Technical - General Flashcards
Whats the difference between IRR and WACC?
WACC:
(often used in DCF)
(is an input variable when calculating UFCFs)
IRR: The discount rate at which the Net Present Value of all cash flows from a project is equal to 0
(Often used by Private Equity Firms / Financial Sponsors in an LBO)
(is an output variable when PV or NPV is set)
Walk me through each statement
What does each statement measure
Where does Net Income go beyond the I/S
Which statement is most important
What accounts for the change in PP&E?
Depreciation, CapEx, Proceeds from any sales
What is the impact if Depreciation changes
What are types of various analysis?
Valuation: (DCF) (Public Comparables) (Precedent Transactions) (LBO Model) (Football Field) (WACC)
M&A:
(Accretion/Dilution)
(Merger/Model)
What is the treasury stock method?
A way to calculate new shares created from options or warrants that are dilutive to the share price
How do you compute the pro forma EPS?
Net incomeS + after-tax incremental adjustments / shares out + new shares issued
Why would you use P/E Multiple? Whats the point / benefit? What does it tell us?
How would you value an internet company?
How would you value a traditional asset heavy company?
Tell me about Enterprise value and Equity value. And why are they different? Can you give me a few examples?
Tell me about a deal you’ve found interesting
GE Split off of Aviation, Healthcare
What does it mean when treasury yields go up? Down?
They are not like stocks. A bonds yield and price are inversely related.
Lower yield means treasuries are in demand. They’re a safe asset. Higher means the opposite.
The cost of equity is cheaper when interest rates are low
What is the relationship between the yield curve and inflation?
Well, the yield depends on whats going on in the markets
- credit risk of the issuer
- the outlook on markets and inflation rates
- and the interest rate set by central banks
What happens when Tax rates rise?
The cost of debt is cheaper (interest exp is tax deductible)
When happens to your WACC when Interest rates rise?
Cost of debt: Rises because you are paying for on interest
Cost of Equity: Rises
What is free cash flow? How do we get there?
Whats effecting the financial markets?
Inflation, Supply disruptions, new variants, climate change
How does a merger model work? (the steps)
1) Determine Purchase Price
2) Determine Purchase Method
3) Project Financial Profiles & statements of buyer
4) Combine buyer & sellers income statements
5) Calculate Goodwill and allocate purchase price
6) Combine BS and adjust for acquisition effects
7) adjust IS and adjust for acquisition effects
8) Calculate Acre/Dil. & create sensitivity tables
How would you combine the balance sheet of a merge?
Add all assets - the amount paid
+ all liabilities
+ Buyers SE only
adjust for Goodwill
What are acquisition effects?
Foregone cash on interest (cash * interest rate)
New Interes expense if paying w/ debt (debt used * interest rate)
Shares outstanding (Old buyers shares + newly issued shares)
Synergies
D&A (Must reflect new expense via DTL or DTA)
Accretion/dilution
Which is better to use when buying? Cash, Debt, or Equity.
Cash: Easiest & cheapest, you miss out on foregone cash from interest, but is generally the cheapest
Debt: less cheap than cash, and you pay interest on it, but the interest expense is tax deductible
Equity: more risky, as it is never promised, the share price may plummet after announcing, and creates a dilutive effect
Whats the rule for using 100% stock in an acquisition
TL;DR - Sellers PE»_space;»» Buyers PE = DILUTIVE !
If P/E multiple of BUYER is MORE = accretive
if P/E multiple of SELLER is MORE = dilutive
Think of it as : P/E = Equity Value / Net Income
Buyer EV(Price) = $100 Buyer Net income (Earning) = $10 PE = 10x
If you FLIP the P/E = 10/100 = $0.10
If you bought it, you’d be getting $0.10 in earnings for each DOLLAR or 10%
Sellers P/E: 80/10 = 8x
Sellers E/P = $0.125 for every dollar OR 12.5%
YOUD GET MORE FOR YOUR MONEY BECAUSE WITH THE SELLER BC ITS PE MULTIPLE IS LOWER.
What are the costs for using Cash, Debt, Stock?
Cash: Interest rate/RF * (1- Buyers tax rate)
Debt: Rate on debt * (1- Buyers tax rate)
Stock: Recipricol of buyers P/E multiple, i.e. Net Income / Equity Value
Yield of Seller: Recipricol of seller P/E multiple (the P/E multiple at purchase price for the deal)
How do you calculate the weighted ‘cost’ for the buyer?
WACOA or look at the yield of the seller and the costs for the buyer
How do you handle a company that isnt synergistic after the merge?
Write down assets and create impairment charges
Reduces:
Pre-tax income, net income, and goodwill
Why would a company want to purcchase another?
Better ROI / Higher EPS (appeals to shareholders)
Undervalued
Gain in market share
Walk me through a merger model
Looks at:
1) Financial profile of the two using purchase price form of payment, and determines the possible effect on the pro-forma EPS
Start by
1) Make assumptions about the acquisition & the form of payment
2) Determine valuations and shares outstanding of both buyer and seller, and project the income statements for each
3) Combine the IS: Revenue, Operating expenses, and adjust for foregone interest on cash, interest paid on debt, in COMBINED PRE-TAX income line; then apply the buyers tax rate to get combined NI, and then divide by the new share count to determine EPS
Discuss Goodwill & combining sheets if asked
Why would an acquisition be dilutive?
If the additional net income received by seller is not enough to offset the buyers Cost of Acquisition
(foregone cash on interest, additional interest paid on debt, and effects of issuing more shares)
Why would an acquisition be dilutive?
If the additional net income received by seller is not enough to offset the buyers Cost of Acquisition
(foregone cash on interest, additional interest paid on debt, and effects of issuing more shares)
- THIS WOULD ONLY WORK IF THEY HAVE THE SAME TAX RATE, no D&A effects, No transaction fees, no synergies, and if you use the current price rather than the purchase price, etc.
Company A: higher P/E
Company B: Lower P/E
Is this accretive or dilutive?
Depends on if its an all-stock deal.
If its ALL STOCK, then the deal with be accretive because the buyer gets more in earning for every $1 used to acquire 88
How much a company is able to borrow/ take out in debt? How do you find out?
Look at precendent transations and public comps -> Debt/ EBITDA ratio
Company A buy Company B using 100% debt
A PE: 15x
B P/E: 10x
Sellers Yield: 1/10 or 10%
AFTER TAX COST OF DEBT MUST BE greater than 10%
To get exact figure:
10%/ (1-.40) = 16.7% approx
Comp A, PE: 10x < — always higher than Comp B
Is debt or using equity more accretive?
Buyers cost of debt: .05 * (1-.40) = 3%
Cost of equity: 10%
9%
A: EntV 100, Market cap 80, EBITDA of 10, Net income of 4
B: EntV 40, Market cap of 40, EBITDA of 8, Net Income of 2
PE = 8/4
A: Ent: 100/10 = 10 , P/E = 80/4 = 20x
B: 40/8 = 5 ; P/E = 20x
Company A requires company B with 100% cash. What do you do? What are the combined PE and EBITDA multiples?
1) ADD the Market Caps =120, add 20 more
-Adjust for Cash, Debt, and Stock used
2)
How do P/E multiples change with different purchase methods (cash, stock, equity)
Enterprise Value is not affected because its cap structure agnostic
Cost of equity increases paying with stock
and Cost of debt increases when paying with debt
What affects P/E ratio in general?
Exploring company growth: Reinvestment = INCREASES
Paying dividends = INCREASES
Increased debt / risk = FALLS
How do you get to from EBITDA, EBIT, Net income to FCF?
