Valuation Quiz Basic
13. When valuing oil and gas companies, which of the following expenses is sometimes added back to EBITDA when it is used in valuation multiples? a. Exploration Expense b. Rental Expense c. Operating Lease Expense d. Research & Development Expense
Explanation: The correct answer choice is A. Similar to the accounting mentioned above, within oil and gas sector some companies will fully expense this 'exploration costs' and thus it will appear on the income statement, whereas other companies may capitalize a certain portion of this expense, so it would skip the Income Statement and only show up on the Balance Sheet. Therefore, for 'apples-to-apples' comparison purposes, exploration expense will be added back to EBITDA when used in the denominator of an Enterprise Value-based valuation multiple.
15. When using more "creative" financial metrics - such as # of unique visitors for tech start-ups or # of subscribers for telecom companies - what should be used in the numerator of the valuation multiple, Equity Value or Enterprise Value? a. Equity Value b. Enterprise Value
Explanation: The correct answer choice is B. In the case of a high-tech pre-revenue start-up, it would be incorrect to use Equity Value in the numerator as the denominator figure - that is # of unique visitors - is an Enterprise Value figure since it would be available to both equity and debt investors. In the same way, when valuing a telecommunication company based on # of subscribers, one must use Enterprise Value in the numerator as the metric in the denominator of the multiple is available to all investors, both debt and equity.
2. All of the following are forms of intrinsic valuation methods EXCEPT: a. Precedent transaction analysis b. M&A accretion / dilution analysis c. Leveraged buyout analysis d. Dividend discount model e. Discounted cash flow analysis
Explanation: The correct answer choice is A. Answer choices B through E are all various hybrid forms of intrinsic valuation methodologies. Only precedent transaction analysis (i.e. M&A comps) is not a form of intrinsic valuation but rather a form of 100% relative valuation methodology. If you think about it, an M&A accretion / dilution analysis is based on the intrinsic earnings of the acquirer and target co. and shows the impact on the former's EPS post transaction. LBO analysis is also based on the intrinsic cash flows of the target company being considered for a buyout. The dividend discount model (DDM) is a twist on the discounted cash flow methodology (DCF) in which future dividends are projected and discounted back to determine intrinsic price per share; the DDM methodology is sector specific to financial institutions. As a general rule of thumb, intrinsic valuation is based on the cash flows specific to the company you are trying to value, whereas relative valuation determines the subject company's valuation based on various financial metrics of publicly traded "peer companies".
6. With which of the following methodologies do you determine the MAXIMUM price a company is worth based on the return that investors are targeting? a. Public Comps b. Precedent Transactions c. Leveraged Buyout Valuation d. Discounted Cash Flow Analysis e. M&A Premiums Analysis f. Liquidation Valuation g. Sum of the Parts h. Future Share Price Analysis
Explanation: C is correct, for exactly the reasons stated in the question: in an LBO valuation you assume that the PE firm needs to achieve a certain IRR (usually 20-25%) and then you work backwards and determine the maximum that it could pay to do that.
12. When valuing retail, restaurant, and airline companies, which of the following expenses is added back to EBITDA for purposes of comparing different companies in the industry? a. Research & Development Expense b. Sales & Marketing Expense c. Rental Expense d. Exploration Expense
Explanation: The correct answer choice is C. Retail, restaurants, and airline companies use a very specific financial metric in the denominator, which is basically added back to general EBITDA. 'Rental expense', as it shows up on the income statement (sometimes buried within SG&A expense overall), is added back to EBITDA, thus resulting in the EBITDAR financial metric. "Rental Expense' is added back to EBITDA for companies in these sectors for comparison purposes; companies in these sectors may either own their own buildings or rent them, and EBITDA will be higher for companies that own buildings since D&A is added back. To make both types of companies truly comparable, you add back the Rental Expense so that you completely ignore the impact from owning or renting buildings.
3. It's obvious how you calculate the Equity Value and Enterprise Value for Public Comps. How do you do it for Precedent Transactions? a. Use the share count, share price, cash, and debt from just before the target company was acquired b. Use the share count, cash, and debt from just before the target company was acquired, but use the buyer's offer price per share in the calculations c. Use the share count, share price, cash, and debt from when the transaction actually closed d. None of the above is correct
Explanation: You always go by the buyer's offer price for the seller and use that to calculate the implied Equity Value and Enterprise Value. This is why there's a "control premium" reflected in the valuation multiples for Precedent Transactions - because a buyer pays a premium over a seller's share price to acquire it. You do not normally show what the final values were at transaction close, because often in Precedent Transactions you're using transactions that haven't even closed yet - it would therefore be inconsistent to use "closed deal" values for some deals and "announcement" values for others.
