hand to provide / deliver the services as well as fund their day to day operations.

The cash flow impact is that there is a lot of cash up front that will get depleted while trying to earn the unearned revenue.

Why is AR an asset but deferred revenue a liability?

AR is an asset because it represents a future benefit. The company has provided a good/service on credit and they expect to recieve cash in the future.

Deffered revnue, the customer pays cash up front, and you have an obligation to providing the service / good.

What are deferred taxes and how do they affect the statements?

Deferred taxes arise from temporary differences between tax accounting and financial accounting. Some deductions reduce taxes today but result in higher taxes in the future, creating a deferred tax liability.

For example, a company might use accelerated depreciation for tax purposes and straight-line depreciation for financial reporting. This gives it larger tax deductions now but smaller deductions later.

The idea is that the tax benefit is temporary: the company delays paying those taxes rather than avoiding them altogether.

A junior accountant in your department asks about how to fund the company’s operations via externa sources and how they impact the fin statements. What do you say?

Company can be funded with the cash the co generates from selling services/products

Or the company can issue equity or debt to raise capital. Debt is intititall chapear but comes with the fixed payments and equity has no fixed payments however equity holders demand higher rates of return.

When issuing equity this will dilute existing equity holders and make their shares less valuable.

Your firm recently acquired another company for $1000 and created goodwill of $400 and other intangible assets of $200 on the balance sheet. A juniuor account in your dep asks you why your firm did this, how would you respond?

Ok so in this case the underlying business is worth $600, where $200 represents the intanbilge asssets like patents, copy right etc. things that can be measured in a quantitative manner. While $400 of goodwill is the accounting plug for the premium you payed to aquire the buinsess.

Explain lease accounting on the fin statements under IFRS 16 / ASC 842 including the differences between operating leases and finance leases

Under IFRS, most leases longer than 12 months are recorded on a company’s balance sheet as a right-of-use asset and a lease liability. Over the lease term, the company depreciates the right-of-use asset and records interest on the liability. Lease payments reduce the liability and cover the interest.

What’s the difference between DTA and DTLs. How do NOLs factor into this?

A deferred tax asset (DTA) represents a potential reduction in future taxes, not necessarily money the government owes the company. For example, net operating losses (NOLs) may be carried forward to offset future taxable income, subject to restrictions. A company recognizes the tax benefit as a DTA, subject to requirements about whether it can use that benefit.

A deferred tax liability (DTL) represents future taxes arising from temporary differences between tax and financial accounting. For example, using accelerated depreciation for tax purposes and straight-line depreciation for financial reporting creates larger tax deductions today but smaller deductions later. This reduces current taxes payable relative to the tax expense associated with accounting profit, creating a DTL.

Conversely, if depreciation is higher for financial reporting than for tax purposes, accounting profit is lower than taxable income. The company pays more tax currently, which can create a DTA if the difference reverses in the future.

How do you calculate FCF and what does it mean?

Free cash flow is the cash flow availble to all capital providers in the business.

CFO - Capex

It reporesents how much cash flow the co generates from its core buisness before repaying debt, paying dividends, repuchase shares, reinvest in the co etc.

Unlike UFCF it does not add back int payments which are already deducted in CFO

Maybe think about the differences between “Free cash flow” and UFCF, and FCFF

What is working capital and operating / NWC

Working capital is CA - CL and it tells you if the company can meet its current obligations to continue buisness.

There is another version which is operating working capital / NWC which is operating ca - operating cl, which will ignore non operational assets and liabilities namely cash and st investments

What does change in NWC mean?

So here you would compare the difference between the NWC at the end of a period and the beiging of period. To see if there was a increase or decr.

For an increase to happen Operating Ca would have to increase or operating CL would have to decr.

In both cases this would would represent a cash outflow in order to aquire more assets you would have to exchange cash, and to reduce you cl you would also have to exchange cash

And then vice versa for if there was a decr. in NWC

Big component of modeling FCF

It will tell you if the companyt needs to spend in advance of its growth or if it generates more cash flow as a result of its growth

In its filings a company states EBITDA is a proxy for its cash flow from operations. The company’s EBITDA has been postive growing at 20% for the past 3 years.

However the company recently ran low on cash and filed for bankruptcy. How could this have happened?

So yes EBITDA is a proxy for cash flow from operations but CFO also includes interest expense because that is baked into net income while EBITDA is earnings before interest, taxes and D&a.

So one possibility is that we have a very higher int. expense and we have a lot of debt outstanding right that is lowering our actual CFO.

Capex is also not included in EBITDA, but heavy capex will also reduce cash on the balance sheet.

