Valuation

What is a DCF/can you walk me through a DCF in under 60 seconds?

" ○ A DCF values a company with the Present Value of its Free Cash Flows plus the Present Value of its Terminal Value ○ You can divide the process into 6 steps ■ 1. Project a company's Free Cash Flows over a 5-10 year period ■ 2. Calculate the company's Discount Rate, usually using WACC (Weighted Average Cost of Capital) ■ 3. Discount and sum up the company's Free Cash Flows. ■ 4. Calculate the company's Terminal Value ■ 5. Discount the Terminal Value to its Present Value ■ 6. Add the discounted Free Cash Flows to the discounted Terminal Value.""

How to Account for RSUs

"Addition" - add units to current outstanding

How to choose Ke?

"Cost of Equity = Risk-Free Rate + Equity Risk Premium * Levered Beta. Levered Beta tells you how volatile this stock is relative to the market as a whole, factoring in both the intrinsic business risk and the risk introduced by leverage (i.e., Debt). This one is always linked to the company's country and local stock market, but no one ever agrees on how to calculate it. The main points of disagreement are: • Do you use historical numbers or projected ones? Projected ones make more sense, but how can you "project" stock market performance?• Do you use the arithmetic or geometric mean? • What period do you use? Do you go back 10 years? 20? 50? 100? Finance textbooks use numbers ranging from 3% to 11% for the ERP; we tend to use numbers in the middle of that range, such as 6-8%, for companies in developed countries like the U.S. and U.K. You could also look at sources such as Damodaran's data on the ERP in different countries and time periods to estimate it based on historical performance. The Equity Risk Premium will be significantly higher in emerging markets (Africa, Latin America, parts of Asia, etc.) because the risk and potential returns are both higher."

Formula for Enterprise Value?

"Enterprise Value = Equity Value + Debt + [Preferred Stock + Non controlling interests] - Cash and Cash Equivalents Note: Preferred Stock and NCI is optional to mention in initial question"

How to Account for Converts. A company has $200 million of convertible bonds with a par value of $1,000 per bond. The conversion price is $20.00, and the company's current share price is $30.00. How many diluted shares get created by the convertible bond?

"If Converted" Method: All or Nothing. # Converts = Issuance Amount/ Par Value of the Bond, Conversion Ratio = Par Value/Conversion price. The current share price exceeds the conversion price, so we count the shares from the convertible bond. $200 million / $1,000 = 200,000 bonds. The Conversion Ratio is $1,000 / $20.00, or 50.0, and so the Dilution = 50.0 * 200,000 bonds = 10 million shares

What are some other valuation methods we could use?

"Other valuation methods include Sum of Parts (such as for a conglomerate like GE), Liquidation Valuation, and the Dividend Discount model (used in FIG for banks / insurance)"

"Company A and Company B have identical EV/EBITDA. Company A has a higher P/E multiple. Why might this be the case?"

"Pay attention to the ""ITDA"" in EBITDA ■ Different capital structures (e.g. one has more debt and thus more interest expense) ■ Different Depreciation / Amortization ■ Different tax rates"

Which Metric do you use?

"Typically you use a range of multiples, but if choosing one - EBIT is better than EBITDA if you WANT to reflect the after-effects (or "impact") of Capital Expenditures. EBITDA might be better in an industry where CapEx matters less, such as software, Internet, services, or anything else where R&D spending drives value. But it also depends on a company's maturity - CapEx tends to be more important for high-growth companies, while it is less important for mature, stable companies"

How does raising $200m in Debt to buy a new piece of equipment affect Enterprise Value?

"■ EV +200m ■ +200m Debt ■ -200m Cash (borrowing in form of debt) ■ +200m Cash (purchase is a decrease in cash, which is subtracted from EV thereby boosting it)"

How does issuing $200m in Equity for an IPO.

"■ EV unchanged ■ +200m Equity Value ■ -200m Cash (increase is subtracted)"

What is FCF? Why do we use it in a DCF?

"○ "Free Cash Flow" means how much after-tax cash flow the company generates on a recurring basis, after you've taken into account non- cash charges, changes in Operating Assets and Liabilities, and required Capital Expenditures ○ You calculate and use Free Cash Flow in a DCF because that closely corresponds to the actual cash flow that you, as the investor, would receive each year if you bought the entire company"

Is a company with a 50x P/E overvalued or undervalued? Why?

"○ A P/E multiple alone does not tell us if it is over or undervalued... we would need to look at the industry average, the expectations for the company's growth and forward performance, and other qualitative and quantitative considerations ○ Maybe the industry average is 40x and this company seems overvalued relative to its performance, or maybe it is lagging behind and this multiple is "cheap" ○ In the REAL WORLD, that multiple may be high relative to the S&P 500's P/E, but from that number alone we can't say conclusively if it is over or undervalued"

What is Beta, and why do you have to unlever and relever it?

"○ Beta is the "riskiness" of this company relative to all other companies in the stock market ■ Ultimately a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole ■ If Beta = 1, that means that the company is just as risky as the overall index (f the market goes up by 10%, this company's stock will go up by 10%) ○ Since each company's capital structure is different, unlever to look at riskiness of company regardless of capital structure ○ Re-lever at end to reflect true risk of company, taking into account capital structure when calculating Cost of Equity"

Tell me 3 places where taxes affect a DCF.

"○ Calculating FCF (NOPAT) ○ Calculating Beta (conversion from Unlevered to Levered) ○ Calculating Cost of Debt (interest on debt is tax deductible)"

What are some flaws of comparable companies & precedent transactions?

"○ Comparable compaines ■ No two companies are 100% comparable ■ Stock market is "emotional" (multiples may be much higher / lower on certain dates based on market movements) ■ Share prices for small companies w/ thinly-traded stocks may not reflect full value ○ Precedent Transactions ■ Past transactions rarely 100% comparable (transaction structure / size of companies/ market sentiment varies greatly) ■ Data on precedents generally more difficult to find than it is for public comps., especially for acquisitions of small / private companies"

Key assumptions/drivers of a DCF?

"○ Discount Rate ○ Terminal Value ○ Revenue growth rate / margins"

Difference between Equity Value versus Shareholders' Equity?

"○ Equity Value is the market value and Shareholders' Equity is the book value ○ Equity Value could never be negative because shares outstanding and share prices can never be negative, whereas Shareholders' Equity could be positive, negative, or 0"

"What metrics do you look at for comparable companies? What additional metric do you look at for precedent transactions?"

"○ FIG → Financials, Industry, and Geography ○ Precedent → Above and Time frame (e.g. past 2 years)"

Would you rather buy a company with a high or low P/E multiple?

"○ Generally, would rather Buy low and sell high, so would want to buy one with a low P / E multiple that increases over time ○ Remember, P / E signifies how much investors are willing to pay per $1 of earnings"

"When would you rather use the Multiples Method vs. the Gordon Growth Method (GGM)?"

"○ If the industry is cyclical or multiples are hard to predict, the Gordon Growth method may be better; if multiples are easier to estimate, the Multiples Method may be better ○ Can't use GGM in industries with depleting resources (e.g. coal mine company) since it assumes cash flows exist into perpetuity"

"What would a situation be where precedent transactions is less than comparable companies?"

"○ If there are no good M&A transactions in recent years that accurately represent the current deal, you may have to extend the time range even further back and that could ultimately end up with a lower valuation ○ Similarly, if recent M&A market is poor (or equity markets are very hot), may lead to depressed valuations"

Do you use planned or targeted capital structure in WACC?

"○ If you know for sure that the company's capital structure will change in the near) future, sure, you can use the new Debt and Equity values in all these calculations ○ In real life this almost never comes up because no one "knows" how a company's capital structure will change far in advance"

"A company buys a factory for $100 in its 4th year. How would the DCF/Enterprise Value change for the company?"

"○ 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 ○ You would calculate the difference by dividing $100 by ((1 + Discount Rate)^4). Then you would subtract this amount from the Enterprise Value"

How would you change a DCF to value a highly speculative technology company?

"○ May employ a longer projection period (may take longer for company to reach "steady state" of cash flows) ○ May use a much higher Discount Rate ○ You may also adjust management's growth or profit expectations"

What is WACC, conceptually? How do you calculate it?

"○ Minimum return a company needs to earn to satisfy all of its investors (equity, debt, preferred stock holders) ○ Firm's overall cost of capital (combination of cost of equity and cost of debt) ○ You're determining the "cost" of each part of a company's capital structure, and then calculating a weighted average based on how much Equity, Debt, and Preferred Stock it has ○ WACC = Cost of Equity * % Equity + Cost of Debt * % Debt * (1 - Tax Rate) + Cost of Preferred Stock * % Preferred Stock

"If you are valuing a coal mine company, would you use the Gordon Growth Method or the Multiples Method to calculate the TV? Explain."

"○ Multiples Method ■ Gordon Growth assumes cash flows exist into perpetuity and coal is a depleting resource"

Why do you typically use 5-10 years for the projection period?

"○ Need to project cash flows until they reach a "steady state" ○ Also, that's about as far as you can reasonably predict for most companies ■ Less than 5 years would be too short to be useful; more than 10 years is too difficult to project for most companies"

How would you calculate the long-term growth rate for the GGM?

"○ Normally you use the country's long-term GDP growth rate, the rate of inflation, or something similarly conservative (~3%) ○ For companies in developed countries, a long-term growth rate over 5% would be quite aggressive since most developed economies are growing at less than 5% per year"

"A company has 10,000 shares at $20 a share. There are 100 call options at an exercise price of $10, 50 restricted stock units (RSUs) and 100 convertible bonds at a price of $10 and par value of $100. What is the diluted equity value?"

"○ Options: Company receives $1000, 100 new shares created, company able to buy back 50 shares (50 new shares) ○ Add 50 restricted stock units (so far 100 new shares) ○ Convertible Bonds ■ Par Value / Price = # of shares per convertible bond → $100/10 10 shares per convertible bond * 100 convertible bonds = 1000 new shares ■ 1000 + 100 (from prev. steps) = 1,100 → diluted share count is 11,100 ○ Diluted Equity Value = 11,100 * 20 = 222,000"

"What are the 4 main valuation methodologies? Rank them from highest to lowest and explain."

"○ Comparable Companies Analysis, Precedent Transactions, Discounted Cash Flow (DCF), & Leveraged Buyout Analysis (LBO) ○ No steady rule as to which will produce the highest valuation ○ Growthy and optimistic assumptions in a DCF might make it highest ○ On average, precedent transactions is almost always higher than comparable companies because of the control premium paid in acquisition scenarios ○ LBO is seen as a floor valuation, what a financial sponsor would shell out to realize a target IRR → typically the lowest"

Why do you add NCI/subtract cash in the EV calculation?

"○ Own over 50% of company → need to consolidate 100% of its financial statements with your own ○ ...but Equity Value only reflects the value of the percentage that you own (which is not 100%), so you need to reflect 100% of that other company in Enterprise Value → if you did not add NCI, you would only be reflecting 60%, or 70%, or however much you own ○ You subtract cash because you are receiving this when you purchase a company (technically you should only subtract away excess cash / cash excess of what you need to operate the company, but this is fine for entry-level interviews)"

What are some multiples you could use for a company with a negative Net Income?

"○ Revenue-based multiples (e.g. EV / Revenue)○ Cash-flow multiples (e.g. EV / FCF)○ Industry-specific multiples (e.g. EV / Unique Users for internet companies)"

Walk me from Revenue to FCF for Unlevered and Levered FCF.

"○ Unlevered FCF: Revenue - COGS - Operating Expenses= EBIT *(1 - tax rate) + Non-Cash expenses -Change in NWC - CapEx ■ Excludes interest and debt ○ Levered FCF: Net Income + Non-cash expenses - Change in NWC - CapEx - Mandatory Debt Repayments ■ Includes interest and debt"

What would you use as your discount rate if you are using Levered FCF? Why?

"○ You would use Cost of Equity as the Discount Rate because you only care about Equity investors there, and you're calculating Equity Value rather than Enterprise Value"

What is the mid year convention

When you use discount periods of 1, 2, 3, 4, and so on, it's not accurate because these numbers imply that the company's cash flows arrive at the end of each year. But that's not true: The company generates cash flow every day, and on average, that cash flow is evenly distributed throughout each year. So, it is more accurate to use discount periods such as 0.5, 1.5, 2.5, and 3.5 when you're calculating the Cumulative Discount Factor and the Present Value of Free Cash Flows. Using these discount periods in a DCF is known as the "Mid-Year Convention" because you're assuming that the cash flows arrive midway through each year rather than at the end.

Impact of Issuing (Repurchasing) Debt

Issuing (Repurchasing) Equity increases (decreases) Equity Value. P/E multiples change accordingly, but EV stays the same.

Stub Period

When you value a company on a specific date, much of its cash flow for the year has already been generated (unless you're valuing it on January 1st). So, you have to reduce the projected cash flow for the year by the amount that the company has already generated. For example, if it's April 30th, the company is projected to generate $1,000 in FCF for the year, and it has already generated $300, you would subtract out that $300 and use $700 for the FCF in the first period of a DCF. But you can't just subtract the already-generated cash flow - you must also change the discount periods because April 30th to December 31st represents a fraction of a year. This period from April 30th to December 31st is called the stub period.

How to Account for Options and Warrants? Diluted Equity Value if S.O.: 10 mm, Share price: $20, 1 mm options @ $10

Treasury Stock Method - assumes issue proceeds repurchase shares. To answer that, assume that all 1 million of shares get created. The company receives 1 million * $10.00, or $10 million, in proceeds. At a share price of $20.00, it can buy back half of those shares, or 500,000. So, the company ends up with 10.5 million diluted shares. The Diluted Equity Value = 10.5 million * $20.00 = $210 million.

Calculat Unlevered/ Levered Beta

Unlevered Beta = Levered Beta / (1 + Debt / Equity Ratio * (1 - Tax Rate) + Preferred / Equity Ratio) Levered Beta = Unlevered Beta * (1 + Debt / Equity Ratio * (1 - Tax Rate) + Preferred / Equity Ratio)

Precendent Transaction Multiples

Screening Criteria: You still screen by industry, geography, and size, but each rule is based on the seller. If the geographic screen is U.S.-based companies, it's fine to use a deal with a U.S.-based seller and a Japanese buyer. One additional criterion is time. Often, Precedent Transactions produce higher multiples than Public Comps because of the control premium built into M&A deals. Control premiums vary based on industry and geography, but they're often between 10% and 30%. With earn-outs, you often assume a 50% payout probability and then add 50% of the earn-out amount to the Transaction Value. Precedent Transactions are useful for valuing companies that lack good Public Comps or that have difficult-to-forecast cash flows

Biggest Drivers of DCF output

The Discount Rate and Terminal Value make the biggest impact on the DCF output. That's because the Discount Rate affects everything and because the PV of the Terminal Value often represents over 50% of the company's Implied Value.

Nuance of Levered DCF vs. Unlever

1) Cost of Equity, Not WACC 2) Subtract the Net Interest Expense and Add/Subtract Net Borrowings Effectively, you start with Net Income rather than NOPAT and factor in changes in the company's Debt principal as well. 3) Terminal Value with P / E or Equity Value-Based Multiples 4) Calculate Implied Equity Value Directly at the End 5) You Must Reflect the Items Formerly in the Bridge in the FCFs Instead - So, you now need to factor in the tax savings from NOLs, Interest Income and Interest Expense, and

Calculaing Terminal Value

1) Gordon Growth Model: Terminal Value = Final Forecast Year FCF * (1 + Terminal FCF Growth Rate) / (Discount Rate - Terminal FCF Growth Rate) - Growth rate typically below GDP growth or in line with inflation 2) Multiples Method: Terminal Value = Terminal EBITDA or EBIT or NOPAT or FCF Multiple * Relevant Metric You might base the Terminal Multiple on the multiples of publicly traded peer companies, but you often apply a substantial discount because multiples tend to decrease over time.

How to choose Kd?

1) If the company has $1,000 of bonds at a coupon rate of 5.0% and another $1,000 of bonds at a coupon rate of 6.0%, then its Pre-Tax Cost of Debt is 5.5%. 2) You could also look at the Yield to Maturity (YTM) on the Debt, which reflects its current market price, or you could look at coupon rates or the YTM of Debt issued by peer companies. Since YTM reflects market conditions, it might be closer to the rate the company would pay on additional Debt. 3) Calculate total Annual interest expense by fair market value. 4) Risk free rate + Default Spread

Other Valuation Methods

1) Liquidation 2) Dividend Discount 3) Asset Based Valuations 4) Sum of the Parts 5)LBO

Why do Kd and Ke change with different capital structures

1) Taxes - Interest PMT is tax deductible 2) Bankruptcy Risk - mandatory PMTs for Debt, not equity 3) Agency Cost - Conflicts of Interest -> Debt want conservative while Equity want risk 4) Efficient Markets - markets are expected to reflect all relevant information, but do not always.

Major Problems with Multiples

1) based on I/S items when value comes from Cash 2) Assumes Discount Rate remains the same 3) non-financial factors impact multiples( i.e. lawsuit)

Problems with Valuation Multiples

1) usually based on I/S metrics like Revenue, EBIT, EBITDA whereas value is dependent on Cash Flow 2)The Rule Assumes Discount Rates stay the same 3) Non-financial factors influence multiples (i.e. lawsuit)

"You have a company with an EV/Revenue of 2x and an EV/EBITDA of 10x. What is the EBITDA margin?"

20% (EBITDA margin = EBITDA / Revenue) "A company has a stock price of $20 a share and a P/E of 20x (so EPS is 1). The company has 10M shares outstanding. How does a 2-for-1 stock split affect EV?" Does not affect EV, there are now 20m shares outstanding and EPS is now 0.5

How to project CAPEX

Capital Expenditures must be linked to the company's sales growth. It's reasonable to make CapEx a percentage of revenue because that reflects both the company's maintenance and growth spending

What risks do Beta Represent?

Beta always reflects 2 risks: Inherent business risk and risk from leverage. When you look up a company's Beta in Google Finance or Bloomberg, it reflects both those risks. Each peer company has a different capital structure, so the risk from leverage will differ for each one. To remove this risk from leverage and isolate the inherent business risk, you have to "un-lever Beta." And then you have to "re-lever Beta" to make it reflect the risk from the leverage of the company you're valuing.

What happens to WACC with more Debt?

Debt is cheaper initially due to the tax shield and limited upside for debt investors (fixed payments). Debt will lower WACC until probability of bankruptcy increases and Cost of debt and Cost of Equity increase

What are Dilutive Securities and what impact do they have?

Dilutive Securities potentially create more shares if the shares reach a certain price. (Options, Warrants, Converts) Could be used to lower cash expenses in the short term. Convertible debt might have lower interest rate than traditional. Multiply diluted share count by current share price

What do Major Line items work? (EBIT, EBITDA, NI)

EBIT reflects operating expenses and the after-effects of CapEx, but not CapEx directly (since Depreciation reduces Operating Income); it EXCLUDES interest, taxes, and non-core activities( Sometimes closer to FCF - reflect after tax CAPEX). EBITDA is almost the same, but it does NOT include any after-effects from CapEx (sometimes close to CFO). Net Income reflects everything - operating expenses, the after-effects of CapEx (because of the Depreciation on the Income Statement), interest, taxes, and non-core business activities.

