Accounting

Question 1

What is Revenue formula and what are advantages of having large revenues?

Answer 1

Revenue = Units sold * Price

Adv. of large revenue:
1) Scale
2) Market share
3) Purchasing power
4) Lower risk profile
=> Premium Valuation

Question 2

What is SG&A?

Answer 2

Selling, General & Administrative expense.

Refers to all the “central” costs and includes expenses such as salesperson’s salaries and commissions, office payroll, executive salaries, etc.

(COGS is all costs directly related to the production of products and services: raw materials, direct labours, plant costs)

Question 3

What is EBITDA?

Answer 3

Revenue - COGS - SG&A

Considered a proxy of operating cash flow generation of a company

Serves as fair mean of comparison among companies in the same sector because it is free from differences resulting from:
1. capital structure (i.e. interest expense)
2. tax regime (i.e. tax expense),
3. accounting policy (D&A)

Question 4

When should you issue equity rather than debt?

Answer 4

• Already too much debt, wants to lower D/E ratio
• Company with predominantly intangible assets
• High growth (young company) or high volatility in CF
• Market signaling (mgmt expect earnings to decrease)

Question 5

How can you reduce your Debt / EBITDA ratio without increasing EBITDA or paying down debt?

Answer 5

1. Acquire a company with lower Debt / EBITDA
2. Convert Debt to Operating Leases

Question 6

What are implications and signalling of Cash Dividends vs. Buybacks?

Answer 6

1. Signalling of Cash dividends
   - Quality of earnings and confidence for the future
   –> Managers don’t increase dividends until they are confident that there will be sufficient cash flows going forward to pay them consistently
2. Signalling of Buybacks
   - Stock price is undervalued
   - One-off events, no commitments over long-term
   - Increase net debt (because we use cash), increasing tax shield

Question 7

How are dividends of a company announced? Absolute amount or other forms?

Answer 7

Company commits to payout ratio

Question 8

What is bullet debt?

Answer 8

When debt is not repaid until maturity

Question 9

What line item can be found in all 3 financial statements?

Answer 9

Net Income

Question 10

If a company changes its inventory accounting policy from LIFO to FIFO, how would that impact the three financial statements?

Answer 10

It would depend whether the cost of materials has been increasing or decreasing

1. If costs are increasing
   - COGS will decrease
   - Operating net income will increase
   - Tax expense will increase

• Net effect on cash is negative since invetory goes up

Question 11

What do you do if you understated depreciation by $100 and discovered the error in a period after the statements are issued? Use a tax rate of 35%.

Answer 11

1. P&L Effect:
   - Depreciation is a non-cash expense, however is tax deductible.
   - Therefore, Net Income decreases of $100* (1-0.35) = $65.
2. Balance Sheet Effect:
   - Liabilities: Shareholders Equity will decrease by $65, (Net Income).
   - Assets: PP&E will decrease by the new depreciation of $100.
   - Assets: A deferred tax asset is created = $35.
3. Cash Flow Statement Effect:
   - Cash Flow remains the same, because we are looking at the past we have created the deferred tax assets to balance the accounting equation (A 0 L + SE):
   - Net income goes down of $65.
   - Add back new depreciation of $100.
   - Take out $35 of deferred tax assets

Question 12

How can a bond’s cash payment and interest expense be different during a given period?

Answer 12

• The cash payment of a bond is equal to the face value multiplied by the coupon rate
• The interest expense of a bond is its market yield times the value of the balance sheet debt liability

Question 13

How do you convert operating leases to finance leases?

Answer 13

1. Calculate PV of the mini. operating lease payments at the current balance sheet date
2. Add the Lease obligation and the value of asset to the balance sheet
3. Adjust EBITDA, by i) removing rent expense, ii) add back the amortization and interest expense to find EBIT and Net Income
4. Adjust CF by removing the rent expense and adding back interest and amortization, classify repayment of debt obligation as financing

Trick: Rule of 8
=> Multiply the operating lease payments by eight in order to come up with an estimate of their value if capitalized

Question 14

You are the adviser of a local restaurant. The owner of the restaurant has had losses this year and asks you to figure out what’s causing the losses. How would you approach it?

Answer 14

I would use a Revenue/costs framework

1. Analyse whether the losses are driven by low revenue or high costs
2. Break down those into sub-areas (e.g. fixed vs variable costs, etc.).

Question 15

What’s the difference between Operating Income and EBIT?

Answer 15

Operating Income –> Includes non-recurring item

EBIT –> cleaned out version, what bankers use

Question 16

What is working capital? Can you explain the intuition behind it?

Answer 16

Working Capital = Current assets - current liabilities

Does not include cash because cash is non-operational

Represents financial needs to operate everyday operations of the business