IBC Guide

Question 1

80% equity 20% debt acquisition

Acquirer Information:

Current Share Price $67.69

Total Assets- 7,604.3

Total Liabiliites: 3,040.8

Existing Goodwill: 134.7

Tax rate: 40%

Interest Rate: 4%

NI: 1,003.1

Diluted shares outstanding: 271.1

EPS: 3.7

Target Information:

Current share price: $13.46

Total Assets: 434.3

Total Liabilities: 99.9

Existing Goodwill: 24.6

NI: 46

Diluted Shares Outstanding 69.372

EPS: 0.66

Offer price/share: $16.15

Transaction expenses $10

Questions

1. Offer value
2. Goodwill created
3. Exchange ratio
4. Number of shares issued to target
5. New debt issued
6. After tax cost of debt
7. Accretion/dilution amount in $
8. Pre tax synergies to break even

Answer 1

1. 1,120.4
2. $810.6
3. 0.1909
4. 13.241
5. $224.1
6. $5.4
7. ($0.029)
8. $13.9

Question 2

Why unlever and relever beta?

Answer 2

Unlevering beta removes the effects of financial leverage on a company. You want the systematic risk associated with a specific industry and the company’s comparables instead of the whole market, then you want to adjust it for company specific risk to incorporate the effects of leverage.

Question 3

Target company balance sheet has assets of 150 and liabilities of 50. You acquire this company for a 30% premium (all cash), what happens to the acquirer’s balance sheet?

Answer 3

30% premium to 100 book value= 130

Assets +150, cash -130, Goodwill +30, liabiliites +50

Question 4

A company has negative cash flow in perpetuity. Can it have a positive valuation?

Answer 4

Yes, it could be a startup. Thus, you could use comparables or precedent transactions that would derive a positive valuation. Also, you’d have to consider the company’s liquidation value.

Question 5

You purchase a bond at 80% of par. The bond has a 10% coupon. You sell it at the end of 3 years at a 10% premium to par. The discount rate is 0%. What is the year 1 cash-on-cash return? What is the total profit over the 3-year investment life? What is the total ROI (not compounded or annualized)?

Answer 5

Purchase price= $800 (assuming $1000 par)

Coupon= $100

Year 1 cash on cash return? (100/800 = 12.5%)

Total Profit over 3 years= 100+100+100+300 = 600

What is the ROI= 600/800=75%

Question 6

You start a company today and put $100 of your own money into it. What is the enterprise value?

Answer 6

0

100 of your own money - 100 cash = 0

Question 7

Would an equity investment be included in EV?

What determines whether or not something should be added to or subtracted from EV?

Answer 7

No. Equity investments could be treated similar to cash, thus reducing the company’s EV given the ability to reduce debt.

Added:

Represents other investors or funding sources

Subtract:

Not related to company’s core business (investments, cash, real estate)

Question 8

What is the primary difference between valuinga company using comparable multiples versus using a DCF?

Answer 8

Comparables uses relative valuation

DCF is an intrinsic valuation. It projects further into the future (perpetuity method, FCF projections, etc)

Question 9

1. How do you derive the savings amount from NOLs?
2. How would you value NOLs in a DCF model?

Answer 9

1. Reduce NOL from taxable income, multiply new taxable income by tax rate, then subtract those taxes from original pre tax income to derive new NI. Then, compare what taxes would have been without the NOL to taxes with NOLs included
2. NOLs increase cash flow, thus I would add the amount of tax savings to the FCF each year

Or

I could simply take the PV of future tax savings and add that at the end and discount it at Ke. However, when going from EV to equity value, I would treat the NOLs as cash.

Question 10

Is the resulting depreciation/amortization from write ups in an acquisition tax deductible?

Answer 10

No, hence the deferred tax liability

Question 11

What happens to the combined balance sheet in an acquisition?

