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Valuation questions Flashcards

1
Q

what are 3 major valuation methods?

A
  1. Comparable companies
  2. Precedent transactions
  3. discounted cash flow analysis

rank from highest to lowest expected value - difficult to determine
–usually Precedent transactions will be higher than comparable companies bc of the control premium built into acquisitions

DCF could be high or low - very variable bc a lot is based on assumptions

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2
Q

when would you NOT use a DCF in valuation?

A

do not use a DCF if the company has unstable or unpredictable cash flows (tech or bio-tech startup) or when debt and working capital serve a fundamentally different role

—For example, banks and financial institutions do not re-invest debt and working capital is a huge part of their Balance Sheets – so you wouldn’t use a DCF for such companies.

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3
Q
  1. DCF analysis
A

finding intrinsic value - the actual value of a company or asset based on both tangible and intangible factors (may not be the same as current market value)

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4
Q
  1. Comparable companies analysis
A

Looking at what other comparable companies are worth (relative valuation
also called “PEER GROUP ANALYSIS” TRADING MULTIPLES”
–you compare the current value of a business to other similar businesses by looking at trading multiples
–“comps” method provides value for business based on what companies are currently worth - easy to calculate and current

3 ways to select companies and transactions (for 3)

  1. industry classification (most important!! always used to screen for companies/transactions)
  2. financial criteria (Revenue, EBITDA)
  3. geography

ex. screen: oil & gas producers with market caps over $5 billion
- -or digital media companies with over $100 million in revenue

flaws with method:

  • -no comp. is 100% comparable to another comp.
  • -stock market is “emotional” - multiples might be dramatically higher or lower on certain dates depending on market’s movement
  • -share prices for small comp. with thinly-traded stocks may not reflect their full value
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5
Q
  1. Precedent transactions analysis
A

relative valuation method - compare company in question to other businesses that have recently sold or acquired in the same industry - the transaction values include the take-over premium included in the price for which they were acquired

limit the set based on date and only look at transactions within past 1-2 years
–most important factor is industry!! - ALWAYS used

ex. screening: airline M&A transactions over past 2 years involving sellers with over $1 billion in revenue
- -or retail M&A transactions over the past year

flaws with method:

  • -past transactions are rarely 100% comparable - transaction structure, size of company, market sentiment all have huge effects
  • -date on precent transactions more diff. to find that it is for public company comparables - especially for acquisitions of small private companies
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6
Q

What other Valuation methodologies are there?

A
  1. liquidation valuation
  2. replacement value
    - –Valuing a company based on the cost of replacing its assets
  3. LBO analysis
  4. Sum of parts
  5. M&A Premiums analysis
    - -Analyzing M&A deals and figuring out the premium that each buyer paid, and using this to establish what your company is worth
  6. ## Future share price analysis• Future Share Price Analysis – Projecting a company’s share price based on the P / E multiples of the public company comparables, then discounting it back to its present value
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7
Q

other valuation 1. liquidation valuation

A

Valuing a company’s assets, assuming they are sold off and then subtracting liabilities to determine how much capital, if any, equity investors receive

most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the company’s debts have been paid off. It is often used to advise struggling businesses on whether it’s better to sell off assets separately or to try and sell the entire company

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8
Q

other valuation 4. sum of parts

A

Valuing each division of a company separately and adding them together at the end

used when a company has completely different, unrelated divisions

  • -Ex. General Electric,
  • -If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division and a tech division, you should not use the same set of Comparable Companies and Precedent Transactions for the entire company
  • –Instead, you should use different sets for each division, value each one separately, and then add them together to get the Combined Value.
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9
Q
  1. Other valuation - 3. LBO analysis
A

Determining how much a PE firm could pay for a company to hit a
“target” IRR, usually in the 20-25% range

Obviously you use this whenever you’re looking at a Leveraged Buyout – but it is also used to establish how much a private equity firm could pay, which is usually lower than what companies will pay.
It is often used to set a “floor” on a possible Valuation for the company you’re looking at.

