Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

IB > VALUATION > Flashcards

VALUATION Flashcards

1
Q

What are the two ways to value a company?

A

Relative Valuation: comparing a company to what similar companies are worth
Intrinsic Valuation: estimating the net present value of its future cash flows

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Example of Relative Valuation

A

Three companies similar to yours in revenue growth, profit
margins, and industry focus have recently sold for 3x annual profits, 5x annual
profits, and 4x annual profits in the past year. From that, you might conclude
that your own company is worth around 4x annual profits, since that’s the
median profit multiple of the set.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

How do we do Intrinsic Valuation?

A

to 1) Estimating
future cash flows and discounting them back to
their present value – because money today is
worth more than money tomorrow
OR
2)
Valuing the firm’s Assets and assuming that the
firm’s total value is linked to its adjusted Asset
value minus its Liabilities in some way.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Example of DCF

A

A firm’s future free cash
flows are $100, $120,
$140, $160, and $180
over a 5-year period.
You assume a Discount
Rate of 10%, so the Net Present Value of those is approximately $516. You
estimate that the company can be sold for $1,000 at the end of year 5 in your
analysis. The present value of that $1,000 is $621 ($1,000 / (1 + 10%)^5). Therefore,
the company’s total value is $1,137 ($516 + $621).

BOTTOM LINE: a firm’s value is the sum of its
discounted future cash flows and its discounted terminal value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Formula for DCF

A

(Cash flow/(1+Discount Rate)^year))

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is an alternative to DCF?

A

Net Asset Value/Liquidation Model: Valuing a firm’s Assets and Liabilities,
subtract the modified Total Liability Value from

(more common in balance sheet-centric industries like insurance)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

In most standard industries, you would use a

A

DCF analysis

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

When would DCF not be relevant in an industry?

A

1) “Free Cash Flow”
is not a meaningful metric; 2) The industry is asset-centric
You’d be better off valuing the company’s Assets and Liabilities.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Industries Where the DCF is Not Relevant:

A

Commercial Banks, Insurance Firms,
(Some) Oil & Gas Companies, Real Estate Investment Trusts (REITs).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Public Comps and Precedent Transactions work best when

A

when there’s a lot of good
market data and there are truly similar companies

not good for when data is spotty and the company you’re analyzing is unique

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

DCF analysis works well for

A

stable, mature companies with predictable growth rates and profit margins;

it doesn’t work as well for high-growth start-
ups, companies on the brink of bankruptcy, and other situations where growthand margins are artificially high, low, or unpredictable.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

If you calculate EV / Revenue or EV / EBITDA multiples for a set of public companies in an industry and recent transactions for that same industry, the
multiples are often higher for the ____________

A

set of transactions

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

To pick comparable public companies, you use the following criteria:

A
  1. Geography (US? China? Europe?)
  2. Industry (Diversified Consumer,? Food and Beverage s?)
  3. Financial (Revenue or EBITDA above, below, or between certain numbers)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

To pick precedent transactions, you use the following criteria:

A
  1. Geography (US? China? Europe?)
  2. Industry (Diversified Consumer,? Food and Beverage s?)
  3. Financial (Revenue or EBITDA above, below, or between certain numbers)
  4. Time (Transaction Since…Or Transaction Between Year X and Year Y)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Liquidation Valuation AKA the “Net Asset Value” model.

A

You value a company’s Assets, and assume they are
sold to repay its Liabilities, and that whatever remains goes to Equity Investors and is the company’s Equity Value.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

M&A Premiums
Analysis

A

You still
select Precedent
Transactions but
instead of calculating
valuation multiples
you calculate the premium that the buyer paid for the seller in each case
(e.g. if the buyer paid $30.00 per share and the seller’s share price was
$20.00, that was a 50% premium).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Future Share Price Analysis –

A

You project a company’s future share price
based on the P / E (or other) multiple of comparable companies, and then
discount it back to its present value.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

Sum of the Parts –

A

You split a company into different segments (e.g.
Chemicals, Manufacturing, and Consulting Services), pick different sets of
Public Comps and Precedent Transactions for each, assign multiples,
value each division separately, and then add up all the values at the end
to determine the company’s total value.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Leveraged Buyout (LBO) Analysis

A

You assume that a private equity firm acquires a company and needs to achieve a
certain Internal Rate of Return (IRR), such as 15% or 20%… and work backwards to calculate how much they could potentially pay to achieve that return.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Revenue Multiple (Enterprise Value / Revenue), which
measures

A

how valuable a firm is relative to its Net Sales,

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Profitability Multiple is used to assess how valuable a firm is relative to

A

its Profits (P / E, EV / EBITDA, EV
/ EBIT, EV / Unlevered FCF, or Equity Value / Levered FCF, all of which measure
different things).

22
Q

P / E

A

Price Per Share / Earnings Per Share, or Equity Value / Net Income.

23
Q

EBIT (Earnings Before Interest & Taxes)

A

This is the company’s
Operating Income from its Income Statement, or Revenue – COGS – Operating Expenses. This includes the impact of Depreciation,
Amortization, and perhaps other non-cash charges.

24
Q

EBITDA:

A

EBIT + Depreciation + Amortization.

The idea here is to remove
most of the non-cash charges and make it more accurately reflect cash

flow potential. You may add back other non-cash charges, such as Stock-
Based Compensation, as well.

25
Q

Unlevered Free Cash Flow (Free Cash Flow to Firm):

A

There are a few
ways to calculate this (see the DCF section); one method is EBIT * (1 – Tax
Rate) + Non-Cash Charges – Change in Operating Assets and Liabilities –
CapEx.

26
Q

Levered Free Cash Flow (Free Cash Flow to Equity):

A

Again, there are a
few methods to calculate this (see the DCF section); one method is Net Income + Non-Cash Charges – Change in Operating Assets and Liabilities– CapEx – Mandatory Debt Repayments.