What is EV/IC?

EV / IC is more useful because it tells you how valuable a company is relative to the capital it has raised over the years. For example, if a firm has raised $1,000 total of Equity, Debt, and Preferred Stock, is its Enterprise Value now more or less than that? It tells you how efficiently a company is using its capital, and it tends to be correlated with Return on Invested Capital (ROIC), which equals NOPAT / Invested Capital. EV / IC is most useful for companies in Asset-intensive industries like manufacturing, airlines, transportation/logistics, and some telecom sectors. It's not meaningful for software, services, or biotech companies because they're more dependent on employees than capital.

Moving from Equity Value to Enterprise Value

Equity Value + Debt + Preferred = Enterprice Value. 1) Add long term funding Soruces When Mobing from Equity to Enterprise (i.e. Unfunded Pension - companies essentially borrowing from employees) 2) Add items that could cost an acquirer extra - (Debt) 3) Subtract Non Operating - non core can differ by industry (fuel hedges - core for airlines, not for tech) 4) Goodwill is incorporated becuase it is created from operations of acquired companies 5) DTAs - Subtract NOLs because of impact on cash, not the rest 6) Subtract Equity Investment (sub 50% stake) - non core business assets and needed for comparability 7) Add back NCI is using Consolidation Mehtod

3 forms of Cash Flow

FCF: CFO - CAPEX ( this includes Capital Structure i.e. interest Expense), Unlevered FCF or FCFF: EBIT*(1-Tax) + NCC - Increase NWC - CAPEX, Levered FCF or FCFE: NI to Common + NCC - Increase in NWC - CAPEX - Mandatory Debt Repayments

REIT Multiples

FFO: Net Income + D&A - Gains + Losses, instead of Net Income. It's still after Interest Expense, so the multiple is Equity Value / FFO. AFFO: FFO adjusts for other non-cash and non-recurring items. (Recurring CAPEX and Straight line Rent) NAV:based on valuing each property individually and determining the REIT's value from that. So, it's a Balance Sheet valuation rather than a super-long-term DCF.

Why would two similar companies trade at different multiples?

Higher multiple = higher expected cash flow growth rate

How to project WC

If you've already built a full 3-statement projection model for the company, this part is easy: Link to the Change in Working Capital from the Cash Flow Statement projections. If not, simplify it and project the Change in Working Capital as a percentage of the Change in Revenue or as a percentage of Revenue. Remember what the "Change in Working Capital" means: Does the company generate more cash than expected as it grows, or does it require more cash to fuel that growth?

A CEO finds $100 of Cash on the street and adds it to the company's bank account. How do Equity Value and Enterprise Value change?"

In this case, the funding source is the company's "internal operations." Since a company's Equity on the Balance Sheet represents what it has saved up internally, Equity on the Balance Sheet increases. Equity Value includes the value of core-business Assets plus non-core-business Assets, but only to common shareholders, so Equity Value increases. It increases not just because Cash is a non-core-business Asset, but also because the increase was attributed to Equity on the Balance Sheet. Enterprise Value includes only core-business Assets, but to all investors. This Cash is not a core-business Asset, and it also doesn't represent any investor group outside of equity investors. Therefore, Enterprise Value stays the same. Any multiples based on Enterprise Value, such as EV / Revenue, EV / EBITDA, and EV / EBIT, also stay the same. The P / E multiple will increase because the numerator - Equity Value - increases, but the denominator stays the same.

A company raises $1,000 in Equity and uses it to purchase PP&E. What happens?

