IBME

Which valuation technique will produce a higher value, M&A comps or public comps, why?

(No method can be guaranteed to produce the highest valuation) Due to the control premium created from revenue or cost synergies, M&A comps will generally produce a higher valuation

Walk me through a DCF

A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value. 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. Once you have the present value of the Cash Flows, you determine the company's Terminal Value, using either the Perpetuity or Multiples 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

How can a company with positive EBITDA still go bankrupt?

A company with a large amount of Debt that create interest and and Assets that create significant taxes, insufficient cash on hand could lead them to default on their debt and need bankruptcy protection

Customer Concentration Risk

A market situation in which there are fewer customers than there are vendors, and thus the customers have greater bargaining power

Horizontal Integration

Absorption into a single firm of several firms involved in the same level of production and sharing resources at that level

If two companies are the same but one has debt on its BS, which will have a higher WACC and why?

After tax-cost of debt is usually less expensive than the cost of equity, so the company with Debt will have a lower WACC. More value is created by a lower WACC because of the resulting increase in spread between WACC and the ROIC. However, if the company has too much debt, its risk relative to the market (levered beta) may increase its cost of equity enough to increase the WACC

Balance Sheet

All economic resources available to a company at a point in time, and how they were generated

If a company has $10M in EBITDA, based on a comparables analysis you think the correct multiple is 10x; principal of outstanding debt is $150M. What is the debt approximately worth? What about the Equity?

Apply the multiple to EBITDA to get the value of Debt, $100M. The equity is worth $0 because we don't know anything about its equity profile

What's the difference between the Income Statement and Cash Flows?

Both cover cash movement over a period but they value those cash flows differently. The income statement focuses on current revenue and expenses, while cash flows considers non-cash expenses as well as long term items like financing

Why is EBITDA used as a proxy for cash flow?

By removing the effect of accounting practices for treatment of interest and D&A, it becomes a better estimate of cash generated to fund operations or service debt

What are valuation methods that are typically used to value companies?

CCA for public comps, M&A multiples / precedent transactions, DCF for intrinsic valuation, LBO, and NAV or Liquidation value

A company generated a large amount of cash selling an underutilized asset. how do you account for this in a DCF?

Cash from selling assets appears below operating income and wouldn't appear in a DCF

Cash Flow Statement

Changes in cash, what is earned and spent, over time, due to Operations, Investing, and Financing. Includes non-cash revenues and expenses, reflecting what doesn't appear on the Income Statement (CapEx, dividends)

Why is Deferred Revenue a Liability?

Company has collected the cash up front and will not receive more, but is obligated to deliver a product/service and will incur additional expenses to do so

To appear on the Income Statement

Corresponds to the period shown, and must affect the business income available to common shareholders

What is EBITDA?

Earnings Before Interest, Taxes, Depreciation & Amortization. It appears on the Income Statement and is commonly used as a proxy for cash flow

If two companies had historically identical financial profiles, explain some reasons they could be trading at different multiples

Fundamental differences such as industry, location, management, and barriers to entry can impact the growth profile of a company, even if they're the same financially

PE Rule (Accretive/Dilutive)

If a higher PE acquires a lower, the deal is accretive. If a lower PE acquires a higher, the deal is dilutive.

Choose two financial statements to analyze a company

Income Statement & Balance Sheets, if we have a beginning and ending BS, because we can derive the statement of Cash Flows Take Net Income from IS, combine Expenses and Working Capital from BS to get Operating cash flows, CapEx and items from IS/BS to get cash from Investing flows, then combine interest, dividends, and debt movement to get Financing cash flows to calculate Net Cash Flow

What happens to the statements when you increase CapEx?

Increase the cash flows from investing which decreases cash on the BS, netting out increased PP&E. Liabilities are unchanged initially, but will be reduced in subsequent periods due to depreciation which will reduce net income and flow into shareholder's equity

What might cause a company's Present Value (PV) to increase or decrease?

Increase: Expected increase in future cash flows, Higher cash flow growth rate, Lower discount rate Decrease: slower growth and higher risk

What is IRR?

Internal Rate of Return is the effective compounded interest rate on an investment. and a way to compare potential returns with the opportunity cost, and the discount rate at which NPV = 0

How do you decide whether or not to invest in a company or asset?

It makes most sense to invest when Asking price is below intrinsic value, and/or potential returns exceed opportunity costs Never invest only based on numbers; also consider qualitative and market factors

In what scenario could a company have negative Shareholders Equity?

Negative Net Income for an extended period can cause negative retained earnings, leading to negative SE. An LBO could also have the same effect, and so would a large dividend payment

How do you calculate Enterprise Value?

Net Debt, which is Debt minus cash, plus equity value. (Sum of all equity and debt, minus cash and equivalents; also referred to as the takeover value of a firm)

What is the link between BS and IS?

Net Income is the link between all financial statements, but specifically to the Shareholders Equity side of the BS via retained earnings. Additionally, debt on the balance sheet is used to calculate interest expense on the IS

What causes change in Enterprise Value?

Operating Assets or Liabilities; PP&E, Inventory, AR, Deferred Revenue

Vertical Integration

Practice where a single entity controls the entire process of a product, from the raw materials to distribution

Strategic Buyer

Primarily interested in increasing shareholder value by realizing long-term synergies; vertical & horizontal integration

Ways to reduce WACC

Reduce the cost of equity or shift the capital structure to include more debt

Shareholders Equity

Relates to company's internal operations that generate resources available to owners of the company, but is still considered a "funding source" which can come internally or externally

Beta

Relative volatility or risk with respect to the market

What is a Liability?