How do you calculate return on invested capital (ROIC) and what does it tell you

Return on invested capital (ROIC) measures how efficiently a company turns the capital it has raised into profit. To calculate it, divide net operating profit after taxes (NOPAT) by average invested capital over the period:

ROIC = NOPAT / Average Invested Capital

NOPAT = EBIT x (1 - T)

Here, EBIT is earnings before interest and taxes, and T is the tax rate.

Invested capital is the total capital funding the actual operating business model so this would include debt + cs + ps - cash and the non operational assets.

ROIC shows how well a company uses all of its capital sources to generate profit.

What are the advantages and disadvantages of ROE, ROA, and ROIC for measuring company performance

To start of ROIC is capital structural nuetral, it focuses on all of the sources of capital in the business.

ROE, ROA are going to focus on returns to equity share holders

going deeper on ROE, this is NI / avg equity, and gives you an idea of how profitable the business is per $1 of equity, ROE is a general metric and is useful for comparing peer companies

Simmilar for ROA, this will tell you how much profit the business is generated for each $1 of assets the company holds on its balance sheet. ROA also an example where there is a mismatch since NI is a eqV numerator, yet assets could be funded with debt. So people also use NOPAT / avg Assets or EBIT / avg assets

ROA is a useful metric for asset intensives business say a co that has a lot of real estate for example, you want to know how profitable the company is for every $1 of land that it owns and compare that to its peers to see who is more efficient currently and for the foreseeable future

A company hires a new employee for a total cost of $100,000 a year walk me through fin statements assuming 25% tax rate

1. On income statement we are going to increase or SGA by $100,000 since we have incr. salaaries expense

2. This is going to decr. EBIT by $100,000

3. Then we tax it, so we have 100,000 less to tax so we get a 25,000 tax break here

4. NI decr. by 75000

1. On the statement of cash flows within the CFO we will start with a Ni that is 75k less, add back our non-cash expenses, changes in NWC as well as gains or losses on sales / impairments related to assets and our cash provided by op. act should be 75k less

2. no other important changes on statement of cash flows

1. on the balance sheet there are some changes we need to make here, first we need to update the cash postion to be 75k less

2. We need to update retained earnings since ni was 75k less so Re will be 75k less
   
   

At the end here we would have a 75k decr. in assets, no change in liabilites, and a 75k decr. in equity

so it balanes

You go into a job interview and the interviewer poitns out that every single interview guide has a questions about how d&A going up by $10 affects the statements.

How does a $10 decrease in D&A assuming 25% tax rate

1. starting with the income statement since we have a $10 decr. in our D&A expense EBIT will actuall increase by $10

2. Then we tax it at 25%, so we will pay and addition 2.5 in taxes here

3. NI will incr. by $7.5

Then moving over to the statement of cash flows within the CFO section

1. NI is 7.5 greater, then since D&A decr. by $10, we would subtract $10 here, to net an additional $2.5 of cash used in operating activies

2. So our cash postion should decr. by $2.5

Moving over to the balance sheet a few things we need to log here

line items that we need to update would first be our cash postion decr. by 2.5

update our accumalated depr. contra asset account so that it is $10 less / or update PPE

and update retained earnings, since our net income incr. by $7.5 so RE incr. by $7.5

in the end equity incr. by 7.5, liabilies remain unchanged and assets incr. by $7.5

A company’s CEO has decided to sell all of its assets, starting with a factory recorded at a book value of $100 on balance sheet?

The factory sells for $140, how do the statements change?

So this is a situation where you have a gain on sale of an asset

the JE would be debit cash for 140, credit PPE 100, credit gain on sale of an asset for 40

1. on the income statement you would record a 40 gain in other revenue/expenses

2. you would tax this at 25% so you pay an addition $10 in taxes

3. so NI is now $30 incr.

On the cash flow statement a few things need to happen

1. for CFO, ni is not 30 higher, then you dont have to add any changes in. D&a or changes in NWC, but then you need to subtract the $40 gain for cash provided on sale of an asset since we dont want to double count this

2. so in CFO we use $10 in cash

3. then in cash flow from investing, we are going to receive $100 for the book value of the asset so this represents an inflow of $140

4. nothing in CFF

So here we net $130 inflow in cash across all of the sections

Then finally on the balance sheet we have some line items to update

1. cash incr. by 130

2. PPe decr. by 100

3. RE is going to incr. by by 30

so here assets incr. by 30, liabilites no chagne and equity incr. by 30 and everything balances

Walk me through the financila statements when a customer orders a product for $100 and receives it byt hasnt yet paid for it. Then walk me through cash collection combining it with the first step. Ignore COGS and other deliver costs for simplicity

Ok so here we are providing a $100 good on credit

1. journal entry where debt AR for $100, credit inventory for $100

The in cash collection what will happen

income statement:

