Acct, Finance, Valuation

Question 1

What are the three main financial statements?

Answer 1

Income Statement (Revenues - COGS - Expenses = Net Income)
Balance Sheet
Assets = Liabilities + OE
Statement of Cash Flows
Beginning Cash +CFO + CFI + CFF =Ending Cash

Question 2

How are the three main financial statements connected?

Answer 2

Many Links:
Income Statement last line is net income. Net income is added to cash flow from operations of the cash flow statement. Beginning cash balance is cash from the balance sheet in the prior period. After Making adjustments to Net Income for non-cash items, the cash flow from operations, investing and financing, the ending cash balance becomes the cash on the current period’s balance sheet under assets. Net income (minus and dividends paid) flows from the income statement onto the retained earnings column of the balance sheet, causing the balance sheet to balance.

Question 3

Major Line Items of an Income Statement

Answer 3

Revenues
-COGS
GROSS MARGIN
-Operating Expenses
OPERATING INCOME
-Other expenses
-Income Taxes
NET INCOME

Question 4

What re the three components of the Statement of Cash Flows?

Answer 4

CFO
CFI
CFF

Question 5

What is EBITDA?

Answer 5

Earnings before interest, taxes, depreciation, and amortization. It is a good measure to evaluate a company’s profitability.

Question 6

EBITDA Equation

Answer 6

EBITDA = Revenues - Expenses (Excluding tax, interest, depreciation and amortization)
Rough estimate of free cash flow

Question 7

What is enterprise value?

Answer 7

Value of an entire firm, both debt and equity.

Enterprise Value = Market Value of Equity + Debt + Preferred Stock + Minority Interest - Cash

Question 8

If enterprise value is 150 and equity value is 100, what is net debt?

Answer 8

Enterprise Value = Equity Value + Net Debt + Preferred Stock + Minority Interests, So Net Debt is 50.

Question 9

Why do you subtract cash from enterprise value?

Answer 9

Cash is already accounted for within the market value of equity. Also because you can either use that cash to pay off some of the debt, or pay yourself a dividend, effectively reducing the purchase price of the company.

Question 10

What is valuation?

Answer 10

procedure of calculating the worth of an asset, security, company, etc. One of the primary tasks that investment bankers do for their clients.

Question 11

Valuation Methods - Comparable Transactions

Answer 11

1. Comparable companies.
   a. Average multiple from comparable companes( based on size, industry, etc), multiplied by the operating metric of the company you are valuing
   b. Most common multiple is Enterprise Value/EBITDA
   C) Other multiples include Price/Earning, PEG, EV/EBIT, Price/Book, EV/Sales

Different multiples may be more or less appropriate for specific industries

Question 12

Valuation Methods -Market Valuation/Market Capitalization

Answer 12

Market value of equity is only for publicly traded companies and is calculated by multiplying the number of shares outstanding by the current share price

Question 13

Precedent Transactions

Answer 13

need to find historical transactions that are similar to the transaction in question. (Size/industry/economic situation/) Once you find transactions that are comparable, look at how the companies were valued. Valuation technique will result in the highest valuation due to the inclusion of the “control premium” that a company will pay for the assumed “synergies” that they hope will occur after the purchase.

Question 14

Valuation Methods - LBO

Answer 14

firm uses a higher than normal amount of debt to finance the purchase of a company, the uses the cash flows from the company to pay off the debt over time. Many times they use the assets of the company being acquired as collateral for the loan.

Since a smaller equity check was needed up front due to the higher level of debt used to purchase the company, this can result in higher returns to the original investors than if they had paid for the company with all their own equity.

Question 15

Valuation Methods - LBO

Answer 15

firm uses a higher than normal amount of debt to finance the purchase of a company, the uses the cash flows from the company to pay off the debt over time. Many times they use the assets of the company being acquired as collateral for the loan.

Since a smaller equity check was needed up front due to the higher level of debt used to purchase the company, this can result in higher returns to the original investors than if they had paid for the company with all their own equity.

Question 16

What are some ways to value a company?

Answer 16

There are a number of ways to value a company. The most simple would be the market valuation, which is just the equity value of the company based on the public markets - this is simply the market capitalization of the company plus the net debt on its books to get to toal enterprise value. You can also use comparable company analysis, precedent transactions analysis, discounted cash flow analysis as well as a leverage buyout valuation.

Question 17

Which of the valuation methods will result in the highest valuation?

Answer 17

Precedent Transacation (control premium and a premium for synergies coming from the merger.

2. DCF (model will many times be optimistic in their projections.
3. Market Comps (Based on other similar companies and how they are trading in the market. No premium or synergies.
4. Market Valuation: How the target is being valued by the market. Just equity value, nor premiums or synergies.

Question 18

What is spreading comps?

Answer 18

Spreading Comps is the task of collecting and calculating relevant multiples for comparable companies.
Many times an analyst can simply pull the relevant multiples from a resource like CapitalIQ. However sometimes the analyst will research the company’s data and financial information in their annual/quarterly reports to make sure they have adjusted for non-recurring charges or irregular accounting across an industry which can skew multiples across comparable companies.

Question 19

Walk me through a DCF?

Answer 19

To begin, we would project the free cash flows of the company for about 5 years. FCF is EBI times 1 minus the tax rate, plus Depreciation and amortization, minus CapEx, minus the Change in Net Working Capital. Then you must predict the FCFs beyond 5 years, which is done either using a terminal value multiple or using the perpetuity method. To calculate the perpetuity you must establish a terminal growth rate which is usually around the rate of inflation or GDP growth ( low single digit percentage). Then multiply the year 5 cash flow by q plus the growth rate and divide it by your discount rate minus the growth rate. Now in order to do this you must have established a discount rate. For a discounted cast flow you use WACC as your discount rate, and discount all your cash flows back to year zero using that rate. The sum of the present values of all those cash flows is the value of the firm..

Question 20

How do you calculate terminal value?

Answer 20

There are two ways to calculate terminal value. The first is the terminal multiple method. To use this ethod, you choose an operation metric ( most common is EBITDA and apply a comparable company’s multiple to that mumber from the final year of proections. The second method is the perpetuity growth method. To use theis method you hoose a modest growth rate, usually just a bit higher than the inflation rate or GDP growth rate, in order to assume that the company can grow at this rate infinitely. We then multiply the FCF from the final year by 1 plus the growth rate, and divide that number by the discount rate (WACC) minus the assumed growth rate.

Question 21

WACC

Answer 21

is the percentage of equity in the capital structure times the cost of equity (which is calculated using the Capital Assets Pricing Model) plus the percentage of debt in the capital structure times one minus the corporate tax rate times the cost of debt(which is the current yield on their outstanding debt plus the percentage of preferred stock in their capital structure times the cost of preferred stock(if there is any pereferred stock outstanding).

Question 22

How do you calculate Free Cash Flow?

Answer 22

Free cash flow is EBIT times 1 minus the tax rate plus Depreciation and Amortization minus Capital expenditures minus the change in net workting capital.

Question 23

Why do you project out free cash flows for the DCF model?

Answer 23

the reason you project FCF for the DCF is the amount of actual cash that could hypothetically be paid out to lenders and investors from the earnings of a company.

Question 24

What is Net Working Capital?

Answer 24

Net Working Capital = Current Assets - Current Liabilities. It is a measure of how able a company is able to pay off its short term liabilities with its short term asets. A positive number means they can cover their short term liabilities with short term assets. If the number is negative, the company may run into trouble paying off their creditors which could result in bankruptcy if their cash reserves are low enough.

Question 25

Free Cash Flow if New Working Capital increases?

Answer 25

Since you subtract the Change in Net working capital in the calculation of Free Cash flow, if Net working capital increases, your free cash flow will decrease.

Question 26

What are the components of each of the items on the statement of cash flows?

Answer 26

Operations: Cash generated from the normal operations of a company.
Investing: Change in cash from activities outside normal scope of the business. Financing: Cash from changes in liablilities and shareholders’ equity including any dividends that were paid out to investors.

Question 27

What is the difference between the income statement and statement of cash flows?

Answer 27

Income statement records company’s sales and expenses. Statement of Cash flows records what cash is acutally being used and where it is being spent by the company during that time period.

Question 28

What is the link between the balance sheet and the income statement?

Answer 28

There are many links between the balance sheet and the income statement. The major link is that any net income from the income statement, after the payment of any dividends, is added to retained earnings. In addition, debt on the balance sheet is used to calculate the interest expense on the income statement, and property plant and equipment will be used to calculate any depreciation expense.

Question 29

What is the link between the Balance Sheet and the Statement of Cash flows?

Answer 29

Well, the beginning cash on the statement of cash flows comes from the previous period’s balance sheet. The cash from operations is impacted by the change in net working capital which is current Assets minus Current Liabilities. Deprecitation comes from property, plant and equipment which affects cash from operations. Any change in property, plant and equipment due to the purchase r sale of that equipment will affect cash from investing. Finally, ending cash balance from the cash flow statement is the cash balance on the new balance sheet.

Question 30

Why might their be multiple valuations of a single company?

Answer 30

Each method of valuation will each give a different value of a given company. The reason for these differences is due to different assumptions, different multiples, or different comparable companies and/or transactions. Explain differences for different valuation methods.

Question 31

How do you determine which of the valuation methodologies to use?

Answer 31

The best way to determine the value of a company is to use a compbination of all the methodologies and zero in on an appropriate valuation. If you have a precedent transaction you feel is extremely accurate, you can give that more weight. Valuing a company is as much of an art as it is a science.

Question 32

What is an IPO?

Answer 32

First sale of stock in a previously private company to the public markets.
Companies IPO fro many reasons, including raising capital, cashing out for the original owners and investors, and employee compensation.

Question 33

Primary Market

Answer 33

market an investment bank will go to in order to sell new securities (IPO/Bond issuance) before they go to market.

Question 34

Secondary Market

Answer 34

is the market that the security will trade on after the initial offering.