Hard Technical Problems Off the Guide(Evercore + Other Drive Questions)

How does an increase in NWC affect terminal value?

(CHECK): Secondly, oftentimes you might choose to set your change in NWC equal to zero. You would only do this if you feel that the business doesn't require (or generate) additional working capital as it matures. As an example, if you look at a company with 100mm of EBITDA, and you see that in some years, you increase NWC by a few million, in others you decrease by a few million, you might say that it's basically zero/negligible (obviously you need to understand what causes these random swings from negative to positive). However, if you have a company with a tremendous amount of deferred revenue (let's say you're looking at a subscription business), and their revenue growth drives this perpetually growing liability, it wouldn't make sense to set your change in NWC = 0 for your stabilized year, because as the business grows, so too will this liability.

What happens to equity value if EV doubles

(it more than doubles becasue Net Debt is constant)

For a DCF, what metrics would you use for the sensitivity tables?

- WACC vs Terminal Multiple - Revenue Growth vs Terminal Multiple - EBITDA margin vs terminal multiple - Terminal Growth rate vs Discount rate - Target D/E vs Exit Multiple

I'm looking at financial data for a public company comparable, and it's April (Q2) right now. Walk me through how you would "calendarize" this company's financial statements to show the Trailing Twelve Months as opposed to just the last Fiscal Year

.TTM = Most Recent Fiscal Year + New Partial Period - Old Partial Period So in the example above, we would take the company's Q1 (January 1 - March 31 of this year ) numbers, add the most recent fiscal year's (January 1 - December 31 of last year) numbers, and then subtract the previous year's Q1 numbers (January 1 - March 31 of last year).

What variable has the greatest impact on cost of equity?

BETA b/c risk free rate and equity risk premium are not dependent on company specific.

How does Net Income from Equity investments, and NI attributable to Noncontrilling interests factor into FCF calculation?

BOTH have no net impact of FCF- for Equity investments you add it at bottom of I/S and then subtract out on CFS, where for noncontrolling interests you subtract it at bottom of IS and addit back on CFS

Why would you not use a DCF for a bank or other financial institution?

Banks use Debt differently than other companies and do not use it to finance their operations - they use it to create their "products" - loans - instead. Also, interest is a critical part of banks' business models and changes in "Operating Assets and Liabilities" can be much larger than a bank's Net Income. Finally, CapEx does not correspond to re-investment in business for a bank, and is often negligible. For financial institutions (commercial banks and insurance firms), it's more common to use a Dividend Discount Model or Residual Income Model instead of a DCF.

How do you calculate multiples for precedent transactions?

Based on purchase price of the company at the time of the deal announcement.

10. A company's ROA has INCREASED from 10% to 15% over the past five years, but its ROE has DECREASED from 13% to 10%. What could have caused this?

Both ROA and ROE have Net Income in the numerator, so it must be something in thedenominators.Let's say that Net Income increased over this period. If that's the case, then the company'sTotal Assets must have increased by a lower percentage than Net Income.But if ROE decreased, then the company's Equity must have increased by a greater percentagethan Net Income.So, one potential cause might be that the company has been continually issuing equity to fundits cash flow-negative business.When the company issues stock, it boosts its Equity on the Balance Sheet and prevents its cashbalance from declining. But the company's Total Assets also don't change by much because thecash raised does not make it to the Balance Sheet - it offsets losses elsewhere in the business.

18. Should you use the company's current capital structure or optimal capital structure to calculate WACC?

A company's "optimal" capital structure is the one that minimizes WACC. But there's no way to calculate it because you can't tell in advance how the Costs of Equity and Debt will change as the capital structure changes. So in practice, you'll often use the median capital structure percentages from the comparable public companies as a proxy for the "optimal" capital structure. The logic is the same as the logic for un-levering and re-levering Beta: You want to capture what this company's capital structure should be, not what it is right now. It's better to use this expected capital structure because the company's Implied Value in a DCF is based on its expected, future cash flows.

What is a contribution analysis and why might we look at it in a merger model?

A contribution analysis compares how much Revenue, EBITDA, Pre-Tax Income, Cash, and possibly other items the buyer and seller are "contributing" to estimate what the ownership of the combined company should be. Most common to look at this with merger of equals scenarios.

What are the mechanics for mergers of equals?

A merger of equals is when two firms of about the same size come together to form a single new company. In a merger of equals, shareholders from both firms surrender their shares and receive securities issued by the new company.

What if there's an option for the management team to "roll over" its existing Equity rather than receive new shares or options?

An Equity Rollover would show up in the Sources column in the Sources & Uses table and it would reduce the amount of Equity and Debt the PE firm needs to use to acquire the company - because now the PE firm only needs to acquire 90%, or 95%, or some number less than 100%, rather than the entire company. At the end, you would also subtract some of the proceeds and allocate them to the management team rather than the PE firm when calculating returns. If nothing else changes, this reduces the PE firm's IRR - but the idea is that it also incentivizes the management team to perform well and deliver greater results, which helps everyone.

What is a earnout and why would a buyer offer it to a seller in an M&A deal?

An earnout is a form of "deferred payment" in an M&A deal- it's usually most common with private companies and startups and highly unusual for public sellers. Usually contingent on financial performance or other goals- for example, the buyer might say, "we will pay an additional 10M in 3 years if you can hit 100M in revenue by then"

What is an exchange ratio and when would companies use it in an M&A Deal?

An exchange ratio is an alternate way of structuring a 100% stock M&A deal, or any M&A deal with a portion of stock involved. Let's say you were going to buy a company for $100 million in a 100% stock deal. Normally you would determine the number of shares to issue by dividing the $100 million by the buyer's stock price. With an exchange ratio, by contrast, you would tie the number of new shares to the buyer's own shares - so the seller might receive 1.5 shares of the buyer's shares for each of its shares, rather than shares worth a specific dollar amount. Buyers might prefer to do this if they believe their stock price is going to decline post-transaction - sellers, on the other hand, would prefer a fixed dollar amount in stock unless they believe the buyer's share price will rise after the transaction.

If I give you two balance sheets, how would you get to EBITDA?

Assuming no dividends, the difference in retained earnings can be traced to net income - Then you add back taxes - Between pre-tax income and EBITDA you add back interest expense which you can get from debt*interest expense assuming no principal paydown - Add back D&A which you can get from the difference in PPE accounts over the 2 years assuming no new PPE is added and look at change in intangibles - And finally this would give you EBITDA

A company has EV/EBITDA of 10x, NI of $10, Interest of $10, $400 in Debt, no cash, Depreciation of $20, and a market cap of $200. What's the tax rate?

Find pre tax income and have net income then take difference for taxes divided by pre tax income That same company is looking to raise either debt or equity. Is there a way to quantify which they would rather raise? Interest expense / 400 times tax rate for cost of debt and compare to cost of equity Now you have an Acquiror looking to buy that company. The acquiror has a NI of $20. Would the deal be accretive or dilutive? In this same deal, what would have to happen for the deal to be neither accretive nor dilutive?

What are the different types of debt that could be used in an LBO, how risky is each, and which of them would have the highest interest rate?

First is Revolver, then term loan A, term loan b, senior notes, subordinated notes, mezzanine. Interest rates increase as your go down the capital structure. Really just Bank Debt, High Yield Bonds, Mezzanine Debt then Equity contribution(First lien secured, second lien secured, senior unsecured, seniors subordinated, subordinated, preferred stock, common stock)

Normally we create Goodwill because we pay more for a company than what its Shareholders' Equity says it's worth. But what if the opposite happens? What if we paid $1000 in Cash for a company, but its Assets were worth $2000 and its Liabilities were worth $800?

First off, you would reverse any new write-ups to Assets to handle this scenario the easy way, if possible. So if we had Asset Write-Ups of $300 then it would be easy to simply reverse those and make it so the Assets were only worth $1700, which would result in positive Goodwill instead. If it is not possible to do that - e.g. there were no Asset Write-Ups or they cannot be reversed for some reason - then we need to record a Gain on the Income Statement for this "Negative Goodwill." I/S: Gain of 200 NI up 120 at 40% Tax rate CFS: NI up 120, subtract 200 gain so cash down by 80. Under CFI record 1000 acquisition so cash down by 1080 BS: Cash down 1080 but we have 2000 new assets so assets up 920. Liabilities up 800 and CSE up 120 due to NI so both sides are up by 920.

You're analyzing a transaction where the buyer acquired 80% of the seller for $500 million. The seller's revenue was $300 million and its EBITDA was $100 million. It also had $50 million in cash and $100 million in debt. What were the revenue and EBITDA multiples for this deal?

First, calculate the Equity Value: $500 million / 80% = $625 million. That represents the value of 100% of the seller. Then, calculate Enterprise Value: $625 million - $50 million + $100 million = $675 million. The revenue multiple is $675 million / $300 million, or 2.3x, and the EBITDA multiple is $675 million / $100 million, or 6.8x.

Why do you add Noncontrolling Interests when moving from Equity Value to Enterprise Value?

First, these Noncontrolling Interests represent another investor group: Another company that the Parent Company owns a majority stake in. Enterprise Value reflects all the investor groups in a company, so you must add Noncontrolling Interests. Second, you need to do this for comparability purposes. Since the financial statements are consolidated 100% when the Parent Company owns a majority stake in the Other Company, metrics like Revenue, EBIT, and EBITDA include 100% of the Other Company's financials. Equity Value, however, includes only the value of the actual percentage the Parent owns. So if a Parent Company owns 70% of the Other Company, the Parent Company's Equity Value will include the value of that 70% stake. But its Revenue, EBIT, and EBITDA reflect 100% of the Other Company's Revenue, EBIT, and EBITDA. Therefore, you have to add the 30% the Parent Company does not own - the Noncontrolling Interest - when you move from Equity Value to Enterprise Value, so that Enterprise Value reflects 100% of that Other Company's value. Doing so ensures that metrics such as EV / Revenue and EV / EBITDA include 100% of the Other Company's value and financial contributions so that the multiples are consistent

Normally we care about the IRR for the equity investors in an LBO - the PE firm that buys the company - but how do we calculate the IRR for the debt investors?

For the debt investors, you need to calculate the interest and principal payments that they receive from the company each year. Then you simply use the IRR function in Excel and start with the negative amount of the original debt for "Year 0," assume that the interest and principal payments each year are your "cash flows" and then assume that the remaining debt balance in the final year is your "exit value." Most of time debt investors will have lower returns than for the equity investors, but if the deal goes poorly or the PE firm can't sell the company for a good price the reverse could be true

If interest rates rise, what will happen to the price of a bond?

Go down b/c inverse relationship. Existing bonds with lower interest rates become less attractive, causing their prices to drop below initial par value. Bond Yield increase, which may provide higher income for new bondholders, but existing bondholders may experience a decrease in the value of their bonds.

