BIWS - 400 Questions; Basic Flashcards
Walk me through the 3 Financial Statements
Income Statement: revenues/expenses and taxes over a period of time. Starts w/ Revenues & expenses, ends w/ Net Income.
Cash Flow Statement: cash inflows/outflows over a period of time. Starts w/ Net Income, adjusts for non-cash expenses & working capital changes, lists CFs from investing & financing activities, ends w/ net change in cash.
Balance Sheet: company’s resources (Assets) and how it paid for those resources/what it owes (Liabilities, Equity). Assets = L + SE.
Examples of major line items from each financial statement?
Income statement: Revenues, COGS, SG&A, Operating Income, Pre-Tax Income, Net Income
CFS: Net Income, Depreciation & Amortization, Stock-Based Compensation, Changes in Operating Assets & Liabilities, CF from Operations, CapEx, CF from Investing Activities, Sale/Purchase of Securities, Dividends Issued, CF from Financing
BS: Cash, Inventory, Accounts Receivables, PP&E, Accounts Payable, Accrued Expenses, Debt, Shareholders’ Equity
How do the 3 financial statements link together?
Net Income (to common) from the IS flows into the top line of the CFS and into the CSE of the BS.
CFS: Changes to BS items appear as Working Capital changes on the CFS and investing and financing activities affect BS items such as PPE, Debt, SE.
Bottom of CFS - Net change in Cash - flows into top line of BS (Cash) & SH.
If you were stranded on an island & only had 1 statement to review overall health of a company - which financial statement to use?
Cash Flow Statement - shows actual cash inflows/outflows of the company; how much cash the co is ACTUALLY generating, independent of non-cash expenses. Cash flow is the most impt thing you care about when analyzing financial health of a co.
If you can only look at 2 financial statements of a co - which would you use?
The IS & BS. Can construct the CFS from these 2 states. Make adjustments from bottom of IS based on non-cash expenses, make adjustments for WC changes based on the BS items. (Assuming you have before/after BS that corresponds to same period as IS).
How would Depreciation going up by $10 affect the statements?
IS: Increase in depreciation (non-cash expense) –> decreases Operating Income –> decreases pre-tax income. –> assuming tax rate of X, decreases net income by 10 * (1-tax rate)
CFS: Net income decreases (from bottom of IS #) –> add back $10 depreciation to net income –> overall CF from Operations increases ==> net change in Cash increases
BS: would decrease PPE (asset) by $10 (b/c of Depreciation); Cash is up by $X - from changes on CFS. SE (equity side) is also down by difference from Assets side –> both sides balance
Depreciation - why does it affect cash balance, if it is non-cash expense?
Depreciation is tax-deductible. Increase in depreciation = decrease in pre-tax net income => affects cash balance b/c decreases amount of taxes paid & taxes ARE a cash expense
Depreciation - where does it usually show up on an IS?
Can be separate line item or imbedded w/in COGS or Operating Expenses. Each co does it diff, but regardless: depreciation always decreases pre-tax income
Accrued Compensation - what happens if it goes up by $10?
Step 1: Confirm Accrued comp is now being recognized as an expense.
IS: Operating Expense increases by $10. Assuming Tax Rate if 40%, Net Income decreases by $6.
CFS: Net Income decreases by $6. Accrued Comp will increase CF: add back $10. Overall CF from operations is up $4 –> Net change in cash = increase by $4.
BS: Accrued Compensation increases -> Liability increases by $10, CSE decreased by $6. Cash (asset) increased by $4, so it balances.
Inventory - what happens if it goes up by $10, assuming you pay for it w/ cash?
Assuming it hasn’t been delivered yet to customer:
IS: NO CHANGE!
CFS: Inventory (asset) decreases CF from Operations by $10 –> Net Change in cash decreases by $10
BS: Inventory increases by $10, Cash decreases by $10. Both sides balance bc charges cancel on Asset side.
Why is IS not affected by changes in Inventory?
Expenses are only recorded when the goods associated with it are sold. (B/c of criteria 1 to show up on the IS: has to 100% match the same period)
Inventory does not show up on IS (not recorded as a COGS or Operating Expense), until it is used by the company in manufacturing a product and sold.
(INITIAL DEBT ISSUANCE) PART 1: Apple is buying $100 of new iPod factories with DEBT. How are all 3 statements affected at the start of Year 1, BEFORE anything else happens?
IS: No change. Debt will last many years, so does not correspond 100% to that period.