You are creating a "football field" valuation summary. Public Comps imply a valuation range of $50.00 to $75.00 per share, M&A comps imply a range of $60.00 to $90.00, and the DCF implies a range of $55.00 to $80.00. What is the company worth? a. $50.00 - $90.00 per share - the full range of values b. $60.00 - $80.00 per share c. $55.00 - $80.00 per share, since the DCF is in the middle here d. $68.33 - the weighted average value
Explanation: A is unlikely because it's such a wide range that it's almost useless. You normally don't look at a full range of values and then say that a company's valuation might differ by up to 2x depending on the point you're at. C is also unlikely because you don't go by just 1 methodology. D is completely wrong because you never just assign a company's value to a single number - it's always a range of values. B is the best answer because it's in the middle of the ranges here - $60.00 is the minimum for the M&A comps, and $80.00 is the maximum for the DCF. We could be even more specific and say something like $65.00 - $75.00 per share.
4. When might you NOT use Precedent Transactions in a valuation analysis? a. If valuation multiples for transactions were significantly below valuation multiples for Public Comps b. If there were no transactions with sellers that are truly comparable to the company you're analyzing c. If you cannot successfully find good data on relevant M&A deals (i.e. they all involve small, private companies) d. If a company has 3-5 publicly traded competitors that are all very similar and have multiples in very similar ranges
Explanation: A is wrong because you can't just discard a methodology because the multiples aren't what you're looking for - that's the whole point of valuing companies in the first place. D is also wrong because just because there are good Public Comps doesn't mean you should discard Precedent Transactions - it just means you may weigh the Public Comps more heavily. B and C are the best reasons for not using Precedent Transactions - lack of comparable deals, and lack of comparable data.
4. A traditional discounted cash flow (DCF) analysis is reasonable to use when valuing companies in all of the following industries EXCEPT: a. Consumer Goods b. High-Technology c. Commercial Banks and Insurance d. Industrials and Manufacturing e. Real Estate Investment Trusts (REITs)
Explanation: Answer choices A, B, and D all constitute traditional industries in which calculated free cash flow would be meaningful to determining intrinsic value. For financial institutions "free cash flow" in the traditional sense is not a meaningful measure due to the lack of CapEx and changes in Operating Assets and Liabilities being massive, whereas for Real Estate Investment Trusts (REIT) since the industry is asset- centric, it would be more meaningful to directly value the company's assets and liabilities (i.e. a Net Asset Valuation or NAV approach).
5. You're valuing a company and the median multiples for the set of Public Comps are ABOVE the median multiples for the set of Precedent Transactions. What could this mean? a. Many of the acquired companies were performing poorly and were valued at low premiums or low multiples b. The set of Precedent Transactions is not very big, so the data may be skewed by low multiples on a few deals c. It means that there is definitely a problem with your calculations, since Precedent Transactions should always have higher multiples than Public Comps d. There is a lot of investor enthusiasm for these companies in the public markets, but not as much excitement among buyers in M&A deals e. It's impossible to speculate without having more information
Explanation: C is wrong because of the word "definitely." Just because this is the case doesn't mean there is "definitely" a problem - there may be, but there may not be. E is also wrong because we can speculate without additional information, just based on what we know of valuation methodologies. A, B, and D are the most likely reasons for this behavior - and it is not even that unusual. You'll often see scenarios like this in real life, especially if the sets of companies and deals were picked based on slightly different criteria.
11. Which of the following valuation multiples are best for COMPARATIVE purposes, as opposed to true approximations of cash flow? a. EV / EBITDA b. EV / Unlevered FCF c. P/E d. EV / EBIT e. EV / Levered FCF
Explanation: EBITDA and EBIT are the two most common profitability metrics used to compare different companies - because you exclude certain, very specific expenses when calculating them and remove the impact of capital structure, taxes, and so on. Unlevered FCF is more of a "cash flow approximation" metric and isn't the best for comparing companies because it takes much longer to calculate. P / E (and EPS) has a lot of items that differ according to the company, such as interest income / expense, D&A, taxes, and so on. Levered FCF is an even better approximation of true cash flow than Unlevered FCF, and takes even longer to calculate, so it's not as good for comparative purposes.
14. Which of the following valuation multiples would be appropriate to use for valuing a company in the oil and gas sector? a. Enterprise Value / EBITDAR b. Enterprise Value / Proved Reserves c. Enterprise Value / CapEx d. Enterprise Value / Daily Production
Explanation: In addition to EV/EBITDAX, both 'Proved Reserves' as well as 'Daily Production' can also legitimately be used in the denominator of an Enterprise Value valuation multiple for the oil and gas sector. These are relevant because oil & gas companies' revenue is subject to massive swings in commodity prices, so sometimes it is more helpful to look at their "supply" and "production" of energy instead. A is more relevant for retail, restaurants, and airlines, and C is not a commonly used multiple in any industry, because CapEx by itself is just a cash outflow.