A company has Net Operating Losses (NOLs) of $100 included in the Deferred Tax Asset (DTA) line item on its Balance Sheet because it has been unprofitable up until this point. Now, the company finally turns a profit and has Pre-Tax Income of $200 this year. Walk me through the 3 statements and assume that the NOLs can be used as a direct tax deduction on the financial statements.

I/S: Company can apply the entire NOL balance to offset its pre tax income, so pre tax income down by 100(instead of 200) and NI down by 60 at 40% tax rate CFS: NI down by 60 but company hasn't truly lost anything- it just saved on taxes. So add back this use of NOLs and label it Deffered Taxes- should be a positive 100 which means that Cash at the bottom is up by $40. B/S: Cash is up by $40 and the DTA is down by $100 so assets side is down by $60. On other side, shareholders equity is down by 60 due to reduced NI

1. You own 70% of a company that generates Net Income of $10. Everything above Net Income on your Income Statement has already been consolidated. Walk me through how you would recognize Net Income Attributable to Noncontrolling Interests, and how it affects the 3 statements.

I/S: Net Income Attributable to Noncontrolling interests is up by $3(10 * 30%). Now Net Income Attributate to Parent is down by $3 CFS: NI down by $3, add back this charge b/c we do if fact receive this Net income in cash when you own over 50% of another company, so cash is unchanged B/S: Noncontrolling interests(included in shareholders equity) is up by $3 due to this net income, RE down by $3 b/c of reduced net income at bottom of B/S so no change.

A company you're analyzing records a Goodwill Impairment of $100. However, this Goodwill Impairment is NOT deductible for cash tax purposes. Walk me through how the 3 statements change.

I/S: Reduce pre tax income by 100 so NI down 60 at 40% tax rate. On tax income statement, pre tax income has not fallen at all and so net income stays the same... which means that cash taxes are $40 HIGHER than book taxes CFS: NI down by 60, add back 100 impairment since its non cash. Then subtract 40 from Deferred Taxes b/c Cash taxes were higher than book taxes by $40.- meaning we same some cash from reduced book income taxes in the future. Adding these up no changes in cash BS: Cash is same but goodwill is down by 100 due to impairment, so assets side is down by $100. DTL down by 40 and RE down by 60 so balance. (Remember that DTLs get created when additional future cash taxes are owed - when additional future cash taxes are paid, DTLs decrease.)

Now lets assume this 30% company issues dividends of $10. Talking into account the changes from the last questions, walk me through the 3 statements again and explain what is different now?

I/S: Same NI up by 6 CFS: NI up by 6 then subtract 6 that attribute to equity interest, then ADD $3 in CFO to reflect the dividends that we receive from these equity interests, cash up 3 B/S: Cash up 3, investment in equity up 6 then falls by 3 due to dividends so assets up 6 total. NI up 6 so RE is up 6 and balance. (The Investments in Equity Interests line item is like a "mini-Shareholder's Equity" for companies that you own less than 50% of - you add however much Net Income you can "claim," and then subtract your portion of the Dividends.)

Let's walk through a real-life example of debt modeling now... let's say that we have $100 million of debt with 5% cash interest, 5% PIK interest, and amortization of 10% per year. How do you reflect this on the financial statements?

IS: 10M interest expense so NI down by 6M at 40% tax rate CFS: NI down 6M, add back 5M PIK interest so CFO down by 1M. Repay 10M of debt each year reflected in CFF so total cash is down by 11M BS: Cash down by 11M, Debt up by 5M from PIK, but down by 10M due to principal repayment so down by net 5M. RE down by 6M from NI so balance sheet balances

Let's say that a company sells a subsidiary for $1000, paid for by the buyer in Cash. The buyer is acquiring $500 of Assets with the deal, but it's assuming no Liabilities. Assume a 40% tax rate. What happens on the 3 statements after the sale?

IS: Gain of 500 since we sold BS assets of 500 for 1000. NI now up 300 at 40% tax rate. CFS: NI up by 300, then subtract gain of 500 in CFO then add full amount of sale(1000) in CFI so cash up by 800. BS: Cash up by 800 but lost 500 in assets so assets up by 300. SE up by 300 due to NI so balance.

Would a DCF work well for an oil and gas company?

If Exploration and production focused no b/c large capex and commodity prices are cyclical and both revenue and FCF are difficult to project

What about the treatment of other securities, like Mezzanine and other Debt variations?

If interest is tax-deductible, you count them as Debt in the Levered Beta calculation; otherwise they count as Equity, just like Preferred Stock. For WACC itself, you normally look at each type of Debt separately and assume that the "Cost" is the weighted average effective interest rate on that Debt.

4. How do Pension Obligations and the Pension Expense factor into a DCF?

If you're running an Unlevered DCF and you're counting Unfunded Pension Obligations as Debt, you should exclude pension-related expenses from Unfunded obligations on the Income Statement and Cash Flow Statement, for the same reason you exclude interest payments on Debt. For a Levered FCF you would do the opposite and leave in these expenses because they're a form of "interest expense."

We're creating a DCF for a company that is planning to buy a factory for $100 in Cash in Year 4. Currently the net present value of this company, according to the DCF, is $200. How would we change the DCF to account for the factory purchase, and what would the new Enterprise Value be?

In this scenario, you would include additional CapEx spending of $100 in Year 4 of the DCF, which would reduce Free Cash Flow for that year by $100. The Enterprise Value, in turn, would decrease by the present value of $100 in Year 4. The math gets messy, but you would calculate the difference by dividing $100 by ((1 + Discount Rate)^4). Then you would subtract this amount from the Enterprise Value.

Now let's say that we decide to buy 100% of another company's subsidiary for $1000 in cash. This subsidiary has $500 in Assets and $300 in Liabilities, and we are acquiring all the Assets and assuming all the Liabilities. What happens on the statements immediately afterward?

Income Statement: No changes. Cash Flow Statement: We record $1000 for "Acquisitions" in the CFI section, so cash at the bottom is down by $1000. Balance Sheet: Cash is down by $1000 on the Assets side, but we add in the subsidiary's Assets of $500, so this side is down by $500 so far. We also create $800 worth of Goodwill because we bought this subsidiary for $1000, but (Assets Minus Liabilities) was only $200. So the Assets side is up by $300. The other side is up by $300 because of the assumed Liabilities, so both sides balance.

What are some examples of incurrence covenants? Maintenance covenants?

Incurrence: company cant take on more than X debt. Proceeds from any asset sales must be earmarked to repay debt. Company cannot make acquisitions of over X in size. Company cannot spend more than 100M on CapEx each year. Etc Maintenance: Total Debt/EBITDA, Senior Debt/EBITDA cant exceed X. EBITDA/Interest Expense, EBITDA/Cash Interst Expense cannot fall below X. Etc.

Do PE firms look for equity value or EV? Why?

Investors, such as private equity funds, will often look to include a higher figure as the Enterprise Value, to make their offer seem more attractive, with the intention of reducing this figure through adjustments to reach the Equity Value which is actually paid.

How do different types of Debt and interest options affect the IRR? For example, does it benefit the PE firm to use a higher percentage of Term Loans or a higher percentage of Senior or Subordinated Notes? What about cash vs. PIK interest?

It is almost always better to use Debt with lower interest rates and Debt that can be repaid early. Otherwise, the company's cash flows are being "wasted" because it's generating cash but the PE firm is not using this cash in any way. So all else being equal, having Term Loans rather than Senior or Subordinated Notes or Mezzanine will boost IRR; cash interest will boost IRR over PIK interest because the debt principal doesn't "balloon" over time; and lower interest rates will also boost IRR. However, this doesn't tell the whole story: sometimes a PE firm will use High- Yield Debt or debt with PIK interest anyway if the company is having cash flow issues or if it's too difficult to raise the funds via Term Loans.

Isn't it a contradiction to calculate the Cost of Stock by using the reciprocal of the Acquirer's P / E multiple? What about the Risk-Free Rate, Beta, and the Equity Risk Premium?

It's not a contradiction; it's just a different way of measuring the Cost of Equity.cThe "Reciprocal of the P / E Multiple" method measures Cost of Equity in terms of EPS impact, whereas the CAPM method measures it based on the stock's expected annual returns.

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

Leased b/c purchase EB is same for both acquisitions, but depreciation is excluded from EBITDA- so EBITDA is higher, and the EB/EBITDA multiple is lower for the one that owns its own machines. For the company with leased machines, the lease expense would show up in Operating Expenses, making EBITDA lower and the EV / EBITDA multiple higher. This shows that it would be more meaningful to use an EBIT or EBITDAR multiple to compare the two potential acquisitions.

If choosing between two companies with same rev. and margins, what are 3 things you would look at in financial statements in choosing a company to lend too?

Mainly maturity outside financials, then debt load(balance sheet), interest expense and interest coverage ratio and liquidity(drawing on revolver capacity).

How do non-recurring charges typically affect valuation multiples?

Most of the time, these charges effectively increase valuation multiples because they reduce metrics such as EBIT, EBITDA, and EPS. You could have non- recurring income as well (e.g. a one-time asset sale) which would have the opposite effects. So be aware that it works both ways, and be ready to adjust for both non- recurring expenses and non-recurring income sources.

Now you own 30% of another company. The other company earns NI of $20. Walk me through the 3 statements after you record the portion of NI that you are entitled to?

Net Income from Equity Interests line item is created below our normal NI, which results in our real NI increasing by $20 * 30% = $6. CFS: NI up 6, but subtract this $6 b/c because we haven't really received it in cash when we own less than 50% - it's not as if we control the other company and can just "take it." Cash remains unchanged. B/S: Investments in Equity Interests on Assets side is up by 6 to reflect this NI, but RE is up by 6 as well to reflect the increased NI so both sides balance

16. If you own over 50% but less than 100% of another company, what happens on the financial statements when you record the acquisition?

Noncontrolling interest. You also subtract Net Income Attributable to Noncontrolling Interests on the Income Statement - in other words, the other company's Net Income * Percentage You Do Not Own. But then you add it back on the Cash Flow Statement in the CFO section. That is just an accounting rule and has no cash impact. On the Balance Sheet, the Noncontrolling Interest line item increases by that number (Net Income Attributable to Noncontrolling Interests) each year. Retained Earnings decreases by that same number each year because it reduces Net Income, so the Balance Sheet remains in balance.

Walk me through the statements when there's $200 of tax depreciation and $100 of GAAP depreciation assuming a 20% tax rate

On B/S reflect what is on GAAP basis. This creates DTL of 100 on CFS so Net Cash up by $20. DTL up by 100, RE down by 80 balance sheet balances

Two companies have the exact same financial profiles (revenue, growth, and profits) and are purchased by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction - how could this happen?

One process was more competitive and had a lot more companies bidding on the target. One company had recent bad news or a depressed stock price so it wa acquired at a discount. They were in industries with different median multiples. The two companies have different accounting standards and have added back different items when calculating EBITDA, so the multiples are not truly comparable.

What's the difference between capital leases and operating leases? How do they affect the statements?

Operating Leases are used for short-term leasing of equipment and property, and do not involve ownership of anything. Operating lease expenses show up as Operating Expenses on the Income Statement and impact Operating Income, Pre- Tax Income, and Net Income. Capital Leases are used for longer-term items and give the lessee ownership rights; they Depreciate, incur Interest Expense, and are counted as Debt. A lease is a capital lease if any one of the following 4 conditions is true: If there's a transfer of ownership at the end of the term. If there's an option to purchase the asset at a "bargain price" at the end of the term. If the term of the lease is greater than 75% of the useful life of the asset. If the present value of the lease payments is greater than 90% of the asset's fair market value.

Walk me through at DDM?

Project the company's earnings, down to Earnings per Share (EPS). Assume a Dividend Payout Ratio - what percentage of the EPS gets paid out to shareholders in the form of Dividends - based on what the firm has done historically and how much regulatory capital it needs. Use this to calculate Dividends over the next 5-10 years. Do a check to make sure that the firm still meets its required Tier 1 Capital Ratio and other capital ratios - if not, reduce Dividends. Discount the Dividends in each year to their present value based on Cost of Equity - NOT WACC - and then sum these up. Calculate Terminal Value based on P / BV and Book Value in the final year, and then discount this to its present value based on the Cost of Equity. Sum the present value of the Terminal Value and the present values of the Dividends to calculate the company's net present value per share.

How does a DCF for a private company differ?

The mechanics are the same, but calculating Cost of Equity and WACC is problematic because you can't find the market value of Equity or Beta for private companies. So you might estimate WACC based on the median WACC of its Public Comps, and do the same for Cost of Equity if you're using that as the Discount Rate.

3. How would you adjust the Income Statement in an LBO model?

The most common adjustments: Cost Savings - Often you assume the PE firm cuts costs by laying off employees, which could affect COGS, Operating Expenses, or both. New Depreciation Expense - This comes from any PP&E write-ups in the transaction. New Amortization Expense - This includes both the amortization from written-up intangibles and from capitalized financing fees. Interest Expense on LBO Debt - You need to include both cash and PIK interest here. Sponsor Management Fees - Sometimes PE firms charge a "management fee" to a company to account for the time they spend managing it.

Differences between term loan and bond

The primary difference between Bonds and Loan is that bonds are the debt instruments issued by the company for raising the funds which are highly tradable in the market, i.e., a person holding the bond can sell it in the market without waiting for its maturity, whereas, the loan is an agreement between the two parties where one person borrows the money from another person which are not tradable generally in the market.

Walk me through an M&A premiums analysis?

The purpose of this analysis is to look at similar transactions and calculate the premiums that buyers have paid over public sellers' share prices when acquiring them. Step 1: Select precedent transactions based on industry, date, size, etc Step 2: For each transaction, get sellers share price 1 day, 20 and 60 days before transaction was announced Step 3: Calculate 1 day, 20 day, etc premium by dividing the per share purchase price by approprate share price on each day Step 4: Get the medians for each set, and then apply them to your company's current share price, share price 20 days ago, and so on to estimate how much of a premium a buyer might pay for it.

Walk me through a future share price analysis?

The purpose of this analysis is to project what a company's share price might be 1 or 2 years from now and then discount it back to its present value. Step 1: get median historical P/E multiple of public comps Step 2: apply this P/E to you companies 1 or 2 year forward projected EPS to get its implied future share price Step 3: Discount this share price back to its present value by using a discount rate in line with company's Cost of Equity. Look at range and create sensitivity tables

What discount period numbers would you use for the mid-year convention if you had a stub period - e.g. Q4 of Year 1 - in a DCF?

The rule is that you divide the stub discount period by 2, and then you simply subtract 0.5 from the "normal" discount periods for the future years.

Walk me through the most important terms of a Purchase Agreement in an M&A deal.

There are dozens, but here are the most important points: Purchase Price: Stated as a per-share amount for public companies; just a number (the Equity Purchase Price) for private companies Form of Consideration: Cash, Stock, Debt... Transaction Structure: Stock, Asset, or 338(h)(10) Treatment of Options: Assumed by the buyer? Cashed out? Ignored? Employee Retention: Do employees have to sign non-solicit or non- Compete agreements? What about management? Reps & Warranties: What must the buyer and seller claim is true about their respective businesses? No-Shop / Go-Shop: Can the seller "shop" this offer around and try to get a better deal, or must it stay exclusive to this buyer?

How can you tell whether a Goodwill Impairment will be tax-deductible?

There's no way to know for sure unless the company states it, but generally mpairment on Goodwill from acquisitions is not deductible for tax purposes. If it were, companies would have a massive incentive to start writing down the values of their acquisitions and saving on taxes from non-cash charges - which the government wouldn't like too much. Goodwill arising from other sources may be tax-deductible, but it's rare to see significant Impairment charges unless they're from acquisitions.

What about if you own between 20% and 50% of another company? How do you record this acquisition and how are the statements affected?

This case refers to an Equity Interest (AKA Associate Company) - here, you do not consolidate the statements at all. Instead, you reflect Percentage of Other Company That You Own * Value of Other Company and show it as an Asset on the Balance Sheet (Investments in Equity Interests). For example, if the other company is worth $200 and you own 30% of it, you record $60 for the Investments in Equity Interests line item. You also add Other Company's Net Income * Percentage Ownership to your own Net Income on the Income Statement, and then subtract it on the Cash Flow Statement because it's a non-cash addition. Each year, the Investments in Equity Interests line item increases by that number, and it decreases by any dividends issued from that other company to you. On the other side, Retained Earnings will also change based on the change in Net Income, so everything balances.

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

This could happen for a number of reasons: The company has just reported earnings well-above expectations and its stock price has risen in response. 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 it competitors.

Can you explain what "Pro Forma" numbers are in a merger model?

This gets confusing because there are contradictory definitions. The simplest one is that Pro Forma numbers exclude certain non-cash acquisition effects: Amortization of Newly Created Intangibles Depreciation of PP&E Write-Up Deferred Revenue Write-Down Amortization of Financing Fees Some people include all of these, other people include only some of these, and companies themselves report numbers in different ways. Excluding Amortization of Intangibles is the most common adjustment here. While a lot of companies report numbers this way, the concept itself is flawed and inconsistent because companies themselves already include existing non- cash charges like Depreciation, Amortization, and Stock-Based Compensation. To make things even more confusing, some people will also add back some or all of those items as well.

Why might a private equity firm allot some of a company's new equity in an LBO to a management option pool, and how would this affect the model?

This is done for the same reason that buyers use Earnouts in M&A deals: the PE firm wants to incentivize the management team and keep everyone on-board until they exit the investment. The difference is that there's no technical limit on how much management might receive from such an option pool: their proceeds will be a percentage of the company's final sale value. In your LBO model, you would need to calculate a per-share purchase price when the PE firm exits the investment, and then calculate how much of the proceeds go to the management team based on the Treasury Stock Method. An option pool by itself would reduce the PE firm's return, but this is offset by the fact that the companies should perform better with this incentive in place.

Wait a minute, then how can both DTAs and DTLs exist at the same time on a company's Balance Sheet? How can they both owe and save on taxes in the future?

This one's subtle, but you frequently see both of these items on the statements because a company can owe and save on future taxes - for different reasons. For example, they might have Net Operating Losses (NOLs) because they were unprofitable in early years, and those NOLs could be counted as Deferred Tax Assets. But they might also record accelerated Depreciation for tax purposes, but straight-line it for book purposes, which would result in a DTL in early years.

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

Unlike normal valuations, in an IPO valuation we only care about public company comparables - we select them as we normally would. After picking the public company comparables, we decide on the most relevant multiple(s) to use and then estimate our company's Enterprise Value based on that (or Equity Value depending on the multiple). Once we have the Enterprise Value, we work backwards to calculate Equity Value. We also have to account for the IPO proceeds in here, i.e. by adding them since we're working backwards (these proceeds are what the company receives in cash from the IPO). 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.

Rank these: 10% increase in price, 10% decrease in cost, and 10% increase in volume

Volume is the worst, then distinguishing between price and cost would rather do price increase b/c that comes with additional market share and the companies margin. Price is always 1st, and cogs vs volume based on margins. If they have a margin greater than 50% would want to go with volume as first.

if you had two identical companies (same industry, growth prospects, etc) and one was trading at 10x pe and the other 15x pe, which one would you want to acquire as an investor

Want more information, but given the information look at comps and see if there is mispricing and want to buy low sell high.

How does the Terminal Value calculation change when we use the mid-year convention?

When you're discounting the Terminal Value back to its present value, you use different numbers for the discount period depending on whether you're using the Multiples Method or Gordon Growth Method: Multiples Method: You add 0.5 to the final year discount number to reflect that you're assuming the company gets sold at the end of the year. Gordon Growth Method: You use the final year discount number as is, because you're assuming the free cash flows grow into perpetuity and that they are still received throughout the year rather than just at the end.

Bond trading at 80, 4% interest maturing in 5 years, what is YTM?

YTM is $% plus 20 appreciation /5. So 8/90.

How do you value NOLs and take them into account in a valuation?

You determine how much the NOLs will save the company in taxes in future years, and then calculate the net present value of the total future tax savings. You might look at NOLs in a valuation but you rarely factor them in - if you did, they would be treated similarly to Cash and you would subtract NOLs to go from Equity Value to Enterprise Value, and vice versa

What is the point of a "Stub period" in a DCF? Could you give m an example?

You use a stub period when you're valuing a company before or after the end of its fiscal year and there are 1 or more quarters in between the current date and the end of the fiscal year. For example, it's currently September 30th and the company's fiscal year ends on December 31st. In this case it wouldn't be correct to assume that Free Cash Flow only starts on January 1st of the next year - there are still 3 months between now and the end of the year, the company still generates FCF in those 3 months, and you need to account for it somewhere in your model. So you would calculate FCF in that 3-month period, use 0.25 for the discount period, and then use 1.25 for the discount period for the first full year of the model, 2.25 for the next year, and so on.

15. A company acquires another company for $1000 using 50% stock and 50% cash. Here's what the other company looks like: Assets of $1000 and Liabilities of $800. Using that information, combine the companies' financial statements and walk me through what the Balance Sheet looks like IMMEDIATELY after the acquisition.

The acquirer has used $500 of cash and $500 of stock to acquire the seller, and the seller's Assets are worth $1000, with Liabilities of $800 and therefore Equity of $200. In an M&A deal the Equity of the seller gets wiped out completely. So you simply add the seller's Assets and Liabilities to the acquirer's - the Assets side is up by $1000 and the Liabilities side is up by $800. Then, you subtract the cash used, so the Assets side is up by $500 only, and the other side is up by $1300 due to the $800 of Liabilities and the $500 stock issuance. Our Balance Sheet is out of balance... and that's why we need Goodwill. Goodwill equals the Purchase Price Minus the Seller's Book Value, so in this case it's equal to $1000 - $200, or $800. That $800 of Goodwill gets created on the Assets side, and so both sides are now up by $1300 and the Balance Sheet balances.

What are some things to consider why the Premium paid on some companies is larger than others (when looking at precedent transactions)

competition within the industry, presence of other bidders, motivations of buyers and sellers, general economic conditions.

Company A has EqV = 800, NI = 80; Comp B has a Purchase Equity = 200 and NI = 10 100% Stock deal how much in Pretax synergies must be realized to make the deal neither accretive or dilutive

d

Merger model question... Company A EV 600. Company B NI 20, equity 600. Is the acquisition accretive or dilutive? ^ what would be the share price premium to make cost of the deal equal to yield of deal?

d

True or false: the cost of capital for a company with 100% equity could be less than one for a company with 100% debt.

d

You have a crystal ball that accurately projects FCF for Company X DCF. Current stock price is $100, and present value of future cash flows for next ten years is $100 using 8% WACC. Business ceases to exist at Year 10 and has 0 terminal value. If you were to LBO company with 100% equity and 0% debt, what would be IRR over 10yr holding period? (8%).

d

Give us a list of items you might see in the sources and uses section and explain the less common ones for an LBO?

ources: Debt and preferred stock, investory equity, dett assumed, noncontrolling interested assumed, management rollover Uses: Equity value of company, advisory and legal fees, capitalized financing fees, debt assumed, noncontrolling interests assumed, debt refinanced, noncontrolling interests purchased Debt and Debt-like items such as existing Preferred Stock and Noncontrolling Interests can always be either assumed (remain on the Balance Sheet) or refinanced / purchased (paid off and disappear). The "Management Rollover" refers to the option to let the management team re- invest their shares and options into the deal.

Explain what a Deferred Tax Asset or Deferred Tax Liability is. How do they usually get created?

A Deferred Tax Liability (DTL) means that you need to pay additional cash taxes in the future - in other words, you've underpaid on taxes and need to make up for it in the future. Deferred Tax Asset (DTA) means that you can pay less in cash taxes in the future - you've paid too much before, and now you get to save on taxes in the future. Both DTLs and DTAs arise because of temporary differences between what a company can deduct for cash tax purposes and what they can deduct for book tax purposes. You see them most often in 3 scenarios: When companies record Depreciation differently for book and tax purposes (i.e. more quickly for tax purposes to save on taxes). When Assets get written up for book, but not tax purposes, in M&A deals. When pension contributions get recognized differently for book vs. tax purposes.

What is call protection? Would a bond or loan have call protection?

Call protection is a provision of some bonds that prohibits the issuer from buying it back for a specified period of time

How capital leases vs operating leases would impact EBITDA/valuation multiples

Capital leases can be treated as debt. Operating leases as opex on I/S an recognize as incurred. Operating capitalized as depreciation.

How would you value a company that has no profit and no revenue?

Comps and Precedent transactions with more creative multiples or fare in future DCF untile companiy earns revenue and profit

What are performance shares?

Count them as normal common shares if they are in the money, but do nothing if they are out of money unlike convertible bonds where then treated as debt

Would you rather decrease NWC by $10, increase volume sales by 10%, or decrease expense by $10

Decrease NWC(direct cash), then decrease expenses(only taxed), then increase volume sales(b/c has associated cogs and then taxes as well)

If a company pays employees with stock or cash, what leads to a higher valuation?

Depends on upside, if they believe the stock will go up higher than cash was a cheaper option.

- Tell me 10 ways in which two companies have different multple with same EBITDA

Different growth rates or potential, stability, technology, competition among bidders driving up price, congolomerate or structural discounts(things where basis of valuation may not be for EBITDA).

Walk me through Ebitda to LFCF and then Net Income to LFCF

EBITDA - Change in NWC - CAPEX - Mandatory Debt Repayments. Net Income to Common + D&A - CHange in NWX - Capex -Mandatory Debt Repayments(Net Borrowing)

If a company raises debt and repurchases shares, how would its EPS change?

EPS increase b/c less shares(denominator) and a less NI(numerator) but by less than change in denominator

Tell me about the different types of debt you could use in an LBO:

Each type of debt is arranged in order of rising interest rates - so the Revolver has the lowest interest rates, Term Loan A is slightly higher, B is slightly higher, Senior Notes are higher than Term Loan B, and so on. "Seniority" refers to the order of claims on a company's assets in a bankruptcy - the Senior Secured holders are first in line, followed by Senior Unsecured, Senior Subordinated, and then Equity Investors. "Floating" or "Fixed" Interest Rates: A "floating" interest rate is tied to LIBOR. For example, L + 100 means that the interest rate of the loan is whatever LIBOR is at currently, plus 100 basis points (1.0%). A fixed interest rate, on the other hand, would be 11%. It doesn't "float" with LIBOR or any other rate. Amortization: "Straight line" means the company pays off the principal in equal installments each year, while "bullet" means that the entire principal is due at the end of the loan's lifecycle. "Minimal" just means a low percentage of the principal each year, usually in the 1-5% range. Call Protection: Is the company prohibited from "calling back" - paying off or redeeming - the security for a certain period? This is beneficial for investors because they are guaranteed a certain number of interest payments.