In this question, for example, $1,000 of Equity will increase Equity Value by $1,000, but the $1,000 in extra Cash offsets the change and Enterprise Value stays the same. The PP&E is a core-business Asset, so this purchase will boost Enterprise Value by $1,000. But Equity Value stays the same after this step - it's still $1,000 higher. That's because the value of the company's Total Assets has not changed. Cash decreased by $1,000, but PP&E increased by $1,000, so Total Assets remained the same. Equity Value includes the value of all the company's Assets, so it doesn't change. If the company had purchased $1,000 in Short-Term Investments with this Cash, then its Equity Value would still be $1,000 higher for the same reason: Total Assets haven't changed. But its Enterprise Value would NOT increase because Short-Term Investments are not a core-business Asset.

What does a Higher multiple signify

Investors are willing to pay more -> cash flow growth rate is higher

Equity Value for Private Company

No straightforward way - most recent round of funding or external estimates

How can EV be negative

Non Core Assets and Cash > Debt and Equity

"Two companies are 100% comparable. Why might one trade at a premium (e.g. higher EV/EBITDA multiple)?"

One company may have high revenue growth rates or high EBITDA margins

Ranking Valuation Range

Precedent Transactions vs. Public Comps: Transactions tend to produce higher Implied Values due to the control premium. But this rule doesn't always hold up, especially if market conditions have suddenly changed. • M&A Premiums Analysis vs. Public Comps: Like the Precedent Transactions, the M&A Premiums Analysis tends to produce higher Implied Values because of the control premium. • Discounted Cash Flow Analysis: This one often produces the most variable output since it's the most dependent on far-in-the-future assumptions. But if you use reasonable assumptions, you should get reasonable results, as we did for Steel Dynamics. Liquidation Valuation: This one will produce the lowest Implied Values for healthy companies because they're worth significantly more than what their Balance Sheets suggest. • Sum of the Parts: If a company truly is worth more in "parts," then this one will produce higher Implied Values than if you valued the entire company using one DCF, one set of comparable companies, and so on. • LBO Valuation: This one tends to produce values on the lower end of the range because it tells you the maximum price a PE firm could pay to achieve a minimum IRR. Unlike the other methodologies, it sets a "ceiling" on valuation

What is a discount Rate conceptually?

The Discount Rate represents the opportunity cost for the investor - what he or she could earn each year by investing in other, similar companies. A higher Discount Rate means the risk and potential returns are both higher; a lower Discount Rate implies lower risk and lower potential returns. A higher Discount Rate makes a company less valuable because it means the investor has better options elsewhere; a lower Discount Rate makes a company more valuable because it means the investor has worse options elsewhere. If you invest proportionally in the company's entire capital structure, WACC gives you the expected, long-term annualized return

Equity Value (Practical Definition)

The value of EVERYTHING a company has (i.e., ALL its Assets), but only to EQUITY INVESTORS (i.e., common shareholders).

Enterprise Value (practical Definition)

The value of a company's core business operations to ALL the investors in the company. (Equity, Debt, Preferred, and possibly others). So, you subtract non-core-business Assets and add Liability & Equity items that represent other investor groups to make this move. The company's Cash and Investments count as "non-core-business Assets" because the company doesn't need them to sell products to customers

How to project NCC

You often project D&A as a percentage of revenue and use the average historical percentage or make it decrease slightly over time as CapEx spending falls. Deferred Income Taxes as a percentage of Income Statement Taxes should decrease over time because they represent simple timing differences. Something is wrong with your analysis if Deferred Taxes are a major value driver

How do you calculate Cost of Equity? Cost of Debt? Cost of Preferred Stock?

■ Cost of Equity = Risk-Free Rate + Equity Risk Premium * Levered Beta ■ Cost of Debt = Interest Rate on Debt ■ Cost of Preferred Stock = Effective Yield on Preferred Stock"

Why does a DCF almost always produce a higher valuation than an LBO?

○ LBO = only valued based on TV no value from cash flows in holding period) ○ DCF = takes into account both cash flows in projection period and terminal value"