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Investment Banking > Valuation > Flashcards

Valuation Flashcards

1
Q

What is comparable companies analysis?

A

Comparable companies analysis is a method of valuation that compares the company we are wanting to value against other companies in the relevant sector and preferably sub sector. This comparison takes place typically with the use of publically traded companies.

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2
Q

How does one formulate a list of comparable companies?

A

Identify the industry and sub levels of the industry that the business is a part of. If available, compare to a list in the company’s bank of knowledge.

In addition, narrow down a list of companies that fit the industry of the company starting with publicly traded companies as their value is easier to assess. Then narrow down on a list that is closer in industry to the company that is being valued.

When a list of suitable companies is identified you can begin relative valuation of the companies.

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3
Q

How is the comparable company method flawed?

A
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4
Q

Why value a company?

A

There are a number of situations where a valuation is required: M&A, subsidiary sales, start up investments, Joint venture, IPO, delisting from the stock exchange.

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5
Q

How much is a company worth?

A
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6
Q

What are the benefits of buying a company?

A

Dividends and capital gains. Rate of return is determined by dividend, purchase and sell price.

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7
Q

What is the driving force of dividends?

A

Future cashflows and profits determine the dividends.

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8
Q

What drives a firms value?

A
  • grow its revenue
  • reduce its expenses / increase profitability

OCF = R - E - I

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9
Q

How are cashflows calculated?

A

start from NOPAT - net operating profit less adjusted taxes. does not consider the financial structures of the firm.
NOPAT = EBIT - operating taxes.

calculate the unlevered cash flow - finances should not affect the company in theory.

We need to add back depreciation and amortisation. They are a tax deductible and an accounting trick.

+/- Delta Working Capital

  • Capex

+/- operating assets

+/- operating liabilities

unlevered FCF

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10
Q

What is the time value of money?

A

A dollar today is worth more than a dollar tomorrow. Money sooner is generally better.

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11
Q

What is a discount factor?

A

This is required so that we can account for the time value of money within our calculations. The further in the future the cashflow the greater the discount rate.

This allows us to measure the present value of the company based on its future cashflows.

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12
Q

How should be discount a company?

A

The discount factor is determined by the type of cashflow we are discounting.
- equity cashflow requires cost of equity discounting
- debt cashflow requires cost of debt discounting.
When you have a mix of debt and equity you use the weighted average cost of capital or WACC.

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13
Q

what is the WACC formula?

A

WACC = (D / D + E) * k_d*(1-t) + (E / D + E) * k_e

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14
Q

How do you calculate the cost of debt?

A

Look at the balance sheet:
cost of debt = interest expenses / financial liabilities.

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15
Q

How do you calculate the cost of equity?

A

Using CAPM: the capital asset pricing model.

Risk free rate is the 10y government bond.

beta = covariance / var, this is a measure of volatility and correlation with the market,
< 1 less volatile than the market, 1 is as volatile as the market, > 1 more volatile than the market.

market risk premium = 4.5% to 5%

CAPM = risk free rate + beta * market risk premium.

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16
Q

How do we calculate beta and cost of equity for an unlisted company?

A
  1. select a peer group of listed companies that are comparable:
    - size
    - leverage
    - business stratergy
    - geography
    - etc
  2. calculate the beta for all comparable companies
  3. calculate unlevered beta for each of the comparables.

unlevered Beta = levered Beta / (1 + (1-t)*D/E)

  1. take the average of the unlevered betas.
  2. relever using your unlisted company.

levered Beta = unlevered Beta * (1 + (1-t)*D/E)

17
Q

How far forward do we forecast?

A

5 to 10 years explicit forecasting period. growth company requires a longer forecasting period.

18
Q

What is the terminal value?

A

This is when the company is no longer growing.

TV = FCF_5 * (1+g) / (WACC - g)

FCF = free cashflow of the last year we are projecting

g = long term growth rate after explicit forecast

WACC = weighted average cost of capital.

19
Q

How do we get the present value?

A

Present Value = Future Value / (1 + WACC)^n

20
Q

Calculating the Enterprise and Equity Values.

A

Enterprise value = present value of cashflows + present value of terminal value + non operating assets

Equity value = EPV - financial liabilities + cash - debt like items

price per share = Equity value / number of shares

21
Q

what is a financial model?

A

A virtual representation of a business. The benefit of financial models is scenario building.

22
Q

Why use financial models?