When calculating FCF, you always take into account taxes. But when you calculate Terminal Value, you don't do that - isn't this inconsistent? How should you treat it?

Here's how to think about this one: First off, if you use the Gordon Growth method to calculate Terminal Value, you are taking into account taxes because you're valuing the company's Free Cash Flow into perpetuity. And if you're using the Terminal Multiple method, you're implicitly taking into account taxes because you're assuming that [Relevant Metric] * [Relevant Multiple] is the company's present value from that point onward, as of the final year. You're not assuming that the company is actually sold... just estimating what a buyer might pay for it, fully taking into account the value that the buyer would receive from its far-in-the- future, after-tax cash flows.

How could you tell if a company's stock price is inflated?

High P/E Ratio, valuation multiples are elevated, company insiders are selling, economic cycle about to turn(look in comparison to comps)

Give examples of companies that would have a beta of 1, 0 and -1

High beta is tech bio tech, negative beta is extreme defensive stock,

How does a DCF change if you are valuing a company in an emerging market?

Higher discount rate, preimium for political risk and uncertainty. Reduce managements growth or profit expectations.

Same as above, but now company issues $5 of dividends, walk me through how that is recorded on the statements?

I/S No change b/c dividends never show up on the IS CFS: CFF down by $5 b/c of the dividend, but we own 70% of other company so we actually get 70% * $5 or $3.50 in cash, and cash decreases by $1.50 as a result B/S: Assets down by 1.5 bc cash, and RE down by 1.50 due to the dividend payment

Allowance for uncollectable accounts increases by 10. Walk me through the 3 statements. (hint: Bad debt expense also increases by 10)

I/S: BDE increased by 10 so NI down by 6 at 40% tax. CFS: CFS: -6 add back 10 non cash, cash up 4 B/S: cash up 4, AR down 10 assets down 6 Shareholders equity down 6 from NI so balance

Think of a situation when precedent transactions produce a lower valuation than comps?

Rare but when substantial mismatch between the M&A market and the public markets. For example, no public companies have been acquired recently but lots of small private companies have been acquired at low valuations

5. Consider two potential investments each with 25% IRR. Why would someone choose one investment over the other?

Risk profile, liquidity needs, tax implications. Fits your investment thesis, qualitative factors, management, etc? Market sentiment.

If company A has a market share of 10%, margin of 30%, company B has a market share of 30%, margin of 10%, which company would you invest in?

Same profitability, probably go with company B b/c having additionally market share is advantageous.

I have a set of precedent transactions but I'm missing information like EBITDA for a lot of the companies, since they were private. How can I find it if it's not available via public sources?

Search online and see if you can find press releases or articles in the financial press with these numbers. Failing that, look in equity research for the buyer around the time of the transaction and see if any of the analysts estimate the seller's numbers. Also look at online sources like Capital IQ and Factset and see if any of them disclose numbers or give estimates for the deals.

Can you describe a few of the additional items that might be a part of Enterprise Value, beyond Cash, Debt, Preferred Stock, and Noncontrolling Interests, and explain whether you add or subtract each one?

Subtracted Items: Net Operating Losses - Because you can use these to reduce future taxes; may or may not be true depending on the company and deal. Short-Term and Long-Term Investments - Because theoretically you can sell these off and get extra cash. May not be true if they're illiquid. Equity Investments - Any investments in other companies where you own between 20% and 50%; this one is also partially for comparability purposes since revenue and profit from these investments shows up ithe company's Net Income, but not in EBIT, EBITDA, and Revenue (But with Equity Interests, you only subtract them if the metric you're looking at does not include Net Income from Equity Interests). Items that may be counted like Debt like items and ADDED: (Some) Operating Leases - Sometimes you need to convert Operating Leases to Capital Leases and add them as well, if they meet the criteria for qualifying as Capital Leases (see the Accounting section). Unfunded Pension Obligations - These are usually paid with something other than the company's normal cash flows, and they may be extremely large. Restructuring / Environmental Liabilities - Similar logic to Unfunded Pension Obligations. Capital LEases- Like debt, these have interest payments and may need to be repaid

What are some due diligence considerations when structuring a LBO deal?

Target company overview(understading their business model and why company wants to be bought by PE firm), Financials, Technology/patents, strategic fit, target base, legal, management, employee compensation and other documents.

What's the difference between options and warrants?

a. Mechanically, options and warrants are the same but Options are issued by companies to employees and internally. Warrants are issued by companies to and are exercised by external parties, typically offered as a sweetener for a deal to a seller

12. How do you find EBITDA for a company if you only had its Balance Sheet?

a. NEED TO MAKE ASSMPTIONS: Interest Rate, Tax Rate b. Take Net Income from Retained Earnings c. Assume interest rate and multiply by debt outstanding in LT Debt under liabilities, then add (interest expense*tax rate) for tax-adjusted interest expense add back to get EBIT d. Then add back Depreciation and Amortization, which are under PPE and Intangible Assets, respectively to get to EBITDA

What is the purpose of "calendarization"?

b/c different companies have different fiscal years→ this creates a problem b/c you can't directly compare all these periods- you always need to look at the same calendar period when you create a set of Public Comps. For example Disneys fiscal year end is unusual and in september.