Answer 11

• Target’s assets and liabilities added
• Remove target’s equity and add new stock issued
• Add new debt amount
• Add write ups and resulting DTL
• Remove from cash/retained earnings transaction expenses
• Remove target’s Goodwill and add new Goodwill

Question 12

Purchase 20% in a joint venture for $200. The JV NI is $60 in Year 1 and $90 in Year 2. Cash dividends are $0 in Year 1 and $50 in Year 2. Walk me through the financial statements for year 0, 1, 2.

Do not incorporate taxes

Answer 12

Year 0:

IS: 0

CF:

(200) CFI- purchase of investment

BS:

Assets: (200) cash 200 Investment

Liab/SHE: 0

Year 1:

IS:

12 Equity income

CF:

12 NI

(12) Equity investment income CFO

0 Cash

BS:

Assets: 12 equity investment

Liab:0

SHE: 12 investment income

Year 2

IS:

18 Equity investment income

CF:

18 NI

(18) equity investment income CFO

10 equity investment dividends CFO

10 cash

BS:

Assets: 18 investment

(10) investment (received dividends)

10 cash

Liab: 0

SHE: 18 investment income

Question 13

A PE invested $100M in equity with 20% IRR. After 3 years, how much money would it make?

Answer 13

(X/100)^(1/3) - 1 = .2 (20%)

Solve for x. Get $172.8. Make $72.8 million.

Question 14

If tax law boosts profitability of companies - what will happen with that money?

Answer 14

• Share buybacks
• Pay dividends
• Pay down debt
• Invest in growth achieving projects
• Conduct M&A
• Invest in securities

Question 15

A/R increases by $5M, how would this change your valuation?

Answer 15

It would increase your working capital, thus reduce your cash flow because you have not received the cash. Thus, it would reduce your overall valuation.

EBIT increases $5 x (1-20%), but then cash decreases $5, thus it is an overall FCF reduction. The total valuation impact is that amount discounted.

Question 16

What are all of the factors that affect an IRR?

Answer 16

Entry equity, exit multiple, leverage, time, management, CapEx

(Exit equity/Entry Equity)^(1/n) - 1

Question 17

Acquirer Info:

P/E 25x

Cost of debt: 8%

Tax rate: 40%

Do you use debt or equity to finance acquisition?

Answer 17

Stock: 1/25 = 4%

Debt: 8% x (1-40%) = 4.8%

Use equity because it is a “cheaper” form of currency. You’re using a currency that yields less to pay for an acquisiton, thus you’re giving up less

Question 18

You’re purchasing a company with $30M EBITDA. You’re paying 10x multiple and financing 50% with debt. After 1 year, you have fired 1,000 employees making $10/hour, and will exit at the same multiple you purchased for. What is your IRR?

Answer 18

$300m purchase price

$150 debt, $150 equity

1,000 x 10/hr x 40hrs/week x 50 weeks= $20m

New EBITDA= $30 + $20= $50

New value= $50 x 10 = $500

New Equity = $500 - $150 = $350

IRR = (350/150)^(1/1) - 1= 133%

Question 19

Under what circumstances would an LBO not work?

Answer 19

Unstable cash flows, poor management team, large CapEx

Question 20

When would a company’s NOPAT be lower than its unlevered FCF?

Answer 20

• Adds back depreciation expense
• Receives significant cash from AR, incurs but does not pay AP
• Does not use cash for CapEx

Question 21

What is the deferred tax liability formula resulting during an acquisition?

What tax rate?

Answer 21

DTL = Sum of write ups x statutory tax rate

Acqurier’s statutory rate

Question 22

If I were to give you $1 per day, how much would you pay me?

Answer 22

$1/WACC

Figure out WACC. Use some cost of debt % and average historical S&P return

Question 23

Name the 5 key changes from the 2017 tax act

Answer 23

1. Corporate tax rate decreased from 35% to 21%
2. One time transtion tax on foreign earnings
3. Interest deduction capped at 30% of EBITDA
4. Use of NOLs limited to 80% of taxable income
5. Full expensing of CapEx for tax purposes

Question 24

What is evaluated when determining the level of debt financing a company can attain?

