MS Prep Flashcards
How do you determine cost of debt?
Interest rate on the debt, if its offered in tranches you can for a weighted average cost of debt.
What do you use for the discount rate?
WACC
How do you calculate WACC?
%equity (cost of equity) + % debt (cost of debt)(1-tax rate) + (% preferred)(cost of preferred)
What is an LBO?
The floor value of a company, the lowest value the existing owner would accept for their company
Two large publicly traded companies are looking to merge. What might they consider prior to agreeing to merge?
Strategic fit, recognize synergies, optimism in shareholders, boost the equity value of the company
Would you prefer to use perpetuity model or multiples method for terminal value?
Perpetual growth method assumes that a business will generate cash flows at a constant rate forever. Using the perpetuity growth model generally renders a higher value
What are the 4 types of valuations and rank them?
Precedent transaction, comparable companies, DCF, LBO
What is the difference between comparable and precedents?
Comps focus on current market values of specific public companies; precedents use historical transaction data from past deals. Precedents often result in higher valuations due to the inclusion of premiums
Describe what synergies are?
Cost & Revenue synergies are savings. Cost synergies are more concrete, removing redundant roles, economies of scale with combined companies. Revenue synergies can be access to patents or other intellectual property, cross-selling or cross marketing products to an existing customer base.
Why do we use EBITDA? Why not gross margin?
EBITDA provides a clear view of a company’s operating performance on its core business operations without the influence of capital structure. Gross margin only measures profitability after cost of goods sold, and its does not include other operating expenses like overhead, salaries.
Is EV/Net Income a good multiple? Then what is a good pair for Net Income?
EV / Income is not good because EV represents both debt and equity holders when net income represents only equity holders. A better pair for net income is the P/E ratio
What is WACC? How do we calculate cost of equity?
WACC is the weighted average cost of capital, represents the company’s average cost of financing its operations and is used as a discount rate in a DCF.
Cost of Equity - CAPM, Risk free rate + Beta * Equity risk premium
If you are an investor looking at a company, cost of debt 8% while cost of equity 9.5%, what do you think?
A lower cost of debt suggests the company may have room to leverage more debt however it is important to analyze the company’s cash flow stability and market conditions
What are some of the frequently used valuation methodologies and how would you present them?
Comps analysis, Precedent Transaction Analysis, DCF, LBO, Sum of the parts, they are displayed in a football field chart, to show the range of expected values.
What’s your intuition about why a sponsor would do an LBO?
They believe they can maximize their returns through leverage, can make operational improvements, stable cash flows, easy exit, assets they can sell or use as collateral, company is undervalued.
What does Beta represent and how do you calculate it
Beta is a measure of a stock’s volatility or risk compared to the overall market. It indicates how sensitive a stock’s price is to movements in the broader market.
Use publically available betas, unlever them and relever using your capital structure
Beta = Covariance of stock and market returns / variance of market returns
why do you lever and unlever Beta
Betas used from comparable companies is levered to that companies capital structure, we need to remove that capital structure and lever it to our capital structure