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10
Q

What are the most common multiples used in Valuation?

A 
EV/Revenue
EV/EBITDA
EV/EBIT
P/E (Share Price / Earnings per Share)
P/BV (Share Price / Book Value)
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11
Q

would an LBO or DCF give a higher valuation?

A

either way…but usually LBO
will give LOWER valuation
–in LBO…don’t get any value from cash flows btwn yr. 1 and final year - only valuing based on its terminal value
–but with DCF…take into account BOTH comp. cash flows in btwn and its terminal value

Note: Unlike a DCF, an LBO model by itself does not give a specific valuation. Instead, you set a desired IRR and determine how much you could pay for the company (the valuation) based on that.

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12
Q

How would you present these Valuation methodologies to a company or its investors?

A

“football field” chart - show valuation range - ALWAYS show range rather than one specific number
–shown valuation in diff. ranges under diff. assumptions

create using minimum to maximum multiples

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13
Q

How would you value an apple tree?

A

The same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the value of the apple tree’s cash flows (intrinsic valuation)

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14
Q

Why can’t you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA?

A

bc there is a certain line on income stmt…and above that line information is available to everyone - debt and equity holders - but under EBT line…it only involves equity

  • -have to compare apples to apples - EBITDA is available to all investors in company and so is enterprise value
  • -equity value is information only available to equity holders so it is not comparing apples to apples - equity value does not reflect the company’s entire capital structure (only part available to equity holders)
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15
Q

With levered and unlevered free cash flow when would you use equity value or enterprise value

A

unlevered free cash flows excludes interest - therefore represents money available to ALL investors - so use enterprise value

levered free cash flows - includes interest expense - so it is money only available to EQUITY investors - so use equity value multiples
–debt investors have already “been paid” with interest pmts. they received

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16
Q

How do you apply the 3 valuation methodologies to actually get a value for the
company you’re looking at?

A

take the median multiple of a set of companies or transactions, and then multiply it by the relevant metric from the company you’re valuing.

  • –ex. if median EBITDA multiple from precedent transactions is 8x and company’s EBITDA is $500 million - the implied enterprise value would be $4 billion
  • -for football field valuation graph…you look at the min., max., 25th percentile and 75th percentile in each set and create a range of values based on each methodology
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17
Q

what do you actually use a valuation for?

A

Usually you use it in pitch books and in client presentations when you’re providing updates and telling them what they should expect for their own valuation

also be used in defense analyses, merger models, LBO models, DCFs (because terminal multiples are based off of comps), and pretty much anything else in finance.

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18
Q

Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium?

A

This could happen for a number of reasons:
• The company has just reported earnings well-above expectations and its stock price has risen recently.
• It has some type of competitive advantage not reflected in its financials, such as a key patent or other intellectual property.
• It has just won a favorable ruling in a major lawsuit.
• It is the market leader in an industry and has greater market share than its
competitors.

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19
Q

Do you always use the median multiple of a set of public company comparables or precedent transactions?

A

no rule..but usually want values from middle range of the set
–but if comp. you are valuing is distressed - or at competitive disadvantage - might use 25th percentile in lower range instead

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20
Q

Two companies have the exact same financial profile and are bought by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction – how could this happen?

A
  1. One process was more competitive and had a lot more companies bidding on the target.
  2. One company had recent bad news or a depressed stock price so it was acquired at a discount.
  3. They were in industries with different median multiples.
21
Q

Why does Warren Buffett prefer EBIT multiples to EBITDA multiples?

A

“Does management think the tooth fairy pays for capital expenditures?”

He dislikes EBITDA because it excludes the often sizable Capital Expenditures companies make and hides how much cash they are actually using to finance their operations.

In some industries there is also a large gap between EBIT and EBITDA – anything that is very capital-intensive, for example, will show a big disparity.