CFS: Additional investment in factories would show up under CF from Investing –> reduces CF by $100. But, debt raised would show up under CF from Financing –> increases CF by $100. So, no change to net change in CF.
BS: Assets increase by $100 (PP&E), but Liabilities also increase by $100 (Debt). So it balances.
(INTEREST EXPENSE & DEPRECIATION ex): Apple is buying $100 of new iPod factories with DEBT –> go out 1 year to the start of YEAR 2. Assume the debt is high-yield, so no principal is paid off, and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens?
IS: $10 Depreciation Expense recorded. $10 Interest expense also recorded under Non-Operating Expenses. –> Leads to a $20 decrease in Pre-Tax Income. Presuming a tax rate of 20%, Net Income would be decreased by $16.
CFS: Net Income decreased by $16. But, add back depreciation expense of $10 (b/c it is a non-cash expense). Overall, net change in cash = decreased by $6.
BS: Cash decreases by $6. PP&E decreases by $10. So overall, assets side decreased by $16. On L&E side, CSE decreased by $16 (flows in from Net Income). So, BS balances.
(WRITE DOWN & DEBT PRINCIPAL REPAYMENT ex): Apple bought $100 of new iPod factories w/ Debt. assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. At the end of year 3, the factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk me through the 3 statements.
- come back
Why do we look at both Enterprise Value and Equity Value?
Enterprise Value = value of core business operations of a co (net operating assets) to ALL investors
Equity Value = value of EVERYTHING in co to only the EQUITY investors
Look at both b/c: Equity Value = # the public at large sees, while Enterprise Value = “true” value of a co.
When looking at an acquisition of a co, do you pay more attention to the Enterprise or Equity Value?
Enterprise Value: b/c that’s how much an investor “really” pays & includes often mandatory debt repayment
Enterprise Value Formula?
Enterprise Value = Equity Value + Debt + Preferred Stock + Non-Controlling (Minority) Interests - Cash
Why do you need to add Minority Interest to Enterprise Value?
When a Co A owns majority (more than 50%) of another company B –> reports 100% of subsidiary (Co-B) financial performance as part of Co A’s financial performance, even though it doesn’t own 100% of subsidiary.
So, have to add Minority Interest to TEV so that numerator (TEV) and denominator (financial performance metric) both reflect 100% of majority-owned subsidiary.
How do you calculate fully diluted shares?
1) Take basic share count, and 2) add in dilutive effective of stock options and any other dilutive securities (ex: warrants, convertible debt, convertible preferred stock)
To calculate dilutive effect of options: use Treasury Stock Method (TSM)
Ex: Say a Co has 100 shares outstanding at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each - what is its fully diluted equity value?
The options are “in the money” (exercise price is less than current share price).
When these options are exercised –> 10 new shares will be created.
To exercise the options, will pay the co $5 per option (exercise price) ==> Co will have $50 in additional cash. –> uses proceeds to buy back 5 new shares (50/10 = 5) ==> so fully diluted share count is 105 & fully diluted equity value is 1050 (= 105 * 10)
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Fully Diluted EqV = (Basic Share Count + Dilutive Effect of Options (and other dilutive securities)) * Current Share Price
Dilutive Effect of Options:
- $5 (exercise price) < $10 (share price)
- proceeds = 5 * 10 = $50
- proceeds/current price = shares repurchased by co –> 50/10 = 5 shares
- net dilution = 10 - 5 = 5 shares
Fully Diluted Share Count = 100 + 5 = 105 shares
Fully Diluted EqV = (100 + 5) * 10 = $1,050
Ex: A co has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each - what is its fully diluted equity value?
Fully diluted equity value is $1,000.
Since the strike price is above the share price, will assume the options will not be exercised ==> options have no dilutive effect.
Why do you subtract cash in the formula for Enterprise Value? Is it always accurate?
1) Official Reason: Cash is considered a non-operating asset –> Enterprise Value represents value of operating assets, so cash is subtract. Also, Equity Value implicitly accounts for cash.
Subtracting cash is not always accurate b/c technically every co needs some minimum amount of cash to operate; so, technically, should only be subtracting EXCESS cash: amount of cash co has ABOVE minimum cash it requires to operate.
2) Alt reason: In an ACQ, buyer “gets” the cash of the seller –> buyer effectively pays less for the co based on how large its cash balance is. ==> & TEV tells us how much you’d really have to “pay” to acq another company.
Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?
Most of the time: yes, b/c terms of debt agreement usually says that debt MUST be refinanced in an ACQ ==> in most cases, buyer will pay off seller’s debt, so it’s accurate to say that any debt “adds” to the purchase price.
