All Qs

Question 1

Metrics:
1) cash flow proxy
2) credit
3) returns based
4) cash conversion
5) liquidity

Answer 1

1) EBIT (operating income - non-recurring charges ie. write-downs, impairments) -> FCF (CFO - capex): doesn’t include taxes & interests, includes D&A from previous capex, so partial capture of capex
EBITDA -> CFO: does add back D&A, but doesn’t factor interest & taxes
EBITDA vs UFCF: doesn’t factor taxes and doesn’t take into account capital intensity (delta NOWC and capex)
2) leverage ratio (total debt / EBITDA), interest coverage ration (EBITDA / interest expense)
3) return on equity (RoE) net inc / avg equity, return on Assets (RoA) net inc / avg total assets go from 1 to other using A = L+E, ROIC (return on invested capital): NOPAT / average invested capital -> equity + debt + preferred stock + other LT sources of funding
NOPAT = EBIT * (1- tax rate) -> income available to “all” investors after taxes (excludes net interest exp & preferred dividends)
4) days sales outstanding (DSO = 365AR / Rev ), days inventory outstanding (DIO = 365inventory / COGS ), days payable outstanding (DPO = 365*AP / COGS ), Cash conversion cycle: DIO + DSO - DPO
5) current ratio = CA/CL ->
quick ratio = “quick assets”/CL = (Cash + AR + Cash eqs)/CL liquid assets vs liabilities

Question 2

Operating Inc. vs EBIT

Answer 2

They are the same only if the firm doesn’t have non-operating income or non-operating expenses. For example, if the firm earns dividend income, that would be in EBIT but not operating Inc or if the firm has for ie write offs.

Question 3

Operating As and Ls (for operating working capital vs working capital)
Examples of non-operating assets?

Answer 3

Net OWC = OCA - OCL -> OCA=AR+Inv+Prepaid Exp. OCL=AP+Accrued Exp.+Deferred Rev
Net Working Capital: factor in cash/cash eqvs and ST portion of debt (CA - CL)

Extra non-operating assets: side businesses, discontinued operations, rental properties, assets held for sale, net operating losses

Question 4

What non-cash items are not deductible for cash-tax purposes?

Answer 4

SBC, Amortization, Write-Downs and impairments if change -> change to DTA -> if tax schedule > taxes on income statement, DTA goes up, as tax schedule is what is actually paid -> reverse deferred inc. taxes on CFOs, as we paid extra taxes vs what the Inc. St. says AND reverse the change in non cash account
Dep. and G/L of PP&E sale are deductible so if there’s a change -> cash changes

Question 5

How to calculate EV?

Answer 5

2 ways:
1. discounted cash flows analysis of free cash flows
2. Market equity + Debt + preferred stock + NCI - Cash/Cash eqs.

Question 6

What are the 3 statements?

Answer 6

IS: measures revenue and expenses over a period of time, giving us net income on the final line as after tax profits
CFS: measures movement of cash over a period of time for a company’s operating, investing and financing activities; shows us generation and uses of cash
BS: snapshot of a companies financials. Show the company’s resources (assets), it’s obligations (liabilities) and shareholder’s equity. A = L + SE

Question 7

What are retained earnings?

Answer 7

The amount of profit a company has left over after paying all its direct costs, indirect costs, income taxes and its dividends to shareholders

Question 8

How do the 3 statements link together?

Answer 8

1. Everything on IS affects Net income, which flows into 2 spots, 1. top of line of CF statement 2. into retained earnings on the BS.
2. Changes in BS items appear on the CFS. working capital changes and non cash expenses in the operating section. For financing and investing sections, other BS accounts are involved such as debt, PPE & SE.
3. The net change in cash from the CFS gets added to the BS sheet’s last period cash, creating this period’s cash.

Question 9

What’s the most important financial statement?

