valuation questions and answers (400 + red book)

Question 1

3 major v aluationn methods

Answer 1

1. trading comps, precedent transactions, Discounted cash flow

Question 2

rank 3 valuation methods in terms of value?

Answer 2

Doesnt always follow the rule
1. precedent transaction: due to control premium
2. DCF - can vary depending on assumptions, DCF model can be very prone and sensitive to assumptions put in, often more bullish
3. Comparable companies

Question 3

when wouldn you not use DCF in valuation?

Answer 3

1. unstable or unpredicted cash flows (tech or biotech startup)
2. when debt and working capital are used for different role (banks and FIGs dont re-invest debt)

Question 4

what other valuation methodology

Answer 4

1. Liquidation valuation - a company which needs to be liquidated. To value a companies assets and liabilities to see if they sold off assets and paid off liabiloities, how much capital they can return to equity investors
2. LBO: how much a PE firm pays for a leverage buyout, to hit the IRR
3. sum of parts: for big conglomerates where they value each division separately and add them at the end
4. future share price analysis: projecting a company’s share price based on P/E of public comps and discounting it back to present value

Question 5

most common multiples to use and why

Answer 5

1. split into Enterprise based or equity based
2. EV/Rev, EV/EBIT, EV/EBITDA = for all capitals, capital neutral (both debt and equity investors), generally higher due to EV being generally bigger than equity value
3. P/B, P/E - equity investor only

Question 6

how do you compare equity/revenue, vs EV/revenue

Answer 6

1. used for FIGs with big cash balances, so negative EV, hence can only use equity value/revenue
2. generally use EV when possible
3. EV/Rev would generally be greater than Equity/Rev bcuz Ev > equity V, unless for FIGs where equity is bigger

Question 7

why would we never use Equity/EBITDA

Answer 7

• EBITDA includes before interest, which would mean interest is included in EBITDA, and hence applies to debt and equity investors
• Equity Value only applies to equity shareholders, and numerator and denominator dont include the same things, hence no

Question 8

would EV based multiple generally be larger than equity based

Answer 8

1. generally EV based would be larger bcuz EV> equity
2. but also depends, cuz sometimes EV is smaller than equity value

Question 9

how to select comparable companies/precedent transactions

Answer 9

1. time
2. industry clasficiation
3. financial criteria: revenue, EBITDA
4. Geography

Question 10

how do you aply 3 valuation methods to get an actual value

Answer 10

1. after getting multiples for comps or precedents, you multiply it with the relevant metric to get EV
2. use a football field to illustrate the different methodologies values in 25th and 75th percentile, and produce a range of values

Question 11

where do you actually use valuations for?

Answer 11

1. pitch books during when pitching for a deal
2. client presentations

Question 12

why would 2 companies w similar growths and profitability and similar financials have different comps

Answer 12

1. good news/bad news for a specific company
2. one company had more bidders/more competitive biddings
3. one had intangiblen assets like IP which isnt shown in financials

Question 13

flaws w public comps

Answer 13

1. not always 100% the same
2. smaller companies which dont have a lot of traded stocks may not show its fully value
3. market is volatile and sensitive to macroeconomic changes

Question 14

how to take into account a companies competitive advantage in a valuation?

Answer 14

1. 75th percentile or higher multiples rather than median
2. add in a premium
3. use more aggressive projections

Question 15

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

Answer 15

1. No, it depends on whether if u think company is performing well
2. if you dont, u can chose to look at 25th or below

Question 16

You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies – can you think of a situation where this is not the case?

Answer 16

2. if only small private deals recently
3. if good market news in industry atm

Question 17

What are some flaws with precedent transactions?

Answer 17

1. not 100% exactly comparable
2. data on private M&As are harder to find

Question 18

why does warren buffet prefer EBIT to EBITDA

Answer 18

1. so for industries like industrials or oil and gas, with big CapEx, ignoring D&A can cover up how much is spent on capex
2. can end uo w good EBITDA but on the brink of bankrupting because D&A is so huge
3. so using EBIT for capex heavy industries can be better for comparing, see how much they spend on capex

Question 19

If you were buying a vending machine business, would you pay a higher multiple for a business where you owned the machines and they depreciated normally, or one in which you leased the machines? The cost of depreciation and lease are the same dollar amounts and everything else is held constant.