27
Q

Most common multiples in finance

A

EV / EBITDA and EV / EBIT

28
Q

Least accurate multiple

A

P / E
because it includes non-cash charges and is impacted by tax rates and capital structures – and is more common among the general public than
finance professionals.

29
Q

The Free Cash Flow multiples are “more accurate” than the EBIT and EBITDA multiples, but there are two problems with using them:

A
  1. They take more time to calculate and you have to go through the
    company’s financial statements in detail.
  2. They may not be standardized because companies include very different
    items in the Cash Flow from Operations section of their Cash Flow
    Statements.
30
Q

Book Value Multiples (Equity Value / Book Value,
or Price per Share / Book Value per Share)

A

tell you how valuable a company is
relative to its Balance Sheet.

31
Q

P / BV multiples have become less relevant over time for
most industries because

A

most companies’ Equity Values are vastly different from
the Shareholders’ Equity on their Balance Sheets.

32
Q

Valuation gives u a

A

RANGE of POSSIBLE values for a company

33
Q

Liquidation Valuation

A

Valuation: Good because it ignores “noise” in the market and
determines value based on Assets and Liabilities; but it’s not useful for
most healthy companies because it tends to produce extremely low values.

34
Q

M&A Premiums Analysis

A

Data can be
spotty (especially
for private co.
acquisitions)
* There may not be
truly comparable
transactions
Also, you can’t use acquisitions of private companies for this because
premiums only apply to public companies with stock prices.

35
Q

Public Comps

A

Adv: Based on real
data as opposed
to future
assumptions

Dis: There may not
be true
comparables
* Less accurate for
thinly traded
stocks or
volatile
companies

36
Q

Precedent Transactions

A

Adv: Based on what
real companies
have actually
paid for other
companies

Dis: Data can be
spotty (especially
for private co.
acquisitions)

There may not be
truly comparable
transactions

37
Q

Discounted Cash Flow Analysis

A

Adv: Not as subject
to market
fluctuations
* Theoretically
sound since
it’s based on
ability to
generate cash
flow

Dis: Subject to far-in-the-future assumptions
* Less useful for fast-
growing, unpredictable
companies

38
Q

Future Share Price Analysis

A

Good because it tells you how much a company might be worth, theoretically, 1-2 years into the future, but bad because of its dependence on assumptions.

39
Q

Sum of the Parts

A

Good because it more accurately values diversified,
conglomerate-type companies; but bad because often you lack the appropriate data for each division.

40
Q

Leveraged Buyout (LBO) Analysis

A

Good because it sets a “floor” on
valuation by determining the maximum amount a PE firm could pay to
achieve its returns (which is almost always lower than all these other methodologies); bad because it gives a relatively low / “floor” number rather than a wide range of values.

41
Q

All else being equal, a company with higher revenue growth will

A

also have higher revenue multiples than companies not growing as quickly.

42
Q

Similarly, a company with higher EBITDA growth tends to have

A

higher EBITDA multiples than companies not growing as quickly.

43
Q

What are the 3 major valuation methodologies?

A

Relative Valuation:
Public Company Comparables (Public Comps), Precedent Transactions and

Intrinsic Valuation:
the Discounted Cash Flow Analysis.

44
Q

How you use Public Comps and Precedent
Transactions?

A
  1. select the companies and transactions based on criteria such as
    industry, financial metrics, and geography
  2. determine the appropriate metrics and multiples for each set – for example, revenue, revenue growth, EBITDA, EBITDA margins, and revenue and EBITDA multiples – and you calculate them for all the companies and
    transactions.
  3. you calculate the minimum, 25th percentile, median, 75th percentile, and
    maximum for each valuation multiple in the set.
  4. you apply those numbers to the financial metrics for the company you’re
    analyzing to estimate the potential range for its valuation.
45
Q

How to select Comparable Companies or Precedent Transactions?

A
  1. Industry classification
  2. Financial criteria (Revenue, EBITDA, etc.)
  3. Geography
46
Q

For Public Comps, you calculate Equity Value and Enterprise Value for use
in multiples based on companies’ share prices and share counts… but what
about for Precedent Transactions? How do you calculate multiples there?

A

They should be based on the purchase price of the company at the time of the
deal announcement.

47
Q

When is a DCF useful? When is it not so useful?

A

DCF is best when the company is large, mature, and has stable and predictable cash flows (think: Fortune 500 companies in “boring” industries).

not as useful if the company has unstable or unpredictable cash flows
(tech start-up) or when Debt and Operating Assets and Liabilities serve fundamentally different roles (ex: Banks and Insurance Firms – see the industry-
specific guides for more).

48
Q

When is a Liquidation Valuation useful?

A

It’s most common in bankruptcy scenarios and is used to see whether or not
shareholders will receive anything after the company’s Liabilities have been paid
off with the proceeds from selling all its Assets.

49
Q

When would you use a Sum of the Parts valuation?

A

When a company has completely different, unrelated divisions – a
conglomerate like General Electric, for example.

If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division, and a technology division, you should
not use the same set of Comparable Companies and Precedent Transactions for
the entire company.

50
Q

When do you use an LBO Analysis as part of your Valuation?

A

Use this whenever you’re analyzing a Leveraged Buyout – but it is also used to “set a floor” on the company’s value and determine the maximum
amount that a PE firm could pay to achieve its targeted returns.

You often see it used when both strategics (normal companies) and financial
sponsors (PE firms) are competing to buy the same company, and you want to
determine the potential price if a PE firm were to acquire the company.

51
Q

How do you apply the valuation methodologies to value a company?

A

You would present everything in a “Football Field” graph

IB (4 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions