WSO Flashcards
What does spreading comps mean?
Spreading comps means calculating relevant multiples from comparable companies and summarizing
them for easy analysis and comparison. It can be challenging when a company’s data and financial
information must be scoured to conduct the necessary research.
What happens to Free Cash Flow if Net Working Capital increases?
You subtract the change in Net Working Capital when you calculate Free Cash Flow, so if Net Working
Capital increases, your Free Cash Flow decreases and vice versa.
(This might be wrong) double check
What is a primary market and what is a secondary market?
The primary market is the market where a new stock or bond is sold the first time it comes to market.
The secondary market is where the security will trade after its initial public offering (NYSE, Nasdaq).
Describe a company’s typical capital structure.
A company’s capital structure is made up of debt and equity, and there may be multiple levels of each.
Debt can be senior, mezzanine, or subordinated, with senior being paid off first in the event of
bankruptcy, then mezzanine, then subordinated. Since senior debt is most secure and will be paid off
first in bankruptcy, it offers the lowest interest rate. The most senior debt is bank loans; the rest is
bonds, which can be issued to the general public. Equity is either preferred or common stock. Preferred
stock combines some features of both debt and equity: it can appreciate in value, and also pays out a
consistent dividend but it has very little or no rights in a bankruptcy. Common stock is traded on the
exchanges, if the company is public. In the event of bankruptcy, common stockholders have the least
claim to assets in the event of liquidation, and therefore they bear the highest level of risk and earn the
highest return on investment. Common shareholders are the company’s owners and are entitled to
profits, which may be reinvested in the business or paid as dividends
When should an investor buy preferred stock?
An investor should buy preferred for the upside potential of equity while limiting risk and assuring
stability of current income in the form of a dividend. Preferred stock’s dividends are more secure than
those from common stock, and owners of preferred stock enjoy a superior right to the company’s assets,
though inferior to those of debt holders, should the company go bankrupt.
If you have two companies that are exactly the same in revenue, growth, risk, etc. but one is private and one is
public, which company’s shares would be higher priced?
If you have two companies that are exactly the same in revenue, growth, risk, etc. but one is private and one is
public, which company’s shares would be higher priced?
What could a company do with excess cash on its Balance Sheet?
Although it seems like having a lot of cash on hand might be a good thing, especially in a recession, it
really isn’t, because there is an opportunity cost to holding cash. A company should have enough cash
to protect itself from bankruptcy in a downturn, but any excess cash should be put to work. The company
could pay a dividend to its equity holders or bonuses to employees, although a growing company will
tend to reinvest rather than pay out cash. It can reinvest its cash in plants, equipment, personnel, or
marketing; it can pay off debt, repurchase equity, or buy out a competitor, supplier, or distributor. If
nothing else, that cash can earn a little something invested in CDs until it can be put to better use.
how does goodwill affect net income?
through impairment/writedown
When should a company buy back stock?
A company should buy back its own stock if it believes the stock is undervalued, when it has extra cash,
if it believes it can make money by investing in itself, or if it wants to increase its stock price by
increasing its EPS by reducing shares outstanding or sending a positive signal to the market.
What is the default premium?
The default premium is the difference between the yield on a corporate bond and the yield on a
government bond with the same time to maturity to compensate the investor for the default risk of the
corporation, compared with the “risk-free” comparable government security.
What is the difference between a corporate bond and a consumer loan?
The main difference between a corporate bond and a consumer loan is the market that it is traded on. A
bond issuance is usually for a larger amount of capital, is sold in the public market and can be traded. A
loan is issued by a bank, and is not traded on a public market.
How do you price a bond?
The price of a bond is the net present value of all future cash flows (coupon payments and par value)
expected from the bond using the current interest rate.
For the example below, assume the current interest rate is 7% on comparable bonds. The bond you are
looking to invest in has a $100 face value and pays 10% annual interest. Since the bond you are
investing in pays a higher coupon than bonds of comparable companies, you will be required to pay a
premium for that higher interest rate, hence the $112.30 price, which brings the yield on the bond down
to levels in line with comparables.
The company earns $100 in Pre-Tax Income, and has an initial NOL balance of $175. Walk through changes on three statements
The company applies $100 of its NOL balance to offset its Pre-Tax Income and reduce its Taxable Income to $0.
It therefore pays $0 in true cash taxes. Its DTA decreases by the tax rate of 40% * $100, or $40.
On the Income Statement, nothing changes because taxes are recorded as-is. So the company’s Net Income is simply $60, or $100 of Pre-Tax Income minus $40 of Taxes.
On the Cash Flow Statement, the DTA decreasing by $40 causes cash flow to increase by $40. So at the bottom, cash is up by $100 due to $60 of Net Income and the $40 decrease in the DTA.
On the Balance Sheet, cash is up by $100, the DTA is down by $40, so the Assets side is up by $60. On the other side, Retained Earnings is up by $60 due to the Net Income of $60, so both sides balance.
The company records a $200 Pre-Tax Income loss, and has an initial NOL balance of $75 from the previous step. Changes on three statements?
he company’s NOL balance increases by $200. It pays $0 in cash taxes. Its DTA increases by $200 * 40%, or $80.
On the Income Statement, Net Income is simply negative $120 (negative $200 of Pre-Tax Income, minus negative taxes of $80).
On the Cash Flow Statement, Net Income is negative $120, and the DTA increasing by $80 reduces cash flow by $80. So cash is down by $200 at the bottom.
On the Balance Sheet, cash is down by $200, the DTA is up by $80, so the Assets side is down by $120.
On the other side, Retained Earnings is down by $120 due to the Net Income of negative $120, so both sides balance.
The company earns $300 in Pre-Tax Income, and has an initial NOL balance of $275 from the previous step. 3 Statements?
In This Case: The company applies $275 of its NOL balance to offset its Pre-Tax Income, and reduce its Taxable Income to $25.
It therefore pays $10 in true cash taxes ($25 * 40%). Its DTA decreases by 40% * $275, or $110.
On the Income Statement, nothing changes. So the company’s Net Income is simply $180, or $300 of Pre-Tax Income minus $120 of Taxes.
On the Cash Flow Statement, the DTA decreasing by $110 causes cash flow to increase by $110. So at the bottom, cash is up by $290 due to $180 of Net Income and the $110 decrease in the DTA.
On the Balance Sheet, cash is up by $290, the DTA is down by $110, so the Assets side is up by $180. On the other side, Retained Earnings is up by $180 due to the Net Income of $180, so both sides balance.
