WSO Finance, Accounting, and Valuation
Why Do You Subtract Cash From Enterprise Value?
One good reason is that cash has already been accounted for within the market value of equity. You also subtract cash because it can be used either to pay a dividend or to reduce debt, effectively reducing the purchase price of the company.
What Is Operating Leverage?
Operating leverage is the percentage of costs that are fixed versus variable. A company whose costs are mostly fixed has a high level of operating leverage. If a company has a high level of operating leverage, it means that much of any increase in revenue will fall straight to the bottom line in the form of profit, because the incremental cost of producing another unit is so low.
If Enterprise Value Is $150mm, And Equity Value Is $100mm, What Is Net Debt?
Since Enterprise Value = Equity Value + Net Debt + Preferred Stock + Minority Interest, if we assume there is no minority interest or preferred stock, then Net Debt will be $150mm -$100mm, or $50mm.
How Would You Calculate The Wacc Of A Private Company?
Since a private company has no market capitalization and no beta, you would most likely use the WACC for a comparable public company.
How Does Depreciation Affect The Cash Balance If It Is A Non-cash Expense?
Since depreciation is an expense, it will reduce the amount of taxes a company will pay. Since taxes are a cash expense, anything that affects them—including depreciation—will affect the cash balance.
Why Are Increases In Accounts Receivable A Cash Reduction On The Cash Flow Statement?
Since our cash flow statement starts with net income, an increase in accounts receivable is an adjustment to net income to reflect the fact that the company never actually received those funds
How Much Would You Pay For A Company With $50 Million In Revenue And $5 Million In Profit?
Since you have no information about historical or projected performance, and no details about the firm's capital structure, it would be impossible to do a DCF analysis. Assuming you know the firm's industry, you could identify a group of comparable companies and do a multiples analysis using the ratios from those most relevant to the company being valued.
Describe A Company's Typical Capital Structure.
A company's capital structure is made up of debt and equity, and there may be multiple levels of each. Debt can be senior, mezzanine, or subordinated, with senior being paid off first in the event of bankruptcy, then mezzanine, then subordinated. Since senior debt is most secure and will be paid off first in bankruptcy, it offers the lowest interest rate. The most senior debt is bank loans; the rest is bonds, which can be issued to the general public. Equity is either preferred or common stock. Preferred stock combines some features of both debt and equity: it can appreciate in value, and also pays out a consistent dividend but it has very little or no rights in a bankruptcy. Common stock is traded on the exchanges, if the company is public. In the event of bankruptcy, common stockholders have the least claim to assets in the event of liquidation, and therefore they bear the highest level of risk and earn the highest return on investment. Common shareholders are the company's owners and are entitled to profits, which may be reinvested in the business or paid as dividends.
What Is The Difference Between The Income Statement And Statement Of Cash Flows?
A company's sales and expenses (both cash and non-cash) are recorded on its Income Statement. The Statement of Cash Flows records what cash is actually being generated and used during the reporting period and where it is being spent. Other items included on the Cash Flow Statement could be issuance or repurchase of debt or equity and capital expenditures or other investments. Amortization and depreciation will be reflected as expenses on the Income Statement, but they will be added back to Net Income on the Cash Flow Statement since they are expenses but not actually a use of cash.
What Is A Dividend Discount Model?
A dividend discount model is much like a DCF, but it will use dividends rather than free cash flow. Rather than projecting out free cash flow, you project out the earnings per share for the business. Assume that a certain percentage of EPS is being paid out as a dividend based on the historical dividend policy and how much cash the company wants to retain on its Balance Sheet. Project out the dividends for the next 5-10 years just as you would with free cash flow, and then discount them back and sum them like in a DCF, but rather than using WACC, you are going to use the cost of equity for the firm. For the terminal value, you will want to use an equity valuation multiple like P/E, and then discount that back to year 0, just as you would do in a DCF. The sum of the PV's of all the dividends is the per share value of the company.
Is it possible for a company to show positive cash flows but be in grave trouble?
Absolutely. Two examples involve unsustainable improvements in working capital (a company is selling off inventory and delaying payables), and another example involves lack of revenues going forward in the pipeline.
What Is The Difference Between Accounts Payable And Accrued Expenses?
Accounts payable is typically a one-time expense with an invoice (such as the purchase of inventory) while accrued expenses are recurring (like employee expenses). Both accounts are reflected in working capital calculations.
What Is The Difference Between Accounts Receivable And Deferred Revenue?
Accounts receivable is revenue, which has been earned and recognized because the product has been delivered, but the customer has not yet paid the cash. Deferred revenue is cash that has been collected for products which have not yet been delivered, so the revenue has not yet been recognized. Accounts receivable is an asset on the Balance Sheet, whereas deferred revenue is a liability.
When Should An Investor Buy Preferred Stock?
An investor should buy preferred for the upside potential of equity while limiting risk and assuring stability of current income in the form of a dividend. Preferred stock's dividends are more secure than those from common stock, and owners of preferred stock enjoy a superior right to the company's assets, though inferior to those of debt holders, should the company go bankrupt.
How Could A Company Have Positive Ebitda And Still Go Bankrupt?
Bankruptcy occurs when a company can't make its interest or debt payments. Since EBITDA is Earnings BEFORE Interest, if a required interest payment exceeds a company's EBITDA, then if they have insufficient cash on hand, they would soon default on their debt and could eventually need bankruptcy protection.
What Is Xxx On The Balance Sheet?
Basically know what each line item on the balance sheet is
How Do You Determine Which Valuation Methodology To Use?
Because each method has unique ability to provide useful information, you don't choose just one. The best way to determine the value of a company is to use a combination of valuation techniques. For example, if you have a precedent transaction valuation that you feel is extremely accurate, you may give that result more weight. Or if you are extremely confident in your DCF analysis, you will place more emphasis on its outcome. Valuing a company is as much an art as it is a science.
When Looking At The Acquisition Of A Company, Do You Look At Equity Value Or Enterprise Value?
Because the acquiring company must purchase both liabilities and equity in order to take over the business, the buyer will need to assess the company's Enterprise Value, which includes both the debt and the equity.
What Is The Link Between The Balance Sheet And The Statement Of Cash Flows?
Beginning cash on the Statement of Cash Flows comes from the previous period's Balance Sheet. Cash from operations on the Cash Flow Statement is affected by the Balance Sheet's numbers for change in net working capital, current assets minus current liabilities. Property, plant, and equipment is another Balance Sheet item that affects the Cash Flow Statement because depreciation is based on the amount of PP&E a company has. Any change due to purchase or sale of property, plant, and equipment will affect cash from investing. Finally, the Cash Flow Statement's ending cash balance becomes the beginning cash balance on the new Balance Sheet.
What Is Beta?
Beta is a measure of the volatility of an investment compared with the market as a whole. The market has a beta of 1, while investments that are more volatile than the market have a beta greater than 1 and those that are less volatile have a beta less than 1.
What's The Difference Between Cash-based Accounting And Accrual Accounting?
CASH BASED ACCOUNTING: This form of accounting recognizes revenues and expenses as of the time cash is actually collected or disbursed. For example, if a company receives a payment on a credit card, it wouldn't be recorded as revenue until the credit card company actually deposits the money into the company's bank account. ACCRUAL ACCOUNTING: With accrual accounting, as soon as the company makes a payment or sale and believes it will pay for or be paid for a good or service, it will recognize the expense or revenue. Using the prior example, if the company is using accrual accounting, they will book the revenue as soon as they are paid, and it will show up as an accounts receivable on the Balance Sheet until the money is actually deposited into their account, at which time the accounts receivable balance will go down and the cash balance will go up.
What Are The Three Components Of The Statement Of Cash Flows?
