IBC Guide Flashcards
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
- Offer value
- Goodwill created
- Exchange ratio
- Number of shares issued to target
- New debt issued
- After tax cost of debt
- Accretion/dilution amount in $
- Pre tax synergies to break even
- 1,120.4
- $810.6
- 0.1909
- 13.241
- $224.1
- $5.4
- ($0.029)
- $13.9
Why unlever and relever beta?
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.
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?
30% premium to 100 book value= 130
Assets +150, cash -130, Goodwill +30, liabiliites +50
A company has negative cash flow in perpetuity. Can it have a positive valuation?
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.
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)?
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%
You start a company today and put $100 of your own money into it. What is the enterprise value?
0
100 of your own money - 100 cash = 0
Would an equity investment be included in EV?
What determines whether or not something should be added to or subtracted from EV?
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)
What is the primary difference between valuinga company using comparable multiples versus using a DCF?
Comparables uses relative valuation
DCF is an intrinsic valuation. It projects further into the future (perpetuity method, FCF projections, etc)
- How do you derive the savings amount from NOLs?
- How would you value NOLs in a DCF model?
- 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
- 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.
Is the resulting depreciation/amortization from write ups in an acquisition tax deductible?
No, hence the deferred tax liability
What happens to the combined balance sheet in an acquisition?
- 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
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
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
A PE invested $100M in equity with 20% IRR. After 3 years, how much money would it make?
(X/100)^(1/3) - 1 = .2 (20%)
Solve for x. Get $172.8. Make $72.8 million.
If tax law boosts profitability of companies - what will happen with that money?
- Share buybacks
- Pay dividends
- Pay down debt
- Invest in growth achieving projects
- Conduct M&A
- Invest in securities
A/R increases by $5M, how would this change your valuation?
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.
What are all of the factors that affect an IRR?
Entry equity, exit multiple, leverage, time, management, CapEx
(Exit equity/Entry Equity)^(1/n) - 1
Acquirer Info:
P/E 25x
Cost of debt: 8%
Tax rate: 40%
Do you use debt or equity to finance acquisition?
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
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?
$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%
Under what circumstances would an LBO not work?
Unstable cash flows, poor management team, large CapEx
When would a company’s NOPAT be lower than its unlevered FCF?
- Adds back depreciation expense
- Receives significant cash from AR, incurs but does not pay AP
- Does not use cash for CapEx
What is the deferred tax liability formula resulting during an acquisition?
What tax rate?
DTL = Sum of write ups x statutory tax rate
Acqurier’s statutory rate
If I were to give you $1 per day, how much would you pay me?
$1/WACC
Figure out WACC. Use some cost of debt % and average historical S&P return
Name the 5 key changes from the 2017 tax act
- Corporate tax rate decreased from 35% to 21%
- One time transtion tax on foreign earnings
- Interest deduction capped at 30% of EBITDA
- Use of NOLs limited to 80% of taxable income
- Full expensing of CapEx for tax purposes
What is evaluated when determining the level of debt financing a company can attain?
Debt and coverage ratios
Industry risk
Company’s cash flows/ability to service debt
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?
Year 1- 160
Year 2- 320
Year 3- 0 (All of DTL reversed)
Two companies have the same EBITDA, different P/E multiples. What could be the reason?
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
In strategic M&A, what kind of synergies would companies look for? (Specific synergies)
Revenue and Cost (most probable) synergies
Cost:
- Overhead reduction
- Economies of scale
- Production/distribution synergies
- Real estate
Revenue:
- Marketing/complementary products
Your analyst comes to you and provides you these numbers for companies in the same industry. What are the 3 issues that you see?
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
What is sum-of-the parts analysis? When is it typically used?
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
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?
- 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)
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?
Levered company because leverage amplifies gains.
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
1) 0.571
2) 25%
3) offer value- $325,000
Transaction value- $500,000
4) Sales- 0.8x
EBITDA- 12.5x
NI- 22.5x
What are the most common non-cash add backs to cash flow of operations?
Depreciation/amortization, impairments, stock compensation, equity income
What are 3 things that make for a good associate?
Coachable, reflective, adaptable
- If financial statement tax expense > tax return tax expense, then book….?
- If financial statement tax expense < tax return tax expense, then book….?