22
Q

The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company’s profitability. What’s the difference between them, and when do you use each one?

A

P / E depends on the company’s capital structure whereas EV / EBIT and EV / EBITDA are capital structure-neutral. Therefore, you use P / E for banks, financial institutions, and other companies where interest payments / expenses are critical.

EV / EBIT includes Depreciation & Amortization whereas EV / EBITDA excludes it – you’re more likely to use EV / EBIT in industries where D&A is large and where capital expenditures and fixed assets are important (e.g. manufacturing), and EV / EBITDA in industries where fixed assets are less important and where D&A is comparatively smaller (e.g. Internet companies)

23
Q

How do you value a private company?

A

use the same methodologies as with public companies: public company comparables, precedent transactions, and DCF. But there are some differences:

You might apply a 10-15% (or more) discount to the public company comparable multiples because the private company you’re valuing is not as “liquid” as the public comps.
• You can’t use a premiums analysis or future share price analysis because a private company doesn’t have a share price.
• Your valuation shows the Enterprise Value for the company as opposed to the implied per-share price as with public companies.
• A DCF gets tricky because a private company doesn’t have a market capitalization or Beta – you would probably just estimate WACC based on the public comps’ WACC rather than trying to calculate it.

24
Q

Walk me through an IPO valuation for a company that’s about to go public.

A
  1. Unlike normal valuations, for an IPO valuation we only care about public company comparables.
  2. After picking the public company comparables we decide on the most relevant multiple to use and then estimate our company’s Enterprise Value based on that.
  3. Once we have the Enterprise Value, we work backward to get to Equity Value and also subtract the IPO proceeds because this is “new” cash.
  4. Then we divide by the total number of shares (old and newly created) to get its per-share price. When people say “An IPO priced at…” this is what they’re referring to.
25
Q

walk me through a DCF

A

“A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value.

  1. First, you project out a company’s financials using assumptions for revenue growth, expenses and Working Capital; then you get down to Free Cash Flow for each year, which you then sum up and discount to a Net Present Value, based on your discount rate – usually the Weighted Average Cost of Capital.
  2. once you have PV of FCF - determine terminal value of the company - using Multiples Method or the Gordon Growth Method, and then also discount that back to its Net Present Value using WACC.

Finally, you add the two together to determine the company’s Enterprise Value.”

26
Q

walk me through how to get from revenue to free cash flow in the projections

A
  1. revenue and subtract COGS and operating expenses to get operating income (EBIT)
    - -then multiply (1 - tax rate), add back depreciation and other non cash expenses then subtract capital expenditures and change in working capital

NOTE!! This gets you to Unlevered Free Cash Flow since you went off EBIT rather than EBT. You might want to confirm that this is what the interviewer is asking for

27
Q

What’s an alternate way to calculate Free Cash Flow aside from taking Net Income, adding back Depreciation, and subtracting Changes in Operating Assets / Liabilities and CapEx?

A

Take Cash Flow From Operations and subtract CapEx – that gets you to Levered Cash Flow.
–To get to Unlevered Cash Flow, you then need to add back the tax-adjusted Interest Expense and subtract the tax-adjusted Interest Income.

28
Q

why do you usually project5-10 years?

A

That’s usually about as far as you can reasonably predict into the future. Less than 5 years would be too short to be useful, and over 10 years is too difficult to predict for most companies

29
Q

what do you usually use for discount rate? how to calculate?

A

Normally you use WACC (Weighted Average Cost of Capital), though you might also use Cost of Equity depending on how you’ve set up the DCF
—WACC = Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) + Cost of Preferred * (% Preferred).

cost of equity = CAPM = risk free rate + Beta*equity risk premium

  • -risk free rate - is what a 10 year or 20 year U.S. treasury should yielf
  • -beta calculated based on “riskiness” of comparable companies
  • -equity risk premium - % by which stocks are expected to out-perform “risk-less” assets
30
Q

how do you find Beta in cost of equity calculation?