Answer 9

Use the CFS because it tells us the about cash generation/consumption of a business,

Balance sheet is just a snapshot, doesn’t tell us how the company is operating

IS has non cash revenues/expenses, so data could be misleading

Question 10

If you had to choose 2 statements?

Answer 10

IS + BS, can build the CFS from there. Would have some ambiguity ie. split of capex & depreciation
Could use CF + IS if we have starting BS items

Question 11

3 major valuation methods?

Answer 11

1. precedent transactions
2. public comparables
3. discounted cash flow
   if anything else:
   LBO, 52 week trading range
   anything else:
   liquidation value
   DDM

Question 12

What is a DCF?

Answer 12

DCF is an intrinsic method of valuation (vs relative)

Question 13

What is a deferred tax asset/liability? Give examples

Answer 13

1) When a company has paid more for taxes due to tax accounting then what taxes look like on the income statement -> warranty expense, not tax-deductible until warranty work has been performed -> will reduce net income, but not tax accounting taxes owed, so create a deferred tax asset (you owe fewer taxes)
2) when a company has paid fewer taxes due to tax accounting then what the income statement says -> accelerated deprecation for tax accounting vs straight line for IS -> will pay fewer taxes, so create deferred tax liability (you owe more taxes)

Question 14

Why are preferred dividends on the IS?

Answer 14

IS is available to common shareholders, preferred dividends reduce earnings available to common

Question 15

A, L E definitions

Answer 15

A: resource that will provide future benefit or can be turned into cash
L: 3rd party claims on the assets of the firm and are obligations that the company has
E: owner’s claim on the assets of the company

Question 16

What is an intangible asset? What is goodwill?

Answer 16

1. An asset that doesn’t have physical substance (ie goodwill, trademarks, patents,etc..)
2. goodwill is the amount paid above the fair market value for a company, (FMV is if sold in open market)
3. new intangibles are not tax deductible, subtract the tax diff -> create positive DTA, doesn’t actually decrease taxable income on income statement

Question 17

Enterprise value?

Answer 17

intrinsic value designed to represent the entire value of the company’s operations to all investors

Question 18

Go from IS to CFS?

Answer 18

Net Income + non-cash expenses (D&A) - change in WC +/- non-operating loss/gain (PPE)
- change in WC:
1) add: decrease in assets, increase in liabilities
2) subtract: increase in assets, decrease in liabilities

Question 19

Accretion & Dilution, what to think about?
If you get debt/cash/equity split, what to do?

Answer 19

1.Buyer’s cost of acquisition (1/ (P/E) ) seller/target’s yield (1 / (P/E) )
2. If 100% stock, then accretive if Target has lower P/E
Q2:
1. Use the equity purchase price (if includes premium)
2. Ask for pre-tax cost if not given, calculate post tax cost
3. Get WCA (weighted cost of acq.) by weights of split
4. Compare WCA to target’s yield
Remember:
P/E = price/share / earnings / share = price/earnings = equity/net income thus for target’s cost -> net income / equity (or purchase equity value)

Question 20

How to calculate weights for WACC?
How accretive/dilutive?

Answer 20

1. cash: assume 3% then get post-tax rate: 3%*(1-t)
2. debt: get date rate post-tax: pre-taxrate*(1-t)
3. stock/equity: 1 / (P/E) of buyer, already post tax as earnings are post-tax
4. if all equity, the stock issuance says how many extra shares were issued -> target + buyer Net Inc / total new shares of buyer
5. check to see how much extra is needed to be accretive, remember affect of taxes
6. if other funding methods, take into account in net income ie. take out interest expense, add synergies -> make sure to consider tax placement

Question 21

How to calculate diluted EPS?

Answer 21

Net Inc. - Pref Divs / (Performance Shares (stock app. rights have target metrics, not public, add all) + common shares + convertible bonds (if SP>conversion price, convert all to shares) + options (calculate from strike # new shares) + warrants (same as options) + RSU (just use number) + )

Question 22

Convertible bonds?

Answer 22

Lower interest rate than debt, bondholders can convert their bonds into new shares given a certain conversion price, usually get all principle back if conversion price isn’t reached.
If SP > conversion price, convertible bonds are debt and are added to debt for EV

Question 23

What is a capped call transaction?

Answer 23

company purchases call options on its own stock, with strikes at the conversion price of convertible bonds, and then sells its warrants on its own stock at a higher price.
If SP reaches conversion price, convertible bonds create new shares, which the company they buys back via their call options, cancelling dilution
If SP keeps climbing, and reaches warrant exercise price, new shares will be created, but less than the amount of shares temporarily created from convertible bonds

Question 23

Why use multiples and what are they?

Answer 23

Similar to when comparing housing prices and Price / sq ft. to be able to compare properly. Companies compared must still be somewhat similar ie. comparing pre-revenue biotech vs large manufacturer with multiples makes no sense
EV/ Rev or EBITDA or EBIT & P/E or PpS/EpS
company value or price related to its profit, or sales
Opex vs CapEx, Rent/Lease Expense, Interest, taxes * non-core business activities -> think about which metrics includes what

Question 23

What is treasury stock method?

Answer 23

Calculating diluted shares for warrants and options by calculating the impact of non-exercised ITM warrants & options.

Question 23

EV and pensions?

Answer 23

unfunded pension gets added to get EV: (Pension Ls - Pension As)*(1-tax rate) other costs of the plan should be excluded ie. expected return, amortization, etc.. that show up on IS. ONLY “service cost” should be included.
essentially this is employee funding, they act as investors, they accept lower salaries today for pension payments in the future

Question 24

Current vs implied EV

Answer 24

current is based on market equity, implied is directly valuing business operations
then we can get implied Eq vs current (or market) Eq using implied EV

Question 24

TTM (LTM) and forward multiples, what to use?

Answer 24

Always use current EV, assuming companies are growing, further forward multiples should be lower than current or trailing

Question 24

NOLs for EV?

Answer 24

“Non-operating”, not necessary to run the business,

Question 24

Pensions: defined-benefit plan vs defined-contributions plan

Answer 24

benefit: company sets aside $ and promises to pay employee in future.
usually tax deductible.
contributions: responsibility of employee (the company match only shows up on IS in op exps, not on BS)

Question 24

FCF? UFCF? LFCF?

Answer 24

FCF: CFO - capex, how much cash does company generate after interest but before debt principal repayments ie. company could repay debt, acquire a co, issue dividends, repurchase stock etc…
UFCF: EBITD*(1-t) + D&A - NOWC - capex how much discretionary cash does a company generates, available to all investors
LFCF: Net Income + D&A - NOWC - capex - Net Mandatory Debt Repayments how much discretionary cash does a company generates, after servicing all of its debt related expenses

Question 25

Are capital leases included in EBITDA? What to do with in EV?
Operating lease?

Answer 25

debt-like items, used to acquires equipment, property, factories and other PPE.
there are interest expense and depreciation associated with corresponding asset
Thus, not included in EBITDA
Added to the other side of EV equation, because debt-like and for multiples consistency.
Operating lease is a normal IS line expense item, no need to include in bridge to EV. For capital leases, principal repayments decreases Op Lease A and L every year. Only include if using EBITDAR, where leases are added back.

Question 26

What to do with NOLs in EV? What about DTLs?

Answer 26

Subtract from both sides of the EV acct equation, as non-operating assets, not required to sell and delivery products/services vs other components of Deferred tax asset (ie. SBC, lease liabilities)
Remember to adjust NOLs via valuation allowance, same as accounting exam, if net income is expected to be heavily negative going forward, take a write-down
DTLs correspond to timing differences, that will reverse in the future, not an investor group so not part of the bridge to EV from Eq.
Similarly, part of DTLs are from temporary differences and thus don’t get subtracted.