Answer 24

Debt and coverage ratios

Industry risk

Company’s cash flows/ability to service debt

Question 25

Purchase a machine costing 2,400 with a 3 year useful life (no salvage value). Machine generates $3,000 in revenue per year. Financial reporting depreciation is straightline over 3 years. Tax return depreciation is straightline over 2 years. 40% tax rate. What is the cumulative DTL in Years 1, 2, and 3?

Answer 25

Year 1- 160 Year 2- 320 Year 3- 0 (All of DTL reversed)

Question 26

Two companies have the same EBITDA, different P/E multiples. What could be the reason?

Answer 26

One company could have a lot of CapEx, thus leading to higher depreciation. Or, the capital structures of the companies could be significantly different, thus one company incurring higher interest expense than the other

Question 27

In strategic M&A, what kind of synergies would companies look for? (Specific synergies)

Answer 27

Revenue and Cost (most probable) synergies **Cost:** - Overhead reduction - Economies of scale - Production/distribution synergies - Real estate **Revenue:** **-** Marketing/complementary products

Question 28

Your analyst comes to you and provides you these numbers for companies in the same industry. What are the 3 issues that you see?

Answer 28

Check to make sure the multiples make sense: - Mutiples get higher as you move down the P&L since there is less income (same amount over a decreasing number leads to a higher multiple) **Revenue X \< EBITDA X \< EBIT X**

Question 29

What is sum-of-the parts analysis? When is it typically used?

Answer 29

Valuing a company based on its aggregate divisions if they were spun off or acquired by other companys. It values each division and then sums the values to derive a total EV. Typically used when a company has many different segments that operate across a multitude of industries

Question 30

Your analyst hands you a DCF model that shows a stock price of $40. The current market price is $15. Walk me through what you do next?

Answer 30

- Check 52 week high/low - Check equity research targets - If neither check out, review DCF inputs. Check WACC and terminal value inputs (growth rate assumptions or terminal multiple)

Question 31

Two companies, one with 100% equity, another 50% levered, everything else the same, assume a world with no taxes. Which one would you want to invest in if you know EBITDA is going to grow?

Answer 31

Levered company because leverage amplifies gains.

Question 32

Company A buys target for $20/share for 100% stock Company A's stock price is $35, and target's price is $16 Target has 15,000 shares, 2,000 options with an average exercise price of $7.5 and $175,000 in net debt. Target's Financials: LTM Revenue- $625,000 LTM EBITDA- $40,000 LTM NI- $14,440 **1) What is the implied exchange ratio?** **2) Premium paid** **3) offer value and TV** **4) sales x, EBITDA x, and NI x**

Answer 32

1) 0.571 2) 25% 3) offer value- $325,000 Transaction value- $500,000 4) Sales- 0.8x EBITDA- 12.5x NI- 22.5x

Question 33

What are the most common non-cash add backs to cash flow of operations?

Answer 33

Depreciation/amortization, impairments, stock compensation, equity income

Question 34

What are 3 things that make for a good associate?

Answer 34

Coachable, reflective, adaptable

Question 35

1. If financial statement tax expense \> tax return tax expense, then book....? 2. If financial statement tax expense \< tax return tax expense, then book....?

Answer 35

1. DTL or reduce DTA 2. DTA or reduce DTL

Question 36

Stock based compensation is up $100. Walk me through the 3 financial statements. How would it be different if paid in cash?

Answer 36

**Balance Sheet:** Equity- 100 stock, (100) comp expense Income statement: (100) comp expense (20) taxes (80) NI **Cash Flow:** (80) NI 100 comp expense 20 cash (due to taxes) **Final Balance Sheet:** Assets: 20 cash Equity: 100 stock, (80) R.E. **_Cash Portion_** Difference is stock-based non cash, whereas cash payment is cash based. Assets: (100) cash Equity: (100) compensation expense **Income statement**: (100) comp expense (20) taxes (80) NI **Cash Flow:** (80) NI

Question 37

You are given historical financials and only allowed to ask 5 questions to value a company. Which 5 questions would you ask?