A

You look up the Beta for each Comparable Company (usually on Bloomberg), un-lever each one, take the median of the set and then lever it based on your company’s capital structure. Then you use this Levered Beta in the Cost of Equity calculation.

31
Q

why do you un-lever and re-lever beta?

A

want to compare apples to apples - when look up betas in bloomberg, they will be levered to reflect the debt assumed by each company
–but each company’s cap strucutre is different - want to look at how “risky” a company is regardless of what % debt or equity it has

unlever to make them comparable
–we need to re-lever after bc we want Beta used in cost of equity calculation to reflect the true risk of our company…taking its cap structure into account

un-levered beta = Levered Beta / (1 + ((1 - Tax Rate) x (Total Debt/Equity)))

levered beta = Un-Levered Beta x (1 + ((1 - Tax Rate) x (Total Debt/Equity)))

32
Q

lets say you use levered free cash flow rather than unlevered FCF in DCF? what is effect?

A

you would use EBT in your calc. of FCF bc includes interest expense - this will give you equity value, not enterprise value
–(bc cash flow is only available to equity investors - bc debt investors have already been “paid” with the interest pmts. you took out - remember…trying to find free cash flow leftover to investors after operations…if already included interest expense…debt holders are paid and rest is left to equity)

in levered FCF - you would just use cost of equity for discount rate, not WACC bc not concerned with debt or PS in this case - calculating equity value, not enterprise value

equity value = Equity value is the value of a company available to owners or shareholders

enterprise value = measure of a company’s total value

33
Q

how do you calculate terminal value?

A

apply an exit multiple to the company’s year 5 EBITDA, EBIT or FCF (multiples method) or use GGM to estimate value based on its growth rate into a perpretuity

formula for TV using GGM: t terminal value = year 5 FCF * (1 + growth rate)/ (discount rate - growth rate)

34
Q

which method is better in finding terminal value? growth rate or multiples method?

A

multiples method almost ALWAYS use in banking - easier to get appropriate data for exit multiples since they are based on comparable companies

  • -picking a long term growth rate is difficult
  • -but you might use GGMi if you have no good comparable companies or have reason to believe multiples will change significantly in industry years down the road
  • -ex. if industry is very cyclical - might use long-term growth rates rather than exit multiples

don’t know which will give higher valuation bc both are dependent on assumptions - multiples method might be more variable bc exit multiples span a wider range than long-term growth rates

35
Q

what is appropriate growth rate to use when calc. terminal value?

A

Normally you use the country’s long-term GDP growth rate, the rate of inflation, or something similarly conservative.

For companies in mature economies, a long-term growth rate over 5% would be quite aggressive since most developed economies are growing at less than 5% per year.

(about 3% - GDP)

36
Q

How do you select appropriate exit multiple when calc. terminal value?

A

Normally you look at the Comparable Companies and pick the median of the set, or something close to it.
–show a range of what the TV looks like - don’t pick one specific number

Ex. if median of EBITDA multiple of set was 8x - show a range of values using multiples from 6x to 10x

37
Q
  1. Should Cost of Equity be higher for a $5 billion or $500 million market cap company?
A

It should be higher for the $500 million company, because all else being equal, smaller companies are expected to outperform large companies in the stock market (and therefore be “more risky”).

WACC?
trick question bc depends on capital structure - if it is the same for both companies, the WACC will be higher for $500 million company for same reasons

38
Q

What’s the relationship between debt and Cost of Equity?

A

more debt means company is more risky - company’s levered beta will be higher - all else being equal, additional debt would raise cost of equity and less debt would lower cost of equity

39
Q

How can we calculate Cost of Equity WITHOUT using CAPM?

A

Cost of Equity = (Dividends per Share / Share Price) + Growth Rate of Dividends

This is less common than the “standard” formula but sometimes you use it for companies where dividends are more important or when you lack proper information on Beta and the other variables that go into calculating Cost of Equity with CAPM.