Question 27

Interest + Dividends Paid/Received on CFS

Answer 27

CFO: interest paid, interest received, dividends received
CFF: dividends paid

Question 28

3 ways of calculating UFCF?

Answer 28

1) EBIT(1-t) + D&A - NOWC - capex
2) (EBITDA-D&A)(1-t) + D&A - NOWC - capex
3) CFO - (reverse Interest expense and items between operating income and pre-tax income)*(1-t) - capex

Question 29

Valuation methodologies?

Answer 29

Public Comps:
pros: real data, less assumptions of future, quick to calc
cons: sometimes few comps, less accurate for volatile stocks, market might be wrong, only takes into account financials

Precedent Transactions:
pros: few assumptions on future, based on what companies have paid, also quick to calc, may show industry trends better than comps
cons: data can be limited, few precedents, specific market conditions can affect, value to the buyer specifically

Discounted Cash Flow Analysis:
pros: less subject to current market conditions/trends, finance theory argues for it, reflects company specific factors
cons: highly dependent on future assumptions, time consuming to be accurate, some disagreement on calculations ie. cost of E

Question 30

Lever vs un-lever beta, what not to forget?

Answer 30

Tax-rate:
Levered Beta = Unlevered Beta * (1+ Debt*(1-t)/Equity)
so if tax rate changes, it changes cost of debt AND cost of equity

Question 31

Comp & comps vs Precedent Transactions

Answer 31

1) screening: use time and transaction size
2) historicals, hard to find projections after deal announcement
3) calculations: all based on purchase price
4) output: higher than public comps due to control premium

Question 32

SBC in equity bridge?

Answer 32

Do not add back, treat as a cash expense. Accounting diff in CFO vs valuation, and not a true non-cash exp. as it creates additional shares and dilutes investors. If we take out, we need to dilute equity.

Question 33

Why use EPS in thinking about an acquisition?

Answer 33

Reflects all effect of an acquisition: foregone interest on cash, interest paid on new debt, and new shares issue to fund the deal
For a transaction: price paid for target must be reasonable and decent chance of being neutral or accretive to EPS.

Question 34

Why to M&A?

Answer 34

1) consolidation/economies of scale
2) geographic expansion
3) gain market share
4) seller is undervalued
5) acquire customers or distribution channel
6) product expansion or diversification

Question 35

“real” m&a purchase price

Answer 35

target’s purchase eq + transaction/financing fees - target’s excess cash

Question 36

What to do with DTA DTL in m&A?

Answer 36

usually write down both, temporary items that reverse “eventually”, must reverse on deal close.
Because of write-up on assets (PPE or intangible assets), and write-ups are not deductible for cash tax purposes, this will create DTL. Include indefinite lived intangibles, as they will eventually be written down.
D&A from write-ups is NOT cash deductible, so DTL will slowly reverse over time.

Question 37

Seller goodwill, what happens to it?

Answer 37

Gets written-off (aka cancelled) because it has a FMV of 0.

Question 38

private acquisition

Answer 38

target has to pay down all debt before deal closes, so if debt>cash, it uses cash to pay down, then uses part of purchase price to pay rest of debt, before remaining of purchase price goes to Eq
if cash>debt, pay down debt, then distribute excess cash to shareholders
essentially, the purchase price of private is the enterprise value, and we get to equity purchase price value 106

Question 39

Earn-out and where to record?

Answer 39

Goes under Liabilities as a “contingent consideration”, when a buyer pays X and says, if you hit A metric, we’ll give you an additional Y. Earn outs do NOT affect cash taxes, are non-cash adjustments, and
Buyer adjusts the value of an earnout over time, records changes on IS and the adds back non cash and creates DTL/DTA
Earn-out will increase goodwill so as to balance

Question 40

Tender offer?

Answer 40

buyer proposes price directly to shareholders, and they vote whether to sell or not.
in a merger, the board of directors of seller agree with BoD of buyer on a price, then have the vote go through shareholders

Question 41

Stock vs Asset purchase

Answer 41

Stock: buyer purchases all seller’s shares outstanding and gets all A, L and off-balance sheet items
Asset: buyer purchases only selected assets and assumes only selected liabilities. D&A on asset write-ups can be deducted for cash tax purposes unlike stock purchase, NOLs are used -> equity purchase price * highest of L3M adj. LT rate = NOLs you can use / year

but, for Asset, seller shareholders mst pay taxes on purchase price + gains on its net assets, and buyer can’t use seller’s NOL as they are written down 100% after deal closes

so, sellers prefer stock, 1) as shareholders pay taxes only on purchase price,
2) less post transaction risk, everything is acquired
3) faster to execute, no need to specify treatment of every A & L

compromise: 338(h)(10) election, treat stock purchase like asset purchase: everything is bought:
1)buyer can count D&A on asset write ups for cash tax purposes
2)same for goodwill and intangibles
3)NOLs still cannot be used

If there is a HUGE NOL balance, both parties would prefer stock purchase, if not, compromise 338(h)(10) election or asset purchase

Question 42

Issuing a dividend vs. share buyback?

Answer 42

-tax reasons: individual investors have to pay income tax on their dividends + capital gains
-buyback -> signal to market

Question 43

Market or book values for equity to EV bridge?

Answer 43

Use market value of the items, if not, book values are okay except for equity value. For a distressed firm this is particularly important, as items could be worth a lot less than BV.

Question 44

Why do an acquisition?

Answer 44

1) sellers’s asking price > implied value
2) expected IRR > buyer’s discount rate
can use:
qualitative analysis (products, customer base, geographies, etc.)
quantiative: EPS accretion/dilution, could do valuation of seller to see if undervalued and compare IRR/buyer discount rate

Question 45

If you own 20-50% (say 40%)?
If 51-99%
Under 20%?

Answer 45

1) don’t consolidate statements. on IS, below net income, have Net Inc attributable to equity interests which with Net Inc sums up to Net Inc attributable to parent, on CFS, take out that 40% as you don’t have that cash, then on BS, investments in equity interest 40% (this is an asset) and RE up by that 40% as well aka Net inc to parent

2) IS reflects 100%, so have line item - Net income attributable to NCI BEFORE Net income line, CFS add back the diff so no change in total cash, as you control the cash, BS, add the NCI portion to SE, as it was taken out on IS

3) treated as a security from assets

Question 46

Eq value & EV negative?

Answer 46

current Eq: can NOT be negative, base don shares outstanding * current price
implied Eq: yes, if EV is close to 0 and has net debt or if has EV but very large cash and low debt
current EV: yes, cash that is higher than current eq + debt
implied EV: yes, company not performing well, could have negative UFCF from very large capex

Question 47

accretion vs dilution what does it not account for?

Answer 47

short term focus
opportunity cost different deal investment

Question 48

Goodwill formula

Question 49

PE multiples

Answer 49

for doubling money:
1Y 1
2Y 1.41
3Y 1.25
4Y 1.19
5Y 1.15
6Y 1.12
7Y 1.10

2x multiple in 3Y: 25%IRR
2x multiple in 5Y: 15% IRR

3x multiple in 3Y: 45% IRR
3x multiple in 5Y: 25% IRR

Question 50

Finance lease:
Operating:

Answer 50

1. Create asset + liability from PV of payments
2. Cash is fixed paid monthly
   find interest expense, depreciation and lease principal repayment
3. IS expenses: sum of depreciation + interest exp. (discount rate * lease liability)
4. Asset decreases by fixed depreciation
5. Liability decreases by: lease principal repayment = cash payment - interest expense
   IS expense will start higher than go lower

operating:
find interest expense and lease principal repayment
cash payment = rental expense on IS
depreciation = lease principal repayment = cash payment - interest expense, not on IS, but decreases L & A every year