A
  • shows the full picture
  • when will the firm break even
  • how much is the estimated market potential?
  • how much cash does the firm need before it takes its product to market?
23
Q

What are some of the worst financial model practises?

A
  • no formulas with embedded constants
  • not across multiple workbooks
  • do not hide columns
  • do not repeat calculations
  • always use checks
    examples: balance sheet must balance, add totals checks
  • avoid using current sheet references
  • complicated formulas
  • use macros and VBA as little as possible
  • do not use different blocks
24
Q

What are some of the best practices when creating models?

A
  • build a flexible model: only input cells are hard coded
  • uniform structure across all worksheets
  • error free - checks
  • take another look the next day
  • build calculation blocks for replication
  • units in the headers of tables
  • printable documents
  • professional organization
25
Q

What are the different types of financial models we can build?

A
  • credit analysis: cash flows, borrowers ability to repay, quality of guarantees
  • equity investments: valuation and investment opportunity
  • M&A: similar to above, analyse synergies
  • LBO: cash flows, exit multiples and calculate IRR
  • Project finance: cash flow timing, calculate IRR
  • Startup Valuation: break even analysis, market potential.
26
Q

Forecasting P&L and balance sheet items

A

right level of detail: short, mid and long term planning.
short term: line by line
We cannot be too detailed. small variables add complexity without precision.
Long term planning
- Revenue
- Margins
- # of employees
- Capex
- Working capital

27
Q

what are some forecasting guidelines?

A

Avoid the hockey stick effect:
1. be consistent with past performance.
2. avoid predictions that are too rosy.
3. look at the industry outlook.
4. play with the numbers and see if it is ok
5. reasonable hypothesise
6. Stage of development of the company matters
7.

28
Q

What relationships are present between the financial statements?

A

Balance sheet & P&L:
Balance sheet & cashflow:
cashflow & P&L:

29
Q

Forecasting the P&L

A
  1. sales forecast / revenue: top down or bottom up: product level or market cap level. usually the top down approach for long term.
  2. cost line items: CoGs as a percentage of revenue
  3. operating expenses: selling, general and administration as a percentage of revenues.
  4. D & A: Using a fixed asset roll forward schedule.
  5. Taxes: EBT * tax rate

Gross Profit -> EBITDA -> EBIT -> EBT

30
Q

Forecasting the balance sheet

A
  1. working capital: trade receivables, trade payable and inventory. Use the days technique. DSO, DIO and DPO.
  2. other assets and liabilities: as a percentage of revenue.
  3. PPE: D&A reduces it, new PPE capex. End PPE = Beg PPE - D&A + Capex
  4. liabilities: Beg Debt + new debt - debt repayment or historical interest rate: interest expense / liabilities.
  5. shareholders equity:
    Beg Equity + increase in capital +/- net income
    - dividends
    dividends as a percentage if FCF
  6. cash we need a cashflow statement first.
31
Q

The 5 forces of a given industry.

A
  1. existing competitor rivalry
  2. bargaining power of suppliers
  3. bargaining power of buyers
  4. threat of new entry
  5. treat of substitute products
32
Q

understanding a company uses SWOT analysis.

A

List of questions to answer:
1.
2.
3.
Strengths
Weaknesses
Opportunities
Threats

33
Q

What is valuation multiples?

A

Valuation multiples are ratios that can be used to readily get approximate values. We use these to triangulate the DCF results.

34
Q

What are the main types of multiples used?

A

These can be divided into three main categories:
Earnings: P/E, EV/EBITDA, EV/EBITA
Revenue: Price/Sales, EV/Sales - does not consider a negative profitability
Industry: custom industry based multiples are required to do this. EV/barrels per day, web traffic.

35
Q

What is the difference between trading and transaction multiples?

A

Trading multiples rely on stock prices of comparable companies listed on public markets, these are: easy to update, represent the market’s most recent view.
Transaction multiples rely on prices paid in previous M&A deals, 12 * price/EBITDA, these should be applied with caution, they carry a control premium, they are not always up to date,

Best to use both.

36
Q

What are the principles of multiples valuation?

A
  1. value conglomerates as sum of its parts
  2. be careful when using P/E - distorted by capital structure
  3. Adjust for non-operating items - Revenue, Expenses, Assets and Liabilities.
  4. pick your peers carefully - growth, performance, products, target market and strategic positioning.
    5.
37
Q

How to adjust EBIT?

A
38
Q

How to adjust EV?

A

Investment Banking (12 decks)

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