Results in a future obligation, such as a payment for goods or services, or repayment as in the case of debt

IS line items

Revenue minus COGS to get Gross Profit. Subtract operating expenses to get Operating income, minus interest and taxes to get Net Income

What is the formula for CAPM?

Risk free rate, plus the Company Beta multiplied by the Market Risk premium, which is the Market Return minus the Risk Free Rate

Income Statement

Shows revenue, expenses, and taxes over a period of time. It starts with Net Sales and goes down to after-tax profits- or Net Income

If two companies have the same EBITDA, what are some reasons one would be valued higher than the other?

Similar financial profiles doesn't necessarily make companies comparable. They could be in different industries, stages of business, and therefore have different drivers of cash flow and risk behind their cash flow growth

Why do we use unlevered beta?

Since debt has a positive impact on a company, investors want to measure performance in relation to market volatility without the effect of financial leverage; good for comparison of companies with different capital structures

What is an Asset?

Something that will result in a future benefit, like a cash flow, potential growth, or higher valuation

How would a $10 increase in depreciation affect the 3 financial statements?

Start with the IS, where we see increased depreciation as an expense which lowers operating profit by $10. All else equal, Taxes decrease by $10 times the tax rate (40%) which will decrease net income by $6 We carry the Net Income figure to the CF, where we see cash from Operations reduced by $6. We add back the $10 because Depreciation is a non-cash expense, which creates a net increase in cash from operations of $4 Moving to the BS, we see the cash account increase by $4, our PP&E decreased by $10, overall assets fall by $6, and our decrease in Net Income reduces Retained Earnings by $6 which allows BS to balance

If you had to pick one financial statement to assess the financial health of a company, which would it be and why?

Statement of cash flows by itself would be the best to tell how likely a company is to generate the required cash to meet its debt obligations, how much its earnings are dependent on capital expenditures, and how much is being generated from operations vs selling assets or raising debt

What business characteristics drive higher multiples?

Strong cashflow growth projections due to industry outlook or unique properties of the business like IP or barriers to entry, as well as management

How do you unlever beta?

Take each company's beta and divide it by 1 plus, 1 minus the tax rate times the debt to equity ratio (Unlevered Beta = Beta/[1+(1-tax)(D/E)])

A company generates $200 of cash flow today, and its cash flow is expected to grow at 4% per year for the long term. You could earn 10% per year by investing in other, similar companies. How much would you pay for this company?

Take the company value and divide by your opportunity cost minus your cash flow growth rate, to get the Target Price 200/(.1-.06) = 3333.33

How does depreciation affect the cash balance if it's a non-cash expense?

The Tax Shield. Depreciation is a non-cash expense, but affects the cash balance when it creates a Tax Shield by reducing the value of assets which are subject to taxes

If a company's WACC is 8%, what does that mean?

The average return you'd expect if you invested in both the debt and equity of a company to hold over the long term

Levered Beta

The beta reflecting a capital structure that includes debt. To calculate it we take an unlevered beta and multiply it by 1+, 1 minus the tax rate times the debt to equity ratio (Unlevered beta * (1+[(1-tax rate)*(debt/equity)]) )

What is WACC?

The cost of capital to a company and a commonly used discount rate used to calculate the present value of future cash flows. It represents the average return you'd expect if you invested in the Debt and Equity of a company, proportionately.

How do you calculate WACC?

The discount rate used present value projected cash flows when calculating terminal value The weighted average sum of the equity, debt, and preferred stock

How do you calculate Terminal Value?

The estimated value of asset in the future, the terminal period, and can be calculated using the Perpetuity Growth or Terminal Multiple methods. Perpetuity takes the cash flow from the terminal period and multiplies it by 1 plus the terminal growth rate, divided by the discount rate minus the growth rate. Terminal Multiples method applies a multiple to the cash flow in the terminal period

What does "Discount Rate" mean?

The opportunity cost or targeted yield of an investments, and its respective risk-return profile

What is NPV?

The present value of a business Derived from the sum of future cashflows minus the upfront investment

What is Enterprise Value?

The value of a firm's core business operations available to investors across the capital structure; operating assets minus operating liabilities. Represents the price to be paid in acquisition

Will the cost of equity (WACC) be higher for a $100M company or a $1B company?

This represents how willing investors are to provide capital to a company, so a company with a higher market cap will generally be considered more stable and therefore receive a lower risk premium

What's the link between BS and CF?

To start the statement of cash flows we use the cash balance from the balance sheet. Cash from Operations on the CF is derived from changes in BS accounts such as accounts payable or receivable. Net change in cash at the end of the CF goes on the end of period BS

How do you calculate beta for a private company?

Use public comps, unlever their betas, get an average unlevered bet a and then relever that using the debt of the private company

What is CAPM?

Used to Calculate the required/expected return on equity, or the cost of Equity ROE = Risk free rate + Company Beta * (Market Return - Risk Free Rate)

What impacts the IRR of a project, investment, or company?

Value of future cash flows and growth rate of cash flows can impact return of an investment Discount rate doesn't affect potential return- that is what you are solving for

Dilutive

When the acquiring company's EPS will decrease as a result of the merger

Accretive

When the acquiring company's EPS will increase as a result of the merger