BIWS - 400 Questions; Basic Flashcards

1
Q

Walk me through the 3 Financial Statements

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Examples of major line items from each financial statement?

A

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 well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

How do the 3 financial statements link together?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

If you were stranded on an island & only had 1 statement to review overall health of a company - which financial statement to use?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

If you can only look at 2 financial statements of a co - which would you use?

A

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 well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

How would Depreciation going up by $10 affect the statements?

A

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

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Depreciation - why does it affect cash balance, if it is non-cash expense?

A

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

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Depreciation - where does it usually show up on an IS?

A

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

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Accrued Compensation - what happens if it goes up by $10?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Inventory - what happens if it goes up by $10, assuming you pay for it w/ cash?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Why is IS not affected by changes in Inventory?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

(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?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

(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?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

(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.

A
  • come back
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Why do we look at both Enterprise Value and Equity Value?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

When looking at an acquisition of a co, do you pay more attention to the Enterprise or Equity Value?

A

Enterprise Value: b/c that’s how much an investor “really” pays & includes often mandatory debt repayment

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Enterprise Value Formula?

A

Enterprise Value = Equity Value + Debt + Preferred Stock + Non-Controlling (Minority) Interests - Cash

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

Why do you need to add Minority Interest to Enterprise Value?

A

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 well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

How do you calculate fully diluted shares?

A

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)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

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?

A

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)

====
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

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

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?

A

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.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Why do you subtract cash in the formula for Enterprise Value? Is it always accurate?

A

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.

23
Q

Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?

A

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.

24
Q

Could a co have a negative Enterprise Value? What would that mean?

A

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

25
Q

Could a co have a negative Equity Value? What would that mean?

A

No. Not possible to have either 1) negative share count nor 2) negative share price.

26
Q

Why do we add Preferred Stock to get to Enterprise Value?

A

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.

27
Q

How do you account for convertible bonds in Enterprise Value formula?

A
  • 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)
28
Q

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?

A

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

29
Q

Do we use the TSM with convertible bonds?

A

No; because the co is not “receiving” any cash from us.

30
Q

What’s the diff b/t Equity Value & SH Equity?

A

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.

31
Q

Are there any problems w/ the Enterprise Value formula you just gave me?

A

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

32
Q

Should you use the book value or market value of each item when calculating Enterprise Value?

A
  • 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.
33
Q

What percentage dilution in Equity Value is “too high”?

A

No strict rule; but, most bankers would say anything over 10% is unusual.

34
Q

What are the 3 major valuation methodologies? Rank them from highest to lowest in expected value.

A

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.

35
Q

When would you NOT use a DCF in a Valuation?

A

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)

36
Q

What other Valuation methodologies are there?

A
  • Liquidation Valuation
  • Replacement Value
  • LBO analysis
  • Sum of the Parts
  • M&A Premiums Analysis
  • Future Share Price Analysis
37
Q

Most common multiples used in Valuation?

A
  • EV / Revenue
  • EV / EBITDA
  • EV / EBIT
  • P/E (Share Price / Earnings Per Share)
  • P/BV (Share Price / Book Value)
38
Q

Examples of industry-specific multiples?

A

Tech (Internet): EV / Unique Visitors; EV / Pageviews
Retail / Airlines: EV / EBITDAR (Earnings Before Interest, Taxes, D&A, Rent)

39
Q

When you’re looking at an industry-specific multiple (ex: EV/Scientists; EV/Subscribers), why use Enterprise Value rather than Equity Value?

A

==> 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.

40
Q

Would an LBO or DCF give a higher valuation?

A
41
Q

How would you present Valuation methodologies to a co or its investors?

A

Display them on a “football field”: shows a RANGE that each valuation methodology produced.

42
Q

How would you value an apple tree?

A

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

43
Q

Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?

A
  • 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
44
Q

When would a Liquidation Valuation produce the highest value?

A
45
Q

Let’s go back to 2004 and look at Facebook back when it had no profit & no revenue. How would you value it?

A
  • 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.
46
Q

What would you use in conjunction w/ Free Cash Flow multiples - Equity Value or Enterprise Value?

A

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)

47
Q

You never use Equity Value / EBITDA, but are there any cases where you might use Equity Value / Revenue?

A
48
Q

How do you select Comparable Companies / Precedent Transactions?

A

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)

49
Q

How to apply the 3 valuation methodologies to actually get a value for the co you’re looking at?

A
  • 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)
50
Q

What do you actually use a valuation for?

A
  • 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.
51
Q

Why would a co w/ similar growth & profitability to its Comparable Companies be valued at a premium?

A
52
Q

Flaws w/ public company comparables?

A

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

53
Q

How do you take into account a co’s competitive advantage in a valuation?

A

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

54
Q

Do you ALWAYS use the median multiple of a set of public co comparables or precedent transactions?

A

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