Answer 37

- Projected financials - WACC - Terminal Growth Rate/EBITDA X - Precedent transactions multiple - Comparable companies multiple

Question 38

If you could pick between 1 million dollars now or 50K per year into perpetuity, which would you choose? Follow up to this was at what discount rate are the two investments equal?

Answer 38

Depends on the discount rate. Discount rate to make investments equal is 5%.

Question 39

Company’s debt is trading at 50 cents on the dollar, why would that be? Why would a HF want to invest?

Answer 39

The company is in distress, and if the company emerges from its distressed situation to become a healthy company, then its debt would trade at a much higher price

Question 40

Company A trades at $20 per share and has 100M shares outstanding. It has earnings of $100M. Company B is trading at $10 per share and has 50M shares outstanding. It too has earnings of $100M. Assume A acquires B in an all-equity deal that results in $175M annual post-tax synergies. The tax rate is 35%. Is the deal accretive or dilutive to A’s EPS and by how much?

Answer 40

Accretive by $2/share or 200%

Question 41

If the Trump administration gives a big tax holiday for corporations, what would be the implications for EV?

Answer 41

FCF increases (increases EV) WACC increases due to Kd increase (1-T) (decreases EV) **More cash flow due to less cash taxes paid:** - could repurchase shares (increase EV due to increased market value of equity) - More cash, thus reduces EV - Pay down debt, thus reducing EV

Question 42

What are the different types of debt financing a company can raise?

Answer 42

Senior debt (Term Loans A,B,C) High Yield Debt Mezzanine Debt Convertible Debt

Question 43

LBO: Purchase price $325 Sponsor will invest 40% equity In 5 years, the sponsor expects: Sell company at 8x EBITDA Target to have net debt of $60 Target to have EBITDA of $75 What is the IRR?

Answer 43

33%

Question 44

What would make unlevered free cash flows lower than NOPAT in the long run?

Answer 44

Growth CapEx and continuous increases in working capital (increase AR, increased prepaid expenses, etc)

Question 45

1. What is the current 10 year treasury bond rate? 2. What is the current fed funds rate? 3. What is the current discount rate? 4. What is the current LIBOR Rate (1 month rate)? 5. What is LIBOR?

Answer 45

1. 2.78% 2. 2.5% 3. 3% 4. 2.5% 5. The rate at which banks lend funds to one another in London (so, should be very similar to

Question 46

What kind of debt would a high growth start-up need? Assume that it has no profits and no collateral.

Answer 46

Convertible debt because it can then turn into equity, thus the company is not using cash. Essentially, the collateral is the future valuation of the company Or, PIK debt since payments are not due until maturity.

Question 47

Company A is 100% equity. Unlevered FCF = $100, g = 5% in perpetuity, cost of equity = 10%. There are 100 shares outstanding. What is the Price per share?

Answer 47

$20 100/(10%-5%)=2000 Enterprise value = equity value (assuming no cash) 1000/10=$20

Question 48

What are the main adjustments to pro forma NI? What are other adjustments?

Answer 48

- Synergies - Interest expense resulting from new debt - Incremental depreciation/amortization from write ups Others: - Forgone interest income from cash used to finance acquisition - Interest saved from retiring target company's debt

Question 49

How to calculate depreciation expense when it only shows D/A, not just depreciation?

Answer 49

Beginning PP&E (net) + CapEx - sale of PP&E - Ending PP&E (net) = Depreciation

Question 50

Pg 149 TTS booklet

Question 51

What is the difference between a merger and an acquisition?

Answer 51

Mergers are typically two equal companis that join together and legally form a new entity. (Merger of equals) Acquisitions occur when one company acquires another company, and the acquiring company retains its name, etc and conducts the operations.

Question 52

How do you calculate Levered FCF and when and why is it used?

Answer 52

EBIT (1-T) + D/A - Changes in OWC - CapEx - After tax interest expense + After tax interest income - debt repayments It's used to calculate equity value or can be used in LBO analysis to determine amount of cash leftover to either pay down principal of debt or be used as part of residual equity

Question 53

A company with $100M of EBITDA and a leverage ratio of 2.0 decides to purse a $200M dividend recapitalization using $200M of debt. The debt carries a 5% interest rate and the tax rate is 40%. What is the new leverage ratio? **Then** How are the 3 financial statements impacted at Y0 and Y1?