CASH FROM OPERATIONS: Cash generated or lost through normal operations, sales, and changes in working capital (more detail on working capital below). CASH FROM INVESTING: Cash generated or spent on investing activities; may include, for example, capital expenditures (use of cash) or asset sales (source of cash). This section will also show any investments in the financial markets and operating subsidiaries. NOTE: This section can explain a large negative cash flow during the reporting period, which isn't necessarily a bad thing if it is due a large capital expenditure in preparation for future growth. CASH FROM FINANCING: Cash generated or spent on financing the business; may include proceeds from debt or equity issuance (source of cash) or cost of debt or equity repurchase (use of cash).
Why do capital expenditures increase assets (PP&E), while other cash outflows, like paying salary, taxes, etc., do not create any asset, and instead instantly create an expense on the income statement that reduces equity via retained earnings?
Capital expenditures are capitalized because of the timing of their estimated benefits - the lemonade stand will benefit the firm for many years. The employees' work, on the other hand, benefits the period in which the wages are generated only and should be expensed then. This is what differentiates an asset from an expense
What Basic Tools And Metrics Does A Financial Professional Use To Evaluate Potential Projects Or Investments? (See Accompanying Basic Finance Case Study)
Cost of Capital: An individual's cost of capital, or "discount rate" represents what he or she could earn by investing in another asset (the opportunity cost). In general, if an investment is expected to generate a return in excess of an investor's cost of capital, that investor should pursue the project. In general, equities tend to have a higher discount rate because the expected potential returns are higher, and carry more risk than fixed income (higher risk and higher reward). Bonds/debt typically have a lower discount rate because the investor's compensation is primarily limited to the interest earned on the debt instrument, rather than appreciation in price of the asset. Furthermore, the risk on the investment is also generally lower since it is more senior than equity in the waterfall in the event of a default. Interest paid on debt reduces taxable income, so there is a tax deductibility benefit from having some debt.
What Is Deferred Revenue And Why Is It A Liability?
Deferred revenue is cash that has been collected in advance for something that hasn't yet been delivered. It is a liability because it represents a product or service that is owed to the customer. For example, if you pay for a monthly gym membership a year in advance, you haven't yet received a year's worth of gym visits; therefore the company has not yet recognized the revenue since the service hasn't been earned. At the beginning of the year they will show the full amount of the subscription in deferred revenue, and that amount will decrease by 1/12 of the amount each month as issues are delivered.
What is a deferred tax asset and why might one be created?
Deferred tax asset arises when a company actually pays more in taxes to the IRS than they show as an expense on their income statement in a reporting period. Differences in revenue recognition, expense recognition (such as warranty expense), and net operating losses (NOLs) can create deferred tax assets.
What is a deferred tax liability and why might one be created?
Deferred tax liability is a tax expense amount reported on a company's income statement that is not actually paid to the IRS in that time period, but is expected to be paid in the future. It arises because when a company actually pays less in taxes to the IRS than they show as an expense on their income statement in a reporting period.
If Depreciation Is A Non-cash Expense, Then How Does It Affect The Cash Balance?
Even though depreciation is a non-cash expense, it is still tax deductible. This means that it reduces your pre-tax income, and therefore reduces the amount of taxes a company must pay, which increases the company's cash balance.
Would You Be Calculating Enterprise Value Or Equity Value When Using A Multiple Based On Free Cash Flow Or Ebitda?
EBITDA and free cash flow represent cash flows that are available to repay holders of a company's debt and equity, so a multiple based on one of those two metrics would describe the value of the firm to all investors. A multiple such as P/E ratio, based on earnings alone, represents the amount available to common shareholders after all expenses are paid, so if you used this multiple, you would be calculating the value of the firm's equity.
What Is Ebitda?
EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization. It's a good high-level indicator of a company's financial performance. Since it removes the effects of financing and accounting decisions such as interest and depreciation, it's a good way to compare the performance of different companies. It serves as a rough estimate of free cash flow and is used in the EV/EBITDA multiple to quickly establish a company's high-level valuation.