- DTL or reduce DTA
- DTA or reduce DTL
Stock based compensation is up $100. Walk me through the 3 financial statements.
How would it be different if paid in cash?
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
You are given historical financials and only allowed to ask 5 questions to value a company. Which 5 questions would you ask?
- Projected financials
- WACC
- Terminal Growth Rate/EBITDA X
- Precedent transactions multiple
- Comparable companies multiple
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?
Depends on the discount rate.
Discount rate to make investments equal is 5%.
Company’s debt is trading at 50 cents on the dollar, why would that be? Why would a HF want to invest?
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
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?
Accretive by $2/share or 200%
If the Trump administration gives a big tax holiday for corporations, what would be the implications for EV?
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
What are the different types of debt financing a company can raise?
Senior debt (Term Loans A,B,C)
High Yield Debt
Mezzanine Debt
Convertible Debt
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?
33%
What would make unlevered free cash flows lower than NOPAT in the long run?
Growth CapEx and continuous increases in working capital (increase AR, increased prepaid expenses, etc)
- What is the current 10 year treasury bond rate?
- What is the current fed funds rate?
- What is the current discount rate?
- What is the current LIBOR Rate (1 month rate)?
- What is LIBOR?
- 2.78%
- 2.5%
- 3%
- 2.5%
- The rate at which banks lend funds to one another in London (so, should be very similar to
What kind of debt would a high growth start-up need? Assume that it has no profits and no collateral.
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.
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?
$20
100/(10%-5%)=2000
Enterprise value = equity value (assuming no cash)
1000/10=$20
What are the main adjustments to pro forma NI?
What are other adjustments?
- 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
How to calculate depreciation expense when it only shows D/A, not just depreciation?
Beginning PP&E (net) + CapEx - sale of PP&E - Ending PP&E (net) = Depreciation
Pg 149 TTS booklet
What is the difference between a merger and an acquisition?
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.
How do you calculate Levered FCF and when and why is it used?
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
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?
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)
How do you account for risk in a valuation?
Modify the WACC, adjust intermediate cash flows, lower growth rate assumptions
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?
WACC and Growth Rate (terminal value inputs) (assuming utilizing perpetuity method)
Mathematically significant when valuing cash flows and terminal value
How does an increase in days payable affect cash flow?
It allows company’s to retain cash for a longer duration of time because it pays its suppliers later
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?
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.
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?
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)
What happens to the P/E ratio in a stock split?
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.
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?
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).
Can EBITDA be lower than Net Income?
Yes, if there are significant nonoperating income such as gains on investments, interest income, etc.
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?
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.
Do LBOs look at unlevered or levered FCFs?
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
Why would you add non-controlling interest (NCI) to calculate EV? Where does NCI sit on the balance sheet?
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.
What factors should you consider when advising a client to go public?
- Recent IPOs in similar industry and their performance
- Current market trends
- Economic environment
- Company ready to handle regulatory requirements for being a public company
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?
The data only tells what the company TRADES at, not what the offer price/share was.
What happens to the Target’s Shareholder’s Equity in an All Stock deal? What about in an all debt deal?
In both instances, the target’s equity is zeroed out.
Assume you have an EBITDA of $100. Walk me through how you would get to unlevered free cash flow (assume your own numbers).
? Talk with the fellas
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
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
Your company sells PP&E for $100 held on the balance sheet for $50. Walk me through how this affects the three financial statements.
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
Data:
P/E 20x
Tax 25%
Rev 2,000
Shares 100
GM 50%
EV/EBITDA 7x
Debt 1,000
Interest 10%
SGA 500
- What is the share price?
- What is D/A, assuming no excess cash?
- $60
- $500
What rate does the Fed change and what does this rate represent? What is the current fed funds rate?
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)
Pg 104 and 106 TTS Prep Booklet
If you could increase valuation in DCF without changing financial projections, what can you potentially do?
- Lower WACC
- Adjust capital structure
- Adjust risk free rate, beta (lower end of comp average) - Mid year convention
What is an unlevered FCF? Levered FCF? Under which circumstances do you use on over the other?
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.
How do we include in WACC the cap on interest 30% EBITDA
(% allowed deductible / total interest expense) x Kd x (1-T)
Plus
(% not allowed deductible / total interest expense) x Kd
Equals
New Kd