1. revenue is going to incr. by $100

2. expenses go unchanged

3. EBIT incr. by $100

4. tax rate of 25%, so $75 incr. to NI

Cash flow statement

1. CFO

2. start with ni that has a 75 incr., no non-cash add backs, change in NW, so AR incr. which means that we had to use cash to incr. our NWC, and AR incr. by $100, so CFO is going to be a net decr. of $25 of cash until we collect the cash

3. When we collect the cash, then we will simply just have $75 incr. in CFO

On the balance sheet

1. before we collec the cash our AR will be $100, our net cash postion will be -25, equity will be incr. by $75

2. After we collect the cash, ar will return to normal, our net cash postion will be $75 incr. and equity will still have incr. by $75

REST of ACCOUNTING PLACEHOLDer

What do eqV and EV mean

EV represents the entire business. It's roughly how much you'd have to pay to buy out both the debt holders and the equity holders, net of the cash you'd acquire.

Equity value is the portion of EV that belongs to common shareholders. It's their claim on the business after debt and other obligations are covered. Usually that makes it a smaller slice of EV, though it can be larger for a company holding more cash than debt.

Why do you need both equity value and enterprise value

Enterprise value (EV) is useful in M&A and for comparing companies. It shows what it would cost to buy the entire business, net of cash, regardless of how it's financed.

Equity value is useful for equity investors. Divide it by diluted shares outstanding to get the value per share.

What is the difference between current and implied EV? Can you give a real life example to explain it?

So current EV is what the business operations are currently worth today. You can find this out by using the balance sheet and an updated shares outstanding / share price

EV is mkt cap + net debt + pref stock + NCI

However implied EV would mean that you have done some kind of forecasting where you have projected out EBITDA and used an EV/EBITDA multiple, or you looked at comps set which implied that the co was trading at a discount or a premium

or you did a DCF and arrived at EV from discounting future cash flows

So it is what you think the business is worth

What is the difference between basic equity valyue and diluted equity value

basic eqV is basic shares outstanding share price, and diluted eqV is diluted shares outstanding times share price

diluted share count >= basic share count, since there are securities that can be converted to common shares, which will increase the share count and diluted the value of each of the shares

examples:

Treasury stock method
1. options ITM - TSM

2. warrants
   
   

convertibles new shares = face value / conversion price
Convertible bonds or debt

add directly

2. Restricted stock units (RSUs)

   1. performance stock units PSUs (simmilar to RSUs)

Lets say you have a compnays diluted equity value. How do you move from equity valyue to EV?

starting with eqV you would add net debt add pref stock add NCI to get to EV

The goal here is to remove the non-operational assets of the business, and to include the additional operating components of the business that do not belong to the equity share holders

Why do you subtract equity investments and add noncontrolling interests in EV?

Equity investments where the company does not have control are not an operating component of the business. However, if the company owns a controlling interest in another company, it reports 100% of that company's financials alongside its own. Naturally, if we are going to include their operations in our financial statements, it only makes sense to require buying out the remaining NCI in that company, so we truly own 100% of the financials of the subsidiary.

Can you explain the proper treatment of pensions in EV?

It depends if the assets to back the pensions exist on the balance sheet. For pensions that are unfunded you should treat this amount as debt. If contributuioibnns into the pension plan are tax deductable you should mutiply the unfunded priotion by (1-T) in Ev bridge

Should you add operating leases in the EV calculation? What about finance leases?

U.S. GAAP (operating leases)

Assume the operating lease is recorded as rent expense. Because the lease cost reduces EBITDA, the lease is not treated as debt, and it is not added to EV or net debt. (Technically, ASC 842 puts an operating lease liability on the balance sheet, but the valuation convention is to exclude it when EBITDA is stated after rent.)

IFRS (all leases)

Under IFRS 16, leases are treated as debt and the right-of-use asset is depreciated each period. The expense appears as depreciation and interest, so EBITDA is not reduced by rent. To stay consistent, the lease liability must be added to EV and included in net debt.

Finance leases

Finance leases are treated as debt under both U.S. GAAP and IFRS. They are therefore included in the net debt calculation in both cases.

Can you give examples of co actions that affect EV but not eqV anmd eqV but not EV?

Sure, to target EV, we need to increase equity and non-operational assets by a certain amount.

For instance, issuing shares for cash would increase equity and cash simultaneously.

To increase EV without increasing equity, we can modify net debt.

Issuing debt would result in cash inflow, but purchasing PPE would increase assets, liabilities, and equity. Therefore, issuing debt and then purchasing an operating asset is a viable option.

It’s generally easier and less restrictive to increase both equity and non-operational assets. For example, a growing company that receives cash for its goods and services can increase equity and then reinvest that cash in purchasing more inventory, thereby increasing both equity and EV.

Could equity value ever be negative?

No, eqV cannot be negative. Mathematically share count * price per share. It does not make sense to have a negative share count, nor a negative price per share.

The most an equity shareholder can lose is 100% of their invested capital.