Why Might There Be Multiple Valuations Of A Single Company?
Each method of valuation will generate a different value because it is based on different assumptions, different multiples, or different comparable companies and/or transactions. Generally, the precedent transaction methodology and discounted cash flow method lead to higher valuations than comparable companies analysis or market valuation does. The precedent transaction result may be higher because the approach usually will include a "control premium" above the company's market value to entice shareholders to sell and will account for the "synergies" that are expected from the merger. The DCF approach normally produces higher valuations because analysts' projections and assumptions are usually somewhat optimistic.
What Is Enterprise Value?
Enterprise Value is the value of a firm as a whole, to both debt and equity holders. To calculate Enterprise Value in its simplest form, you take the market value of equity (aka the company's market cap), add the debt and the value of outstanding preferred stock, add the value of any minority interests the company owns, and then subtract the cash the company currently holds. Market Cap + debt + preferred stock + minority interest - cash
What is the appropriate numerator for a revenue multiple?
Enterprise value. EBIT, EBITDA, or free cash flow all have enterprise value as the numerator because the denominator is an unlevered (pre debt) measure of profitability.
What Is The Difference Between Enterprise Value And Equity Value?
Equity Value represents residual value for common shareholders after the company satisfies its outstanding obligations (net debt, preferred stock, which is senior to common equity).
Walk Me Through A Discounted Cash Flow Model
First step in the process is to build a forecast for the three financial statements based on assumptions about how the business will perform over the next five years. Could be longer, could be shorter. The forecast has to build up to free cash flow to the firm. Next, you would calculate the terminal value with either an exit multiple or the perpetuity method. Now you can discount your cash flows and terminal value to the present. Your discount rate is the Weighted Average Cost of Capital, or WACC. Use that rate to discount all your cash flows back to year zero. (Best function in excel is XNPV which accounts for unevenly spaced out cash flows). The sum of the present values of all those cash flows is the estimated present Enterprise Value of the firm according to a discounted cash flow model.
How Do You Calculate Free Cash Flow?
Free cash flow is EBIT times 1 minus the tax rate plus Depreciation and Amortization minus Capital Expenditures minus the Change in Net Working Capital. EBIT * (1-tax rate) + D&A - CapEx - Changes in net working capital
What kind of investment would have a negative beta?
Gold is an investment that has a negative beta. When the stock market goes up, the price of gold typically declines as people flee from the "safe haven" of gold. The opposite happens when the market goes down, indicating a negative correlation.
What Is Goodwill And How Does It Affect Net Income?
Goodwill is a line item in the assets section of a company's Balance Sheet. Goodwill can arise from an acquisition where the price paid for the firm being acquired is higher than the tangible assets being purchased. The difference between the price paid and the firm's book value would be accounted for in the "goodwill" section of the Balance Sheet. ---- If something happens that impairs the goodwill of the firm (such as a patent running out, an event hurting the brand, etc.), goodwill must be "written down" as an expense on the Income Statement. Impairment of goodwill affects net income in much the same way depreciation does. It is accounted for as an expense, just like depreciation is an expense, even though the company is not physically paying out cash to cover this expense.
What Is Goodwill?
Goodwill is an asset that captures excess of the purchase price over fair market value of an acquired business.
What Are Some Ways You Can Value A Company?
How I think about valuation is there are two main categories of valuation: intrinsic valuation which looks at the company on its own like a discounted cash flow analysis or leveraged buyout analysis and relative valuation which looks at the company compared to others and this would include comparable company analysis or precedent transaction analysis.
How would you choose a set of comparable companies?
I would think about what factors to look at like industry, size of the company, geography, growth rate, profitability, capital structure, and so on. Once I have set some parameters for the comp set I would conduct a search of companies through a data source like Bloomberg or capital IQ and then select a group of companies based on my search parameters.
If You Could Use Only One Financial Statement To Evaluate The Financial State Of A Company, Which Would You Choose?