Answer 53

4x 200 original debt + 200 new debt / Same EBITDA of 100 Remember to sift out unneeded information **Then** **IS:** (10) interest expense (4) taxes (6) NI **CF:** (6) NI 200 debt issuance (200) dividends issued (6) cash **BS:** Assets: (6) cash Liab: 200 debt SHE: (206) RE (dividends + int expense)

Question 54

How do you account for risk in a valuation?

Answer 54

Modify the WACC, adjust intermediate cash flows, lower growth rate assumptions

Question 55

If you are walking a client through a DCF model, which two inputs would you explain as having the most impact on the overall valuation? Why?

Answer 55

WACC and Growth Rate (terminal value inputs) (assuming utilizing perpetuity method) Mathematically significant when valuing cash flows and terminal value

Question 56

How does an increase in days payable affect cash flow?

Answer 56

It allows company's to retain cash for a longer duration of time because it pays its suppliers later

Question 57

A company has $100M of gross PP&E and uses an accelerated depreciation method. Depreciation expense is $10M for the first five years, after which it drops to $5M. Assuming the Company does not make any additional capital expenditures, do you foresee any problems forecasting the Company’s terminal value in DCF using the $5M per year of depreciation?

Answer 57

Yes, using traditional terminal value calculations would continue to incorporate $5m in depreciation, which it would not have in the future. It overstates your FCF because you are adding back the depreciation amount.

Question 58

Part I: You are given that a company has cash = $50, short term securities = $20, accounts payable = $300, loan = $500, minority interest = $20, and 200 shares outstanding @ $10 share price. What is the enterprise value? Part II: In addition to the figures provided in Part I (see above), you are also provided that EBITDA = 100 and net income = 50. What is the EBITDA multiple, leverage multiple, and P/E ratio?

Answer 58

**Part I:** Equity + Debt + P-stock + Minority Interest - cash/equivalents = (200\*10)+500+20-70 = **2,450** **Part II:** EBITDA Multiple= 24.5x (EV/EBITDA) Leverage Multiple= 5x (Debt/EBITDA) P/E Ratio= 40x (Price-share/EPS)

Question 59

What happens to the P/E ratio in a stock split?

Answer 59

Nothing. Price per share changes by the amount EPS changes. Ex. 1:2 stock split, price would halve and then shares outstanding would double, thus halving EPS.

Question 60

2 companies are identical in every way – one is funded 50:50 debt:equity, other is 75:25 debt:equity – which is more expensive and why?

Answer 60

The one with higher debt- it would have a lower cost of capital leading to a higher valuation. (Assuming same amount of capital base, thus no difference in EBIT).

Question 61

Can EBITDA be lower than Net Income?

Answer 61

Yes, if there are significant nonoperating income such as gains on investments, interest income, etc.

Question 62

Suppose a company has two divisions: industrial tool sales and consumer tool sales. The company is currently trading at 9x EBITDA and the CEO is considering splitting the two divisions into two newly combined companies. Each division contributes 50% of total EBITDA and you know that similar industrial tool and consumer tool companies are trading at 8x and 12x EBITDA, respectively. Do you advise the CEO to pursue the break-up and why?

Answer 62

Using a simplified sum-of-the parts analysis, I would assign the company a multiple of 10x, which is the result of 50% of the company at 8x and 50% of the company at 12x (8\*50% + 12\*50%). 10x is greater than 9x, thus I would advise the break-up as that may lead to more value for shareholders.

Question 63

Do LBOs look at unlevered or levered FCFs?

Answer 63

Both- you need to analyze unlevered FCFs to get a sense of ability to service and pay down debt You need to analyze levered FCFs to get a sense of total cash to pay down the rest of the debt to get a net debt figure when calculating residual equity value

Question 64

Why would you add non-controlling interest (NCI) to calculate EV? Where does NCI sit on the balance sheet?

Answer 64

NCI is the portion of a subsidiary that the parent company does not own. A company that owns 50% or more of a company must incorporate the assets and liabilities of that subsidiary into the parent company's financials. Thus, there is a portion of the subsidiary not owned by the parent company that is owed a portion of equity. Thus, on the income statement there is a line item for NI attributable to NCI. On the Balance Sheet, NCI sit in the equity portion and add's to the company's total equity. EV includes NCI in order to compare apples to apples with EBITDA multiples, which includes the portion attributatble to NCI. In an ideal world, you would subtract the income to NCI from EBITDA and not include NCI in EV. But, that is difficult to do.

Question 65

What factors should you consider when advising a client to go public?

Answer 65

- Recent IPOs in similar industry and their performance - Current market trends - Economic environment - Company ready to handle regulatory requirements for being a public company

Question 66

You ask your analyst to run some quick accretion/dilution math for you and he does everything correctly. Company A trades at 19x P/E and they are buying Company B that trades at 18x P/E with 100% equity. They run the numbers and the deal comes out to be dilutive. How?

Answer 66

The data only tells what the company TRADES at, not what the offer price/share was.

Question 67

What happens to the Target’s Shareholder’s Equity in an All Stock deal? What about in an all debt deal?

Answer 67

In both instances, the target's equity is zeroed out.

Question 68

Assume you have an EBITDA of $100. Walk me through how you would get to unlevered free cash flow (assume your own numbers).

Answer 68

? Talk with the fellas

Question 69

Company owns 80% equity, so 20% represents NCI in a joint venture. JV NI in year 1 is $60 and year 2 is $90 with year 1 cash distirubtions of $0 and year 2 of $50. Walk me through the 3 financial statements

Answer 69

**Year 1:** **IS:** (12) NI attributable to JV **CF:** - **BS:** Assets: 0 Liab: 0 Equity: 12 NCI (12) RE **Year 2:** **IS:** (18) income to joint venture **CF:** (10) CFF dividends to NCI **BS:** Assets: (10) cash Liab: 0 SHE: 8 NCI (18) RE

Question 70

Your company sells PP&E for $100 held on the balance sheet for $50. Walk me through how this affects the three financial statements.

Answer 70

**IS:** 50 gain 10 taxes 40 NI **CF:** 40 NI (50) gain 100 PPE sale 90 cash **BS:** Assets: 90 cash (50) PPE Liab: 0 SHE: 40 Retained Earnings

Question 71

Data: P/E 20x Tax 25% Rev 2,000 Shares 100 GM 50% EV/EBITDA 7x Debt 1,000 Interest 10% SGA 500 1. What is the share price? 2. What is D/A, assuming no excess cash?

Answer 71

1. $60 2. $500

Question 72

What rate does the Fed change and what does this rate represent? What is the current fed funds rate?

Answer 72

Discount rate- the rate at which banks borrow from the federal reserve to maintain their reserve requirements. This influences the federal funds rate, which the rate at which banks lend/borrow from each other to maintain their reserve requirements. Federal Funds rate= 2.5% Current Discount Rate= 3% (Yes, it's higher than fed funds rate- want to encourage interbank lending instead of going to fed)

Question 73

Pg 104 and 106 TTS Prep Booklet

Question 74

If you could increase valuation in DCF without changing financial projections, what can you potentially do?

Answer 74

1. Lower WACC - Adjust capital structure - Adjust risk free rate, beta (lower end of comp average) 2. Mid year convention

Question 75

What is an unlevered FCF? Levered FCF? Under which circumstances do you use on over the other?

Answer 75

Unlevered FCF is the theoretical amount of cash flow available to both debt and equity holders and is used in a DCF to derive EV. Exclude debt payments and interest payments. Levered FCF is the theoretical amount of cash available to equity holders and is typically used in an LBO. Includes debt payments and interest payments.

Question 76

How do we include in WACC the cap on interest 30% EBITDA

Answer 76

(% allowed deductible / total interest expense) x Kd x (1-T) **Plus** (% not allowed deductible / total interest expense) x Kd **Equals** New Kd