However EV can be negative if the cash postion exceeds the value of eqV, then you would have a case where eqV + net debt is a negative number and EV could be negative there.

You are comparing companies A and B. Each operates in the same industryt with the same revenue, EBITA and other fin metrics. Co A is fin with 100% equity, and co B is fin with 50% equity and 50% debt

In theory should their EV be the same?

Debt in the capital structure may lower WACC, because debt is cheaper than equity and interest is tax deductible. But debt also adds interest expense and raises default risk. Equity investors may demand a higher return for that extra risk, or shy away from the stock, which can reduce equity value.

In theory these effects balance out. Equity value falls by about as much as net debt rises, so EV stays the same. In practice, many factors are at play, including taxes, distress costs, and how the market prices the added risk, so the balance is rarely exact.

A company issues $200 in CS. How do EqV and EV change?

for eqV we would increase eqV by $200, and we would incr. our cash which is a non operation asset by $200,

so eqV incr. by $200, net debt decr. by $200, so EV does not change (NOA - or net operating assets does not change because cash is not an operational assert)

This same company decices to use the $200 of CS isssuance procceeds to acquire anothe rco for $100 instead how does everything change?

1. $200 issuance incr. eqV by $200

2. incr. cash by $200

3. then we use $100 of cash to buy a operational business so NOA will incr. by $100

4. overall eqV incr. by $200, and net debt will decr. by $100, so we have a $100 incr. in EV

What if the o uses that same $100 from the $200 to acquire an asset rather then an entire co?

Assuming this $100 is a operation asset then nothing changes

if it is not an operational asset then eqV incr. by $200, net debt decr. by $200, and EV stays unchanged

A company issues $100 in debt to purchase a new factory. How do equity value and EV change?

So here cash will incr. $100, then we use $100 cash to purchase an operational asset, so net debt will incr. by $100

eqV remains unchaged, EV will incr. b/c eqV + net debt, and we had a $100 incr. in net debt so $100 incr. in EV

A company issues $100 of common stock and $100 of pref stock, and lets procceeds sit in cash? How do eqV and EV change?

Here we would incr. eqV by $100, net debt decr. by $100, so no change in EV

This same company now issues $10 in common dividends and $10 in pref dividends What happens in just this step?

so here cash decr. by $20, and equity decr. by $20, so eqv decr. by $20
since cash decr. by $20, net debt will incr. by $20, so EV remains unchanged

A company issues $50 of debt to buy a new factory however after this purchase its EV incr. by $100 rather than $50?

Your coworker claims it is because the company issued debt to make this purchase and debt incr. EV is he correct?

Case 1: equity value rises. The company issues 50 of debt, receives 50 of cash, and spends it on the factory. Net debt rises by 50. Investors expect the factory to raise future earnings and cash flows, so equity value also rises by 50. EV = equity value + net debt, so EV rises by 100.

Case 2: equity value doesn't change. Here net debt has to rise by 100 on its own. The factory costs 100. The company issues 50 of debt and uses 50 of cash already on the balance sheet. Debt is up 50 and cash is down 50, so net debt is up 100. EV rises by 100 with equity value flat.

A company purcashes $100 of inventory using cash, how do equity value and Ev change?

eqV is unchagned

net debt will decr. by $100, so EV decr. by $100

Now assume the inventory is sold for $200 and walk me through how the entire prices from beg to end affects equity value and eV?

So please show the work though right so we are going to basically earn $200 of revenue and cash, we had to decr. cash by $100 before, so $200 -100, is a net $100 incr. in cash

thus net debt is going to decr. by $100, while eqV is going to incr. by $100 due to revenue

So EV stays the same

A company has 200 outstanding shares at a current price of $10. It also has 50 options at an excercise price of $8 each. What is diluted equity value?

Ok so what we need to do here is the treasury stock method

so we have 50 otions, they are all itm 1- K/P, so 1 - 8/10 = 1/5

1/5 × 50 = 10

so we will have 200 + 10 = 210 diluted shares outstanding

so dilkuted eqV is 210 × 10 = 2100

A company has 10000 shares outstanding and a current share price of $20. It also has a 100 options at an excercioes price of $10, 50 restricted stock units RSUs, and 100 convertible bonds at a converstion price of $10, and a par value of $100

What is the diluted equity value

Options use TSM:

options n(1- K/P) = 100 * ( 1 - 10 / 20) = 50 new shares

RSUs, we just add 50 new shares

convertible bonds we use n(par value / conversion price) = 100 * ( 100 / 10) = 1000

so 1100 new shares are created

11100 shares in total times 20, so 222000 is eqV diluted

Public companies already have mkt caps and share prices. Why do you need to “value them” at all. You already know how much they are worth.

