GB M&A Flashcards
Why are private companies valued at a discount to public companies?
Public company revenues are often significantly higher than private companies
A private company’s stock or equity is not liquid.
Public companies’ financial records are audited annually. Many private companies are not.
Public companies have to comply with transparency regulations like Sarbanes Oxley (SOX).
How would you calculate the EV of a private company?
Estimate revenues (get company financials, or find the company headcount and use the median revenue/headcount ratio from public peer company analysis).
Estimate EV/Revenue multiple
Discount the private company valuation.
What is a Payback Period?
a financial metric used in business and finance to evaluate the time it takes for an investment to generate enough cash flows to recover the initial investment cost.
The payback period is calculated by dividing the initial investment cost by the annual cash flows generated by the investment.
Provides a rough estimate but doesnt account for time value of money or risks associated with the investment
What is the average rate of return?
It provides an estimate of the average annual return generated by an investment as a percentage of the initial investment cost.
ARR is calculated by dividing the average annual income generated by the investment by the initial investment cost and expressing it as a percentage.
it does not consider the time value of money, does not account for cash flows beyond the average period, and may not reflect the risk associated with the investment.
What is Net Present Value?
A financial metric used in capital budgeting and investment analysis to determine the value of an investment or project. A dollar received in the future is worth less than a dollar received today.
What does a negative NPV indicate? A positive NPV?
A positive NPV indicates that the investment or project is expected to generate more cash inflows than outflows and is therefore considered potentially profitable.
A negative NPV means that the investment or project is expected to generate more cash outflows than inflows and may not be financially viable.
What is the Internal Rate of Return?
A financial metric used in capital budgeting and investment analysis to evaluate the potential profitability of an investment or project.
IRR is the rate of return at which the net present value (NPV) of an investment or project is zero, meaning that the expected cash inflows exactly offset the expected cash outflows.
How is IRR used?
If the calculated IRR is greater than the required rate of return or the cost of capital (WACC), the investment is generally considered attractive, as it implies that the project is expected to generate a return higher than the minimum required return.
What is the Profitability Index
It is calculated as the ratio of the present value of expected cash inflows to the present value of expected cash outflows, both discounted to the present value using a specific discount rate
A PI greater than 1 indicates that the present value of expected cash inflows is greater than the present value of expected cash outflows, suggesting that the investment or project is expected to generate a positive net value.
A PI less than 1 indicates that the present value of expected cash inflows is less than the present value of expected cash outflows, suggesting that the investment or project may not be financially viable
What is WACC
A firms blended cost of capital across all sources, including common shares, preferred shares, and debt. The cost of each type of capital is weighted by its percentage of total capital and then are all added together.
WACC is the discount rate used when valuing a project. It is the required rate a business needs to move forward with a project (otherwise it could earn the WACC rate by investing in their own shares).
What is a hurdle rate?
The minimum acceptable rate of return. The minimum rate of return that investors are expecting to receive on an investment. The IRR should be equal or greater than the hurdle rate.
What are the limitations of hurdle rates?
Hurdle rates can favor investments with high rates of return, even if the dollar amount (NPV) is very small.
They may reject huge dollar value projects that may generate more cash for the investors but at a lower rate of return.
The cost of capital is usually the basis of a hurdle rate and it may change over time.