I would want to see the Cash Flow Statement so I could see the actual liquidity position of the business and how much cash it is using and generating. The Income Statement can be misleading due to any number of non-cash expenses that may not truly be affecting the overall business. And the Balance Sheet alone just shows a snapshot of the Company at one point in time, without showing how operations are actually performing. But whether a company has a healthy cash balance and generates significant cash flow indicates whether it is probably financially stable, and this is what the CF Statement would show.
What Is An Initial Public Offering (Ipo)?
IPO is the acronym for Initial Public Offering. It is the first time a privately-held company sells shares of stock to the public market. Usually a company goes public to raise capital for growing the business or to allow the original owners and investors to cash out some of their investment.
When should you value a company using a revenue multiple vs. EBITDA?
If EBITDA or profits are negative then a multiples analysis will be meaningless
Why do you subtract net working capital from free cash flow?
If current assets are rising - the company is investing money in assets such as inventory. These are cash expenses that are not being captured on the income statement in operational expenses. If current liabilities are rising then the company is "gaining cash" in the sense that it has not yet paid for something that it will in the future. These might be things such as wages payable - which is being accounted for as an expense on the IS but has not yet been paid. You subtract the change in NWC capital from free cash flow because when figuring out the cash flow that is available to investors - you must account for the money that is invested into the business through NWC.
When Would You Not Want To Use A Dcf?
If you have a company that has very unpredictable cash flows, then attempting to project those cash flows and create a DCF model would not be effective or accurate. In this situation you will most likely want to use a multiples or precedent transactions analysis.
When Should An Expense Appear On The Income Statement?
In order to be on the income statement, the expense must be tax deductible and must have been incurred during the period of the income statement. Expenses that end up on the income statement are things like marketing expense, employee salaries, etc.
How Would You Value A Company With No Revenue?
In order to value a company with no revenue, such as a start up, you must project the company's cash flows for future years and then construct a discounted cash flow model of those cash flows using an appropriate discount rate. Alternatively, you could use other operating metrics to value the company as well. If you took a start-up website with 50,000 subscribers, but no revenue, you could look at a similar website's value per subscriber and apply that multiple to the website you are valuing.
I buy a piece of equipment, walk me through the impact on the 3 financial statements.
Initially, there is no impact (income statement); cash goes down, while PP&E goes up (balance sheet), and the purchase of PP&E is a cash outflow (cash flow statement). Over the life of the asset: depreciation reduces net income (income statement); PP&E goes down by depreciation, while retained earnings go down (balance sheet); and depreciation is added back (because it is a non-cash expense that reduced net income) in the cash from operations section (cash flow statement).
What Is The Difference Between Lifo And Fifo?
LIFO and FIFO are different methods of dealing with inventory and COGS in a company's accounting policy. With LIFO, the last inventory produced or purchased will be the first to be recognized when goods are sold. With FIFO, the first inventory produced or purchased will be the first recognized when goods are sold. Individual pieces of inventory will have different carrying values on the Balance Sheet depending on whether or not they are being valued using LIFO or FIFO.
How Would A $10 Increase In Depreciation Expense Affect The Each Of The Three Financial Statements?
Let's start with the Income Statement. The $10 increase in depreciation will be an expense and will reduce net income by $10 times (1-the tax rate). Assuming a 40% tax rate, this will mean a reduction in net income of 60% or $6. So $6 flows to cash from operations, where net income will be reduced by $6 but depreciation will increase by $10, resulting in an increase of ending cash by $4. Cash then flows onto the Balance Sheet where it increases by $4, PP&E decreases by $10, and retained earnings decreases by $6, keeping everything in balance.
What Is Net Working Capital?
Net Working Capital is current assets minus current liabilities. It is a measure of a company's ability to pay off its short-term liabilities with its short-term assets. A positive number means they can cover their short-term liabilities with their short-term assets. A negative number indicates that the company may have trouble paying off its creditors, which could result in bankruptcy if cash reserves are insufficient.
What Is Net Debt?