According to the efficient market hypothesis, yes. In practice, though, markets sometimes misprice companies, so the current market valuation doesn't always match the value implied by valuation methodologies. Those methodologies all depend, to some extent, on your own assumptions and views about the company's performance.

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

1. public comps, you are going to let the market / a consensus value a company according to what all of its peers are valued at using multiples, this can be challenging if the company is unique or does not have direct peers

2. Some type of intrinsic valuation methodology where you make assumptions and your own forecasts about what a company’s growth prospects might look like, and discount the future cash flows of the business back to present value, main disadvantge is sometimes assumptions can be arbitrary / loosely based on estimates

3. Precendent transations, you would look at how companies that sold in the past were valued, and use that as a baseline for what your peer company might be worth today, data is spotty, hard to find data and comparable precentdent transactions more difficult then public comps

Which of the 3 main methodologies will produce the highest implied values?

Typically out of all of the valuation methdoologies precendent transactions will produce the highes values due to the control premium

However I could choose a financial multiple that would drive up the valuation of the company w/ public comps or I could make generous assumptions in my DCF model to skew implied upside

Which one should be worth more a company with $500m EBITDA healthcare, or a $500m EBITDA industrials company?

If we are using a comps set, the multiples depend on which vertical the company sits in within each sector. Companies with higher growth prospects and lower costs of capital are typically worth more, and that lines up better with healthcare companies. So I would expect EV/EBITDA to be higher for healthcare.

With the main driver being the growth prospects in HC

Can you walk me through how you use public comps and precedent transactions in a valuation?

Is this referring to how you would build out a peer set?

So here the goal is to find a bunch of differnt companies which you can extract differnent financial multiples like EV/EBITDA or P/E and then use a measure of center to find a middle range of these multiples and apply it to your target company

Some things to consider here
industry, geography, general business model, margins, size etc.
For precentent transactions it is really important to I guess read the docs closely because transactions can be much more complex then using public comps

Can you give a few examples of how you might screen for “similar” comparable public companies and precendent transactions?

Ya geography industry and size, possibly time for precendent transactions right needs to be same busines s / interest rate environment

How do you decide which metrics and multiples to use in these methodologies?

EV/EBITDA is usually a favorite multiple because it is capital structure neutral. It accounts for differences in how the companies in a peer set fund themselves, so it works as a normalizer.

For equity investors, P/E is a big multiple because they want to know how much they are paying for $1 of earnings.

The way to decide is usually to research the general peer set and look at what their capital structures look like. You also look for anything unique about the business. For example, you would value an oil and gas company very differently from an internet startup.

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

Typically, you value a company based on its future growth prospects and the future cash flows that will belong to you.

Historical metrics, however, can give you an idea of the typical range for the company, based on financials that were actually reported and not just expected.

When calculating the forward multiples for the comparable companies, should you use each company’s current equity value or current enterprise value?

You can use both? you shoudl project the denominator. Never the numerator?

How do you interpres the public comps? What does it mean if the median multiples are above or below the ones of the company you are valuing?

if the median is above, then discount, if median is below then co is at premium

but this is just relative to its peers.

What is a liquidation valuation?

A liquidation valuation is the value of the business's assets after all liabilities have been accounted for. You assume the company sells all of its assets, pays back its debt and other liabilities, and distributes whatever remains to shareholders. That remainder is the liquidation value of the equity.

How does a dividend discount model differ from a DCF?

Sure so just to talk about the DDM a bit more

1. You are using the cost of equity to discount dividends.

2. The DDM will give you equity value directly which you will divided by diluted share count

3. DDM only really makes sense for large mature companies that are going to issue dividends ex. banks and issurers

   1. DDM model makes more sense where FCF is not meaningful / FIG

Why use an M&A premiums analysis?

You want to know how much it would cost to control another co.

YOu would want to estimate the premium a buyer would need to pay over the current share price for a public target

What are the advantages and disadvantages of the sum of the parts?

To start with advantages, lets say the business is very large and has differment business lines or segments that would be valued differntly. Using s SOTP will likely be more accurate since each of these segments might have a different cost of capital, and different risks associated with the buisness lines.

Some disadvantages would be that it requires more research to identify and “seperate” the parts of the co. The financial statements might seperate the revenue, but breaking up the entire balanace sheet can be more difficult or trying to seperate shared cost like admin.

How do you set up an LBO valuation, and when is it useful?

An LBO valuation is useful when you want to know what the “floor” of a company could be worth. Right it is the most a fin sponsor could pay.

1. here would would assume a purchase price, debt, and equity

2. project cash flows, debt paydown, and an exit value, solve for a price that delivers the sponsors target IRR

3. Useful when sponsors are likely bidders, and as a floor valuation, less useful for strategic buyers who have synergies. However not to go into the weeds but PE shops will do platform w/ addons

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

A valuation multiple is a ratio that compares a company's value to its earning power, usually measured by metrics like earnings, EBITDA, revenue, or free cash flow.