Answer 19

1. lease them
2. because lease goes under SG&A and is included in EBITDA, making EBITDA lower and EV/EBITDA higher
3. whereas D&A is not included in EBITDA and will make EBITDQA higher, and multiples lower

Question 20

What does EV/EBITDA actually mean

Answer 20

1. EV essentially is what the market or investors think the company is worth
2. and EBITDA is its earnings
3. so EV/EBITDA, is a way to show expectation for rising EBITDA, high EBITDA stands for higher growth potentials

Question 21

what does P/E actually mean

Answer 21

1. price/Earnings per share, essentially it looks at share price to how much earnings can be made per share
2. is P/E is high, that means investors expect high earnings for this company. has a lot of potential to increase its earnings.

Question 22

How do you value a private company using public comps?

Answer 22

1. add a 10% illiquid discount, bcuz private companies values are not as liquid as public comps, you can just sell/buy the shares on the market
2. high transaction costs and time

Question 23

how to use DCF to value private company

Answer 23

1. more difficult, need to use trading comps to value beta and market cap

Question 24

why do we not add illiquid discount when using precedent transactions for private companies?

Answer 24

1. because when you acquire it, no matter if its public or private, the shares become immediately illiquid anyways

Question 25

How do you value banks and financial institutions differently from other companies?

Answer 25

1. how do you value banks and financial institutions differently from other companies
2. use P/E and P/BV, dont use EV/EBITDA because we want to exclude debt
3. banks have spoecific metrics like NAV, and screen comps and precedent transactions using these instead
4. can use DCF,
5. use a dividend discount model, similar to DF but based on company dividends instead of FCF

Question 26

how would you calendarize companhy financials to show TTM and not fiscal year

Answer 26

TTM = recent fiscal year + new quarter - old quarter

Question 27

I have one company with a 40% EBITDA margin trading at 8x EBITDA, and another company with a 10% EBITDA margin trading at 16x EBITDA. What’s the problem with comparing these two valuations directly?

Answer 27

1. 40% EBITDA margin would normally have a lower multiple anyways due to maths
2. dont nromalize
3. just use a different valuation

Question 28

Walk me through how we might value an oil & gas company and how it’s different from a “standard” company.

Answer 28

1. look at industry specific multiples like P/NAV (net asset value)
2. project commodity prices and also the reserves of company to determine company revenue and FCF
3. dont use DCF, use NAV, similar but everything flows based on companies reserves rather than simple revenue growth, or EBITDA margin projections

Question 29

What are the two main approaches to valuation?

Answer 29

1. intrinsic = valuing business by looking at the fundamental operations of business, and its ability to generate cash flow. DCF
2. relative = looking at the market value or markets perspective of the company/industry, based on trading comps or precedent transaactions, where you compare their multiples

Question 30

What does free cash flow (FCF) mean? not the euqation

Answer 30

1. the discretionary cash flow - the cash flow remaining after accounting for recurring expenditures to contoinue operations

Question 31

Why are periodic acquisitions excluded from the calculation of FCF?

Answer 31

1. periodic acquisitions are not for operational and one time
2. whereas capex is a recurring operations

Question 32

Why would a company issue equity vs. debt (and vice versa)?
The optimal capital structure is the D/E mix that minimizes the cost of capital, while maximizing the firm value.

Answer 32

1. Equity - no required payments, dividend magnitude can be decided, access to vast investor base. Problem - dilutes ownership, and cost of equity is high! COST OF EQUITY&raquo_space;> debt, can lose control of company
2. Debt - interest expense is tax deductible, no dilution of ownership. Problem - interest and principal payments

Question 33

What are share buybacks and under which circumstances would they be most appropriate?

Answer 33

1. when company thinks the market is undervaluing its shares
2. leads to immediately higher EPS and higher P/E

Question 34

what is the impact of share repurchase on financials?

Answer 34

1. theoretically no change in share price, Equity V = share number * price, hence share price = Equity V/share count
2. because although share count (denominator) decreases, the equity value also decreases because company decreases in cash to buy shares. so cancel out
3. but buybacks can have + or negative effect on share price depending on market perception.

Accounting impact: decrease in share count (decrease in shareholders equity), decrease in cash (decrease in shareholders activity), no impact on NI

Question 35

What is CAGR and how do you calculate it?

Answer 35

CAGR is required rate of return
- CAGR = (ending value/ begining value)^ (1/t -1)