Net debt is a company's total debt minus the cash it has on the balance sheet. Net debt assumes that a company pays off any debt it can with excess cash on the balance sheet. One can simplify the Enterprise Value formula above by replacing "Debt" with "Net Debt" and removing the subtraction of Cash, since that is already built into Net Debt.
All Else Equal, Should The Wacc Be Higher For A Company With $100 Million Of Market Cap Or A Company With $100 Billion Of Market Cap?
Normally the larger company will be considered "safer" and therefore will have a lower WACC. However, depending upon their respective capital structures, the larger company could have a higher WACC.
What Is The Difference Between Accounts Payable And Prepaid Expenses?
Prepaid expenses are payments that have been made for products or services that will be delivered in the future. As the products or services are received they will be recognized as expenses on the income statement. Accounts payable is a liability for a good or service that has been received and recognized as an expense, but has not yet been paid for in cash.
What Is The Difference Between Public Equity Value And Book Value Of Equity?
Public Equity Value is the market value of a company's equity; while the book value is just an accounting number. A company can have a negative book value of equity if it has been taking large cash dividends, or running at a net loss; but it can never have a negative public Equity Value, because it cannot have negative shares or a negative stock price.
What Are Some Examples Of Items That May Need To Get Added Back To Ebitda To Get A Better Sense For The Financial Health Of A Company?
Some examples are one-time, non-recurring items like legal expenses, one-time disaster payments or events, restructuring charges, debt/equity financing expenses, etc. Any items that are not likely to continue from one year to the next may be added back to EBITDA. Other items might include non cash compensation or write down of asset values.
What Does Spreading Comps Mean?
Spreading comps means calculating relevant multiples from comparable companies and summarizing them for easy analysis and comparison. It can be challenging when a company's data and financial information must be scoured to conduct the necessary research.
Capital Asset Pricing Model (CAPM)
The Capital Assets Pricing Model, referred to as CAPM, is used to calculate the required return on equity or the cost of equity. The return on equity is equal to the risk free rate (usually the yield on a 10-year U.S. government bond) plus the company's beta (a measure of the stock's volatility in relation to the stock market) times the market risk premium. Risk free return + Beta * (market rate or return - risk free rate of return)
What is the cost of equity and how do you determine it?
The cost of equity depends on which party you are. If you are the investor, the cost of equity is the required rate of return on an investment. If you are the company, the cost of equity determines the required rate of return on a particular project or investment. There are two methods to determine cost of equity: dividend capitalization and capital asset pricing model
Why Might Two Companies With Similar Growth And Profitability Have Different Valuations?
The difference in valuation could reflect some sort of a competitive advantage that isn't represented on the financial statements. Perhaps the more valuable company is a market leader in a key region or owns uniquely valuable intellectual property or enjoys a significantly stronger management track record.
Why Would A Company Distribute Its Earnings Through Dividends To Common Stockholders?
The distribution of a dividend signals that a company is healthy and profitable, thus attracting more investors, potentially driving up the company's stock price.
Dividend capitalization (for WACC)
The dividend capitalization model can be used to calculate the cost of equity, but it requires that a company pays dividends. The calculation is based on future dividends. The theory behind the equation is the company's obligation to pay dividends is the cost of paying shareholders and therefore the cost of equity. This is a limited model in its interpretation of costs. (Dividends per share (next year) / current market value of stock) + growth rate of dividends
All Else Equal, Should The Cost Of Equity Be Higher For A Company With $100 Million Of Market Cap Or A Company With $100 Billion Of Market Cap?
Typically, a smaller company is expected to produce greater returns than a large company, meaning the smaller company is more risky and therefore would have a higher cost of equity.
Walk Me Through The Major Line Items Of An Income Statement (Negative Numbers Are Shown In Parentheses).
The first line of the Income Statement represents revenues or sales. From that you subtract the cost of goods sold, which leaves gross profit. Subtracting operating expenses, depreciation and amortization from gross profit gives you operating income. From operating income, you subtract interest expense and any other expenses (or add other income) to get pre-tax income. Then subtract tax payments and what's left is net income.