You use it to compare similar companies in a peer set.

Examples are EV/EBITDA and P/E. P/E compares the price, or what the company's ownership is worth, to earnings. EV/EBITDA compares enterprise value, which represents the value of the entire business to both debt and equity holders, to EBITDA, an earnings metric that excludes interest, taxes, depreciation, and amortization.

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

The growth prospects for the target company could be greater then the rest of the peer set. This would explain the premium multiple.

EBITDA could also be slightly depressed and expected to recover (this would reduce the denominator)

less risk then peers

or poor comps set

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

Top down: Revenue, minus COGS, minus operating expenses (SG&A, R&D, D&A), equals EBIT. Add D&A to get EBITDA.

Bottom up: Start with net income, add taxes EBIT = NI / (1-t), add net interest expense, and adjust for other non-operating items to reach EBIT. Add D&A to get EBITDA.

How do you decide whether to use eqV or EV in valuation multiples?

Choosing between them comes down to matching the numerator and denominator.

Equity value multiples, like P/E, use metrics after interest, so they reflect what's left for shareholders. Equity investors care about these because they tie directly to share price.

Enterprise value multiples, like EV/EBITDA, use metrics before interest, so they reflect the whole operating business to both debt and equity holders. Financial sponsors and strategic acquirers use them because they're buying the entire business and taking on its debt.

EV multiples are also better for comparing companies with different capital structures, since leverage doesn't distort the result.

A company has $100 of rev, 15% ebit margin D&A 5% of rev. The co eqV is $100, and has $20 of cash, $40 of debt, and $30 in lease liabilities. What is TEV to EBITDA?

So here we would we would get that EBIT is 15 + 5 of D&A so EBITDA is 20

Then EV = eqV + net debt in this case right

operating leases were already included in EBITDA so we can ignore them in net debt calcualtion

$100 + 40 of debt - 20 of cash = 120

so 120 / 20 = 6x

Now same company under IFRS. How would EBIT margin, D&A percerntages change, and how would the TEV / EBITDA change?

So if this company was under IFRS we would need to treat the lease liuabilites as debt.

So the first things that happens is that the rent expense before gets split into depr. which is the principal repayment. and then int. expense

Our EBIT would incr. slightly since derp. < rent exp., then we would add back D&A to get to EBITDA, so out EBITDA is a little greater

our EBIT margin will be greater as well so >15% here

then for the TEV calculation we will have eqV + net debt

so 100 + 40 + 30 -20 = 150, so TEV also incr. a bit

so I would expect that this change would keep EV/EBITDA about the same

What are adcantages of EV/EBITDA, EV/EBIT, P/E?

P/E is an equity value multiple, so it's most useful to equity investors who want to know what they pay for $1 of earnings. It's less useful for acquirers, because leverage affects it.

EV/EBITDA and EV/EBIT are capital-structure neutral. EBITDA also ignores D&A, so it avoids differences in depreciation policy, but it can overstate cash generation for capital-intensive businesses like manufacturers. EBIT accounts for asset wear through D&A, so it's better there.

They are like a specturm

EV/EBITDA does most normalization

EBIT caputures D&A and capital expenidture costs

P/E is affected by all of the financiang costs and is relevant for equity shareholders

A company is currently trading at 10x EV/EBITA. It wants to sell an operating asset for 2x the assets EBITDA. Will that transaction incr. or decr. the company’s EV and its EV/EBITDA multiple?

Will this incr. or decr. the EV/EBITDA multiple?

The rule is that the company's multiple moves toward the multiple of whatever you add or remove.

If you sell an operating asset at a multiple below the company's EV/EBITDA, the company's multiple increases. If you sell above it, the multiple decreases.

If you buy an operating asset with cash at a multiple below the company's EV/EBITDA, the company's multiple decreases. If you buy above it, the multiple increases.

This assumes equity value is unchanged.

What happens to the companys equity value and P/E multiple in this scenario

equity value remains unchanged unless we there was a gain / loss on the asset sale right.

But P/E will change, since our EBITDA decr. this means that EPS should decr.

and therefore P/E will be greater

How do you calculate and use UFCF and LFCF

UFCF = FCFF

starting with EBIT

need to get to NOPAT so EBIT ( 1 - t)

then from NOPAT add back non cash expenses like D&A, subtract incr. in NWC subtract capex

LFCF = FCFE

FCFF = UFCF - after tax int. - mandatory debt repayments + net new borrowing

if you discount UFCF that goes to everyone so EV using WACC

if you discount FCFF you will get eqV using K_e

Why use EBIT and EBITDA if value depends on cash flow?

EBITDA and EBIT are good proxies for cash flow and show how much the company earns from operations before financing and taxes.