40
Q

Two companies are exactly the same, but one has debt and one does not – which one will have the higher WACC?

A

tricky - one without debt will have higher WACC up to CERTAIN POINT - bc debt is less expensive than equity. why?

  • –interest on debt is tax deductible (so use the 1- tax rate multiplication in WACC formula)
  • -debt is senior to equity in company’s cap structure - debt holders paid first in liquidation or bankruptcy

HOWEVER!! once debt goes up high enough…interest rate will rise dramatically to reflect additional risk and cost of debt could increase (Midgliani and miller)

41
Q

EV/Revenue

A

one of valuation multiples - fin. ratio that compares total value of company to its sales
–how many dollars of EV are generated by one dollar of yearly sales

If HIGH means it is overvalued - if LOW it is undervalues (want it to be low!!)

42
Q

What are synergies, and can you provide a few examples?

A

Synergies refer to cases where 2 + 2 = 5 (or 6, or 7…) in an acquisition. Basically, the buyer gets more value than out of an acquisition than what the financials would predict.

  • -revenue synergies - up-sell products
  • -cost - consolidate buildings and staff and lay off eployees
43
Q

Let’s say a company overpays for another company – what typically happens afterwards and can you give any recent examples?

A

high amt. of goodwill - price is far above fair market value of company
–ebay paid huge premium and extremely high multiple for skype - created excess Goodwill

44
Q

What are the main 3 transaction structures you could use to acquire another company?

A

stock purchase, asset purchase and section 338(h)(10) election

45
Q
  1. stock purchase
A

Buyer acquires all asset and liabilities of the seller as well as off-balance sheet items.
• The seller is taxed at the capital gains tax rate.
• The buyer receives no step-up tax basis for the newly acquired assets, and it can’t
depreciate/amortize them for tax purposes.
• A Deferred Tax Liability gets created as a result of the above.
• Most common for public companies and larger private companies.

46
Q
  1. asset purchase
A

• Buyer acquires only certain assets and assumes only certain liabilities of the seller and gets nothing else.
• Seller is taxed on the amount its assets have appreciated (what the buyer is paying for each one minus its book value) and also pays a capital gains tax on the proceeds.
• The buyer receives a step-up tax basis for the newly acquired assets, and it can depreciate/amortize them for tax purposes.
• No Deferred Tax Liability is created as a result of the above.
• Most common for private companies, divestitures, and distressed public
companies.

A seller almost always prefers a stock purchase to avoid double taxation and to get rid of all its liabilities. The buyer almost always prefers an asset deal so it can be more careful about what it acquires and to get the tax benefit from being able to deduct depreciation and amortization of asset write-ups for tax purposes.

47
Q

LBO model walk through

A
  1. make assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt and other variables; you might also assume something about the company’s operations, such as Revenue Growth or Margins, depending on how much information you have
  2. is to create a Sources & Uses section, which shows how you finance the transaction and what you use the capital for; this also tells you how much Investor Equity is required.
  3. adjust the company’s Balance Sheet for the new Debt and Equity figures, and also add in Goodwill & Other Intangibles on the Assets side to make everything balance.
  4. project out the company’s Income Statement, Balance Sheet and Cash Flow Statement, and determine how much debt is paid off each year, based on the available Cash Flow and the required Interest Payments.
  5. assumptions about the exit after several years, usually assuming an EBITDA Exit Multiple, and calculate the return based on how much equity is returned to the firm.”
48
Q

Give an example of a “real-life” LBO.

A

Down Payment: Investor Equity in an LBO
• Mortgage: Debt in an LBO
• Mortgage Interest Payments: Debt Interest in an LBO
• Mortgage Repayments: Debt Principal Repayments in an LBO
• Selling the House: Selling the Company / Taking It Public in an LBO

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