What Is The Market Risk Premium?
The market risk premium is the excess return that investors require for choosing to purchase stocks over "risk-free" securities. It is calculated as the average return on the market (normally the S&P 500, typically around 10-12%) minus the risk free rate (current yield on a 10-year Treasury).
What Is A Primary Market And What Is A Secondary Market?
The primary market is where an investment bank sells new securities before they go to market. With an IPO or bond issuance, the majority of these buyers are institutional investors who purchase large amounts of the security. The secondary market is the market on which a stock or bond trades after the primary offering—the New York Stock Exchange, American Stock Exchange, or Nasdaq, in the United States.
Walk Me Through The Ipo Process For A Company That Is Being Taken Public.
The purpose of an IPO is to issue the least number of shares possible for the highest price per share, therefore raising the most money for the lowest possible ownership percentage of the company. You do this by selling shares of the company at an attractive valuation and recruiting institutional investors (hedge funds, mutual funds, etc.) to support the client's share price once the company lists its stock on the public exchange. First, you will meet with the client to gather information like historical financials, industry information, customer data, company overview, etc. Then you will meet with lawyers to draft the company's registration documents (called an S-1 in the US), which details the business, its operations, its customers, its financials, etc. to potential investors. This goes through many revisions working with the lawyers and the SEC until all parties accept it. The bankers then take the client on a "road show" where the company is presented to institutional investors in different cities around the country (or globe). After the roadshow, and after the company has raised the capital from the institutional investors the shares of the stock will begin trading on one of the public exchanges.
Why Do You Project Out Free Cash Flows For The Dcf Model?
The reason you project FCF for the DCF is because FCF is the amount of actual cash that could hypothetically be paid out to debt holders and equity holders from the earnings of a company.
Where Do You Find The Risk-free Rate?
The risk-free rate is usually the current yield on the 10-year government treasury, which can be found on the front page of The Wall Street Journal, on Yahoo! Finance, etc. This is considered "risk-free" because the U.S. government is considered to be a risk-free borrower, meaning the government is expected never to default on its debt.
What Are The Three Main Financial Statements?
The three main financial statements are the Income Statement, the Balance Sheet, and the Statement of Cash Flows. The Income Statement shows a company's revenues, costs, and expenses, which together yield net income. The Balance Sheet shows a company's assets, liabilities, and equity and is a representation of the company's financial health/position on one particular day in time. The Cash Flow Statement starts with net income from the Income Statement; then it shows adjustments for non cash expenses, non-expense purchases such as capital expenditures, changes in working capital, or debt repayment and issuance to calculate the company's ending cash balance.
How Are The Three Main Financial Statements Connected?
The three main financial statements show separate views, and together they create a whole picture of a company's financial health. For example, the Income Statement closes with a net income figure which flows to retained earnings on the balance and cash from operations on the cash flow statement. Depreciation, which is an expense on the income statement, is added back to cash from operations on the cash flow statement. This, along with CapEx which is subtracted from cash from investing actives is used to calculate PPE on the balance sheet. The Cash Flow Statement's ending cash balance becomes the cash asset on the current period's Balance Sheet.
What is the appropriate discount rate to use in a DCF analysis?
The weighted average cost of capital
What Is The Link Between The Balance Sheet And The Income Statement?
There are many links between the Balance Sheet and the Income Statement. 1. The major link is that any net income from the Income Statement, after the payment of any dividends, is added to retained earnings. 2. In addition, debt on the Balance Sheet is used to calculate the interest expense on the Income Statement, 3.and property plant and equipment will be used to calculate any depreciation expense.
When Should A Company Issue Equity Rather Than Debt To Fund Its Operations?
There are several reasons for issuing stock rather than debt. First, if a company believes its stock price is inflated, then issuing stock can raise a lot of capital relative to the ownership sold. Second, if the projects that the company wants to fund will not generate predictable cash flows in the immediate future, then the company would want to avoid the obligation of consistent debt payments. Third, Issuing stock is also an effective way to adjust the debt/equity ratio of a company's capital structure.
How Do You Calculate A Firm's Terminal Value?
There are two ways to calculate terminal value. The first is the terminal multiple method. To use this method, you choose an operation metric (most commonly EBITDA) and apply a comparable company's multiple to that number from the final year of projections. The second method is the perpetuity growth method where you choose a modest growth rate, usually just a bit higher than the inflation rate or GDP growth rate, and assume that the company can grow at this rate infinitely. You then multiply the FCF from the final year by 1 plus the growth rate, and divide that number by the discount rate (WACC) minus the assumed growth rate.
Say I Have An Unknown Item That Belongs On The Balance Sheet. How Would I Be Able To Tell If It Should Be An Asset Or A Liability?
Think of it this way. Will the line item result in the company receiving cash in the future, or will it result in the company needing to spend cash in the future? If it will result in an increase in cash in the future, then it is an asset. If it will result in a decrease in cash in the future, then it is a liability.
When Would A Company Collect Cash From A Customer And Not Show It As Revenue? If It Isn't Revenue, What Is It?
This typically occurs when a company is paid in advance for future delivery of a good or service, such as a magazine subscription. If a customer pays for delivery of 12 months of magazines in advance, cash from that purchase goes onto the Balance Sheet as cash, but also increases deferred revenue, a liability. As each issue is delivered to the customer over the course of the year, the deferred revenue line item will go down, reducing the company's liability, while a portion of the subscription payment will be recorded as revenue.
What Is Valuation And What Is It Used For?
Valuation is the procedure of calculating the worth of an asset, security, company, etc.
What Is Wacc And How Do You Calculate It?
WACC is the acronym for Weighted Average Cost of Capital. It is used as the discount rate in a discounted cash flow analysis to calculate the present value of a company's cash flows and terminal value. WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight, and then adding the products together to determine the value.
Why would companies with similar EBITDA have different valuations?
Well one company could have large capital expenditures which would impact their free cash flow which would lower their valuation in a DCF analysis.
When Calculating Enterprise Value, Do You Use The Book Value Or The Market Value Of Equity?
When calculating a company's Enterprise Value, you use the market value of the equity (market cap) because that represents the true supply-demand value of the company's equity in the open market.
What is working capital?
Working capital is defined as current assets minus current liabilities; it tells the financial statement user how much cash is tied up in the business through items such as receivables and inventories and also how much cash is going to be needed to pay off short term obligations in the next 12 months.
Could A Company Have A Negative Book Equity Value?
Yes, a company could have a negative book Equity Value if the owners are taking out large cash dividends or if the company has been operating for a long time at a net loss, both of which reduce shareholders' equity.
What Is The Purpose Of The Changes In Working Capital Section Of The Cash Flow Statement?
You are trying to understand the cash that has been spent or generated. Not what was recognized with accrual accounting practices. An increase in working capital figure (current assets are greater than current liabilities) requires additional cash to be tied up in operations because an increase in current assets is a net outflow. In contrast, a decrease in working capital position means the firm has more cash available that can be used for other projects since an increase in current liabilities is a net inflow.
How Do You Value A Private Company?
You can value a private company with the same techniques you would use for a public company but with a few differences that make it more difficult. Financial information will likely be harder to find and potentially less complete and less reliable. Second, you can't use a straight market valuation for a company that isn't publicly traded. In addition, a DCF can be problematic because a private company won't have an equity beta to use in the WACC calculation. Finally, if you're doing a comps analysis using publicly traded companies, a 10-15% discount may be required as a 10-15% premium is paid for the public company's relative liquidity.
What Happens To Free Cash Flow If Net Working Capital Increases?
You subtract the change in Net Working Capital when you calculate Free Cash Flow, so if Net Working Capital increases, your Free Cash Flow decreases and vice versa.