EBITDA approximates operating cash flow, though it ignores taxes, interest, and working capital.

EBIT approximates operating cash flow after capex, assuming D&A is a reasonable stand-in for capex.

Given an example of a company change that affects UFCF but not EBITDA?

Capex is an example that is not included in EBITDA.

Suppose you are building a set of “global” comparable compaies ioperint in the logistics/delivery sector in the U.S., Europe and Asia. What is the saftest valuation multiple in this scneario?

EV/EBITDAR

U.S. GAAP operatin lease rents sit above EBITDA
IFRS leases are below it and treatest as debt

Why do you build a DCF analysis to value a company?

You build a DCF to value a company based on its projected growth and to value the company intrisndically independent of how the market prices similiar companies.

Walk me through a dcf analysis

build out a three-statement model

make some assumptions and forecasts about the financial statements of the co over the next few years

for phase one cash flows

1. each year you will start with EBIT, EBIT(1-t) to get to net operating profit after taxes

2. then add back D&A, and other non-cash expenses

3. subtract incr. in NWC

subtract gains, and add losses from the sale of assets / or impairments

less capex.

This will bring you to UFCF / could jsut say like compute UFCF for each period

then for each period you will discount the unlevered free cash flow back to PV using a discount rate (WACC)

phase 2

finally you might elect to use the Gordon growth method to find your terminal value

and then discount the terminal value back to present value.

You can take the sum of the PV of the phase 1 and 2 cash flows to get EV

reduce that to eqV, and then divide by diluted shares outstanding to bring you to an implied share price

run a sensitivity analysis on some of your assumptions such as WACC, terminal growth rate, or possibly even some of the revenue or margin assumptions.

How do you move from revenue to free cash flow?

Revenue

less cogs

less op expenses

brings you to ebit

subtract taxes: ebit * (1-t) = NOPAT

NOPAT

add non-cash expenses ex. D&A

less incr. in NWC

add or subtract gains/losses on asset /sales / impairments

less capex

= UFCF

How do you calculate terminal value in a DCF?

1. exit multiple method

2. gordon growth method

For the first one lets say you were using EV/EBITDA multiple.

You would take the final years EBITDA, times the multiple, to give you TV

for the second method you would turn the final years cash flow into a growing perputity

to this you would take the final year’s cash flow grow it at some lt growth rate, and then divide this by the discount rate - growth rate

so CF *(1+g) / (r - g)

The gordon growth method is more intrincic, but not always functional

Suppose you build a levered DCF instead of a unlevered dcf?

A levered DCF is differnt because this cash flow is the cash flow after financing costs have been accounted for so it iconsidered free cash flow to eequity

So what happens here is we would want to start at UFCF - intererest expense (1-t) - principal repayment + new borrowing

and then big picture things would be that adding the phase 1 and 2 cash flows will give you eqV directly, which you can divided by diluted share count

and the discount rate sould only be the cost of equity in this case

Will you get the same results from U dcf, and L dcf?

In theory the two methods give the same implied share price if the assumptions are consistent, but in practice they don't.

A levered DCF forecasts FCFE, so you have to build a full debt schedule to get year-by-year interest expense, debt repayments, and new borrowing, and you discount at cost of equity.

An unlevered DCF doesn't require that, because it uses UFCF and discounts at a fixed WACC, which assumes a stable capital structure. That's why the unlevered DCF is more common: it isn't affected by financing assumptions.

A client company plans to change its capital structure. Currenlt it has 10% debt / total capuital but what wasnts to increase this to 30%, claims taht if you use a unlevered DCF to value this company it wont be affected by capital structure?

Moving from 10% to 30% debt usually lowers WACC.

Debt is cheaper than equity, and interest is tax deductible, so the tax shield reduces the after-tax cost of debt. The cost of equity does rise because shareholders face more risk, which offsets part of the benefit, but at moderate leverage the tax shield wins, so WACC falls. Unlevered free cash flow doesn't change, so the higher valuation comes entirely from the lower discount rate.

I guess the thing to think about here is that adding debt to the capital structure, even though it's cheaper than equity, will make it riskier for the equity shareholders and how much more they'll demand to take on this risk? You have to determine if the tax benefit of adding the debt and getting the tax shield outweighs what the equity shareholder thinks.

The logic behind the main components of unlevered free cash flow? For example, why does it include changes in working capital but not net interest expense?

Unlevered free cash flow, or free cash flow to the firm, is the cash flow available to both creditors and equity holders. That's why it's calculated before financing costs like interest and debt repayments. The cost of financing is captured instead in the discount rate, which is the weighted average cost of capital. Including both would double count. Changes in net working capital are included because net income is based on accrual accounting, so the change in working capital converts accounting earnings into actual cash flow. An increase in net working capital uses cash, and a decrease frees it up.