5. A Sum of the Parts Valuation would be MOST useful for which of the following companies? a. A Public Company that focuses on a single market and has 2 fairly related business divisions b. A Private Company that serves a small, niche market and only has 1 main division c. A company on the brink of bankruptcy that is unable to repay its debts d. A large conglomerate with 3 separate and completely unrelated business divisions
Explanation: Sum of the Parts is most useful for companies with substantial but unrelated business divisions - you value each segment separately and then add together the values at the end. B is a red herring answer because public vs. private has nothing to do with it; C is also false because bankruptcy has nothing to do with it. Answer A might be a good candidate for Sum of the Parts, but D is a much better candidate since it has more business segments and since they are unrelated and therefore might be valued much differently.
6. You are valuing two early-stage, pre-revenue start-ups. Company 1 is a biotech company with high-profit potential drugs going through clinical trials. Company 2 is a hot new social gaming company. For which company is a DCF more applicable? a. Company 1 b. Company 2 c. It's completely inappropriate for both of them d. You could use it for either company with the right assumptions
Explanation: The correct answer choice is A. A DCF analysis is one of the most recognized, methodologically correct means of intrinsic valuation. However, there are certain cases in which a DCF would be less meaningful. In the case of Company 2, the social gaming company that is pre- revenue, a DCF valuation would have to rely heavily on very far-in-the-future assumptions of the company turning profitable. In these types of situations, the DCF methodology is not meaningful and a better approach would be relative valuation using "creative" multiples such as EV / Registered Users. However, in the case of Company 1, although it's not profitable yet, a far-in-the-future DCF would be more acceptable because you can more easily estimate the market size in biotech and have a sense of what drugs will cost. Multi-stage DCFs are more common in healthcare / biotech because while a drug's success probability can be very random, the numbers and success probabilities themselves are easier to estimate.
16. Both Company A and Company B are virtually identical in most regards, but Company A has three times the projected revenue growth rate of Company B. Which company would most likely have a higher EV / Revenue multiple? a. Company A b. Company B c. Both companies would have similar EV / Revenue multiples d. There is not enough information to decide
Explanation: The correct answer choice is A. Before explaining why, it should be pointed out that unless 'all- else-is-equal', the multiples can go either way and thus there is no definitive 'rule-of-thumb' in general. However, the question states that both Company A and Co. B are "...are virtually identical in most regards except..." Therefore, this would constitute an all else being equal scenario, so answer choice D would not really apply. As a general rule, when two companies are virtually identical except that one company has a higher revenue growth rate, the company with the higher growth rate will command a higher EV/Revenue multiple. In this case, Company A has three times the expected revenue growth rate as its competitor, so it would be safe to assume Co. A would command the higher revenue multiple - because investors value it more highly.
18. When valuing a financial institution such as a commercial bank, Unlevered Free Cash Flow used in a traditional DCF is modified and you instead use future projected dividends with a Dividend Discount Model. a. True b. False
Explanation: The correct answer choice is A. In general, for financial institutions the accepted methodology is to project future anticipated dividends and discount them back to present as a basis for intrinsic value of the firm rather than taking the general free cash flow available to both debt and equity holders and discounted those cash flows back to present to determine to fair value of the subject company in question. This is because most financial institutions issue dividends that are very close to the "free cash flow" they generate each year, so it is a good proxy in the absence of a traditional FCF metric.
9. Which of the multiples below is considered "capital structure-neutral?" a. Enterprise Value / Unlevered Free Cash Flow b. Equity Value / Levered Free Cash Flow c. Equity Value / Net Income d. None of the above
Explanation: The correct answer choice is A. Since Unlevered Free Cash Flow excludes interest income, interest expense, and mandatory debt repayments, it is considered capital structure-neutral. The others include some or all of those, so they are impacted by the company's capital structure.
2. Company A and Company B are exactly the same, except Company B has a 25% EBIT margin whereas Company A's EBIT margin is 15%. If the Enterprise Value of both companies is the same, which one will have a higher EV / EBIT multiple? a. Company A b. Company B c. Both should have the same multiple d. Need more information
Explanation: The correct answer choice is A. We do not have much information to work with in this question, so answer choice C may be tempting. However, we are told that both Company A and B have the same Enterprise Values, so we know both companies have same value in the numerator of their valuation multiple. All we need to know now is which company has a higher dollar EBIT, which when put in the denominator would result in a lower EV/EBIT multiple (i.e. identical numerator divided by larger denominator results in lower quotient). Again, we are not provided with dollar figures but rather percentages. However, the question states both Co. A and Co. B have identical sales, yet Co. B has a higher EBIT margin. Therefore, we have enough information to conclude that Co. B has a higher dollar EBIT figure, and thus has a lower EV/EBIT multiple. As a general rule of thumb, companies with higher profit margins - and EBIT margin is one of many proxies for this - result in lower valuation multiples if everything else is the same (usually it's not). The opposite is true for growth rates - namely, firms with higher revenue or EBIT, EBITDA, or EPS growth rates command a higher valuation multiple.