BUT - there could always be exceptions: where buyer does NOT pay off the debt.
Could a co have a negative Enterprise Value? What would that mean?
Yes. It means that the co has 1) a very large cash balance AND/OR 2) extremely low market cap. Typically see this with:
1) Co’s on the brink of bankruptcy
2) Financial institutions (ex: banks) w/ large cash balances
Could a co have a negative Equity Value? What would that mean?
No. Not possible to have either 1) negative share count nor 2) negative share price.
Why do we add Preferred Stock to get to Enterprise Value?
1) Preferred Stock pays out a fixed dividend, and 2) Preferred Stock holders also have a higher claim to Co’s assets than equity investors do. ==> Seen as more similar to debt than common stock.
How do you account for convertible bonds in Enterprise Value formula?
- If convertible bonds are “out of the money” (conversion price above current share price) –> assume nothing converts ==> FMV (face value) of the convertibles are counted as part of Co’s Debt
- If convertible bonds are “in the money” (conversion price below share price) –> assume conversion into shares ==> count them as additional dilution to the EqV.
(# of dilutive shares = bond principal / conversion price ==> added to current share count in EqV calculation)
A co has 1 million shares outstanding at a value of $100 p/share. It also has $10 million of convertible bonds, w/ par value of $1,000 and a conversion price of $50. How do I calculate diluted shares outstanding?
First, Conversion price is in the money ($50 < $100). So, assume all convert into shares ==> count convertible bonds as additional shares (rather than debt).
Then, need to figure out how many individual bonds there are = 10 million (value of bonds) / $1,000 (par value) = 10,000 convertible bonds.
Next, need to figure out how many shares this represents: # of shares per bond = par value / conversion price = $1,000 / $50 = 200 shares per bond.
So, the new shares created were 200 * 10,000 = 200,000 shares ==> 200,000 + 1 mill = 1.2 mill diluted shares outstanding
Do we use the TSM with convertible bonds?
No; because the co is not “receiving” any cash from us.
What’s the diff b/t Equity Value & SH Equity?
EqV = MARKET value vs. SH Equity = BOOK value.
EqV can NEVER be negative (b/c shares outstanding & share price can never be negative). VS. SH Equity could be any value.
Are there any problems w/ the Enterprise Value formula you just gave me?
TEV formula is too simple: leaves out other things you need to add into the formula w/ real companies. Such as:
- Net Operating Losses = should be valued and arguably added in, similar to cash
- Long Term Investments = should be counted, similar to cash
- Equity Investments = Any investments in other cos should also be added in, similar to cash
- Capital Leases = Like debt, have interest payments –> should be added in like debt
- (Some) Operating Leases = sometimes need to convert to capital leases & add in as well
- Pension Obligations = sometimes counted as debt as well
So, more accurate TEV formula = Equity Value - Cash + Debt + Preferred Stock + NCI - NOLs - Investments - Investments + Capital Leases + Pension Obligations
Should you use the book value or market value of each item when calculating Enterprise Value?
- Technically, should use the MARKET VALUE for everything.
- BUT: In practice, almost impossible to est. market value for other items in the formula, other than Equity Value ==> Usually use MV for EqV portion, and use #s from BS for the other items.
What percentage dilution in Equity Value is “too high”?
No strict rule; but, most bankers would say anything over 10% is unusual.
What are the 3 major valuation methodologies? Rank them from highest to lowest in expected value.
3 valuation methodologies:
1) DCF (Discounted Cash Flow Analysis)
2) Comparable Public Companies (Public Comps)
3) Precedent Transactions (Acq Comps)
Expected Value:
No hard-line rule for what would create highest in expected value. In general, Precedent Transactions tend to produce higher value than Public Comps b/c of Control Premium built into acquisitions.
DCF could go either way; is more variable than other methodologies. Often produces highest value, but can also produce lowest - depends on your assumptions.
When would you NOT use a DCF in a Valuation?
Do not use a DCF if:
1) Co has unstable or unpredictable cash flows (ex: tech, bio-tech startups) or
2) Debt & Working Capital serve a fundamentally diff role. (ex: banks & financial institutions -> do not re-invest debt & WC is huge part of BS)
What other Valuation methodologies are there?
- Liquidation Valuation
- Replacement Value
- LBO analysis
- Sum of the Parts
- M&A Premiums Analysis
- Future Share Price Analysis
Most common multiples used in Valuation?
- EV / Revenue
- EV / EBITDA
- EV / EBIT
- P/E (Share Price / Earnings Per Share)
- P/BV (Share Price / Book Value)
Examples of industry-specific multiples?
Tech (Internet): EV / Unique Visitors; EV / Pageviews
Retail / Airlines: EV / EBITDAR (Earnings Before Interest, Taxes, D&A, Rent)
When you’re looking at an industry-specific multiple (ex: EV/Scientists; EV/Subscribers), why use Enterprise Value rather than Equity Value?
==> Think through the multiple & see what investors the particular metric is “available” to
Those multiple metrics = “available” to all investors in a company (ex: scientists; subscribers). Same logic doesn’t apply to every metric though.
Would an LBO or DCF give a higher valuation?
How would you present Valuation methodologies to a co or its investors?
Display them on a “football field”: shows a RANGE that each valuation methodology produced.
How would you value an apple tree?
1) Relative Valuation: Look at other comparable apple trees to see what they are worth and/or
2) Intrinsic Valuation: value of apple tree’s cash flows
Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?
- Equity Value = represents value available to EQUITY investors –> does not reflect co’s entire capital structure
vs. - EBITDA = available to all investors in the company.
- Similarly, TEV = available to all SHs
==> Pair EBITDA w/ TEV
When would a Liquidation Valuation produce the highest value?
Let’s go back to 2004 and look at Facebook back when it had no profit & no revenue. How would you value it?
- Use Comparable Companies & Precedent Transactions and look at more “creative” multiples (ex: EV/Unique Visitors; EV/Pageviews) rather than EV/Revenue or EV/EBITDA
- DO NOT use “far in the future” DCF: can’t reasonably predict CFs for a co that is not even making money yet
==> If you can’t predict CF –> use other metric.
What would you use in conjunction w/ Free Cash Flow multiples - Equity Value or Enterprise Value?
Unlevered FCF: Use Enterprise Value
–> UFCF: excludes Interest -> represents $ avail to ALL investors
Levered FCF: Use Equity Value
–> Levered FCF: includes Interest -> represents $ avail only to EQUITY investors (b/c Debt investors have already “been paid” w/ interest payments they received)
You never use Equity Value / EBITDA, but are there any cases where you might use Equity Value / Revenue?
How do you select Comparable Companies / Precedent Transactions?
1) Industry
2) Geography
3) Financial criteria/size (Revenue, EBITDA, etc.; for Precedent Transactions: look at Transaction Value)
Precedent Transactions = same criteria as Comparable Companies, but make sure to focus on criteria of the SELLER. Also some additional consideration(s):
1) Timing: often limit set based on date & often only look at transactions w/in last few years (BUT: sometimes helpful to go further back - ex: cyclical industries)
How to apply the 3 valuation methodologies to actually get a value for the co you’re looking at?
- 1) Take median multiple of a set of companies & transactions –> and 2) Multiply it by the relevant metric from co you’re valuing
=> To get “football field” valuation graph: look at minimum, maximum, 25th percentile & 75th percentile in each set & create RANGE of values based on each methodology ==> Gets you to Implied value of co (compare to current value of Co)
What do you actually use a valuation for?
- In pitch books / client presentations: providing updates & tell them what they should expect for their own valuation
- Fairness Opinion in deals: “proves” value client is paying or receiving if “fair” from financial POV
- Defense analyses, merger models, LBO models, DCFs, etc.
Why would a co w/ similar growth & profitability to its Comparable Companies be valued at a premium?
Flaws w/ public company comparables?
1) No co is 100% comparable to another
2) The market might be wrong.
- B/c it is a relative valuation methodology, using market views of other companies as a whole to find co’s implied value => market might be wrong
(ex: it is “emotional”; multiples might be dramatically higher/lower on certain dates depending on market’s movements)
3) Small companies w/ thinly traded stock -> share prices might not reflect full value
How do you take into account a co’s competitive advantage in a valuation?
1) Look at 75th percentile or higher for multiples, rather than medians
2) Add in a premium to some of the multiples
3) Use more aggressive projections for the co
Do you ALWAYS use the median multiple of a set of public co comparables or precedent transactions?
No “rule” that you have to do this. In most cases, you do want to use the median multiple (values from middle range of the set). Usually, provide a range of 25th-75th percentile, and in certain situations may want to use 25th or 75th percentile multiple.
Ex: Co is distressed, not performing well, at competitive disadvantage -> may use 25th perentile or something in lower range
Ex: Co is doing well, has a competitive adv -> may use 75th percentile or something in higher range