What is the relationship between subtracting an expense and free cash flow projections, and the enterprise value to equity bridge at the end of a DCF?

Should you add back stock-based compensation to calculate free cash flow? It’s a non-cash add-back on the cash flow statement.

Yes, so stock-based compensation is a non-cash expense. So if you just think about the cash flow from operations section of the cash flow statement, you'd start with net income. You're going to add back depreciation and amortization, and then you'd add back stock-based compensation. And I guess the reason or intuition behind it is that you'd have to buy that stock on the open market. And then, you know, use your own cash.

What is the intuition behind the Gordon Growth Formula for terminal value?

Yeah, sure. I can explain the intuition behind the Gordon Growth Formula. So in a DCF, you have your first phase of cash flows where you individually forecast each's free cash flow. And then at a certain point, you can't really see into the future anymore. So you choose a reasonable long-term growth rate. You estimate a long-term growth rate. It's going to be a constant growth rate where you grow the last year of phase one cash flow at that constant growth rate into the future. And you can do this with an infinite series. There's a formula for growing perpetuity. And you'd use that to calculate terminal value. And then, of course, to complete the loop here, you would discount each of the phase one cash flows back to present value. You'd sum those to get enterprise value and you'd continue from there.

Do you use the multiples from public comps or precedent transactions when calculating a term using the multiples method?

I'd use trading comps. The exit multiple should reflect how the market values a comparable company as a going concern, and precedent transactions include a control premium, which would overstate a standalone value.

I'd build a peer set of similar companies, look at several multiples, and use the median EV/EBITDA, applied to the final year's EBITDA, to get the terminal value. I'd then cross-check by calculating the perpetuity growth rate implied by that multiple, to make sure it's reasonable. If the DCF were specifically for an acquisition in the future?, I might look at precedent multiples as well.

Applying a precedent transactions multiple to the terminal-year EBITDA means you're valuing the business at the end of the projection period (phase 1) as if a buyer were acquiring it, with a control premium (and possibly synergies) built into the price.

How do you pick the terminal growth rate when calculating the terminal value using the Gordon growth method?

So this should be in the ballpark of 2-4%. It shouldn't exceed the long-term growth rate for GDP growth. You can't outgrow the economy indefinitely. You can't have a company that's larger than the size of the economy. And I guess the one issue with this is that some companies will have a higher long-term growth rate for a while. So what you have to do for those companies is extend the projection. If you want to increase the valuation, maybe instead of doing like a five-year forecast, you do a 10-year forecast, and then you would apply your 2-4% long-term growth rate.

How can you check whether your terminal value estimate is reasonable?

Also, your terminal value should be somewhere between 60% and 80% of the total enterprise value for the company. So if it starts to get to 85% and definitely 90%, I'm starting to be concerned. Just because that means that the forecasting you did isn't all that important to the valuation. Most of the valuation is going to rest on a large long-term terminal growth rate or if you use an exit multiple. Also, in some cases where this is just a high-growth company, and especially for software companies when using an exit multiple, sometimes the multiples can get a little out of hand. So you kind of have to deal with that. You can just intuitively figure out what seems right. But the 60% to 80% is the right range.

does it ever make sense to use a negative fcf growth rate?

Yeah, it makes sense to use a negative free cash flow growth rate. Let's say the company is, you know, big and mature right now. Like newspaper companies are a typical example of this. And then they're shrinking. You can still use the Gordon growth rate or like the growing perpetuity and use a negative growth rate in that. So you would expect free cash flow to slowly approach zero. In reality, if this is a shrinking business, eventually, you know, they're not going to stay in business for all time. At some point, I would think that they would close up shop. So you might want to go pick, you know, like a set end date or something like that. But I guess for valuation purposes, this does make sense.

Explain how you deal with leases and lease accunting in a DCF?

First I check whether the company reports under US GAAP or IFRS, because that changes the lease treatment.

Under US GAAP, operating leases are a single rent expense in operating expenses, so the full lease cost reduces EBIT.

Under IFRS 16, leases are treated like debt. EBIT only includes depreciation of the right-of-use asset, and the lease interest sits below EBIT.

Either way, I start at EBIT and tax it to get NOPAT, which excludes interest. Then I add back non-cash items like D&A, subtract the change in NWC and capex, and remove gains or losses on asset sales to get unlevered free cash flow.

Under IFRS, the lease payments (principal and interest) are financing flows, so they aren't deducted in FCF. Instead, I treat the lease liability as debt when bridging from enterprise value to equity value.

What are some warning signs in a DCF?

A very high TV that makes up 80%+ of the EV, is a warning sign that your LT growth assumptions or exit multiple may be too high and oyu need to increase the forecast period

Making assumptions purely off of historical averages rather then understand the underlying trends

Capex falls below D&A in the terminal year while growth continues?

Small changes in WACC or growth swing the valuation wildly