17. You are analyzing two companies, Retailer A and Retailer B, that are virtually identical except that Retailer A owns all its buildings whereas Retailer B rents all its buildings. The Depreciation Expense and the Lease Expense are the same amounts. Which company would have a higher EV / EBITDA multiple? a. Retailer A b. Retailer B
Explanation: The correct answer choice is B (Retailer B). Since Retailer A capitalizes its buildings, it would have Depreciation Expense in addition to Interest Expense on the mortgage. Retailer B, on the other hand, simply leases the building and therefore would not recognize Depreciation but rather a simple "Rental Expense" on its Income Statement. In both cases Enterprise Value (the numerator) will be identical, and so whichever retailer has a lower EBITDA value in the denominator will command a higher EV/EBITDA multiple. Between Retailer A and B, the latter will have a lower EBITDA number as the 'rental expense' will be included in its operating expenses, thus resulting in a lower EBITDA (and in turn higher EV/EBITDA multiple).
2. You are valuing a highly profitable, mature, and stable old-economy company. It has no true competitors with similar profiles, and M&A activity has been minimal. Which of the following methods would be most accurate for valuing this company? a. Comparable company analysis b. Discounted cash flow analysis c. Precedent transaction analysis d. None of the above
Explanation: The correct answer choice is B. Answer choice A sounds tempting; however, the question states "...with no 'pure play' competitors..." because the company is in a very niche sector. This being the case, the comparable company analysis methodology would not be appropriate to use in this situation. Answer choice C also seems like a possible correct choice; however, again the question states that the M&A deals that did take place in this sector were acquisitions of small, private companies, in which valuation multiples are often undisclosed, thus ruling out that methodology as well. By process of elimination, the only method remaining is DCF, which would be appropriate to use in this case, as the company is an old-economy type sector. Since it is mature and profitable and its cash flows are stable, the DCF would work particularly well here.
7. You are valuing a company that is losing money from its core business operations. Which of the multiples below would be most meaningful for valuing this company? a. Enterprise Value / EBITDA b. Enterprise Value / Revenue c. Equity Value / Net Income d. Price Per Share / Earnings Per Share (P / E) e. Enterprise Value / EBIT
Explanation: The correct answer choice is B. In the question, it states that the subject company is "losing money from its core business operations". This statement is a key indication that this company is not Operating Income (aka EBIT) positive. Therefore, using an EV / EBIT multiple would be meaningless if the denominator were a negative value. Answer choice A looks tempting as it stands to reason that after adding back depreciation and amortization (D&A) to operating income, the value could theoretically be positive. However, again the question states that this company has "almost no non-cash expenses", which would encompass D&A, among other things. Answer choice C and D are trick choices in that they both use fundamentally the same valuation multiple. It is assumed that if a company loses money from its core operations and is EBIT-negative, then it would also have negative net income (or alternatively, negative EPS), thereby making the multiple not meaningful. The correct multiple would be EV/ Revenue, which is something commonly used to value negative EBIT start-up companies with very high growth rates in top-line revenues.
6. When looking at various relative valuation multiples for the same company, which multiples would you expect to have the highest and lowest values, in order from lowest to highest numerical value? a. EV/Revenue; EV/EBIT; EV/EBITDA; P/E b. EV / Revenue; EV/EBITDA; EV/EBIT; P/E c. EV/EBITDA; EV/EBIT; EV/Revenue; P/E d. EV/Revenue; P/E; EV/EBIT; EV/EBITDA
Explanation: The correct answer choice is B. The easiest way to understand this is through a numerical example. Let's say that Company A has revenue of $100M, EBIT of $20M, net income of $8M, and depreciation and amortization of $5M. Furthermore, assume that Enterprise Value = $150M and Equity Value = $100M. Below are the values for the revenue, EBITDA, EBIT, and P/E multiples for Parent Co: 1) EV/Revenue = $150M/$100M = 1.5x 2) EV/EBITDA = $150M/($20M + $5M) = 6.0x 3) EV/EBIT = $150M/$20M = 7.5x 4) P/E = Equity Value / Net Income = $100M/$8M = 12.5x Please note here that this is not a hard-and-fast rule. Sometimes, for example, P / E might actually be lower than EV / EBIT, depending on the company, the tax rate, and its interest income. However, in general, EV / Revenue multiples tend to be the lowest numerically (since Revenue is always higher than EBITDA and EBIT), with the rest increasing; P / E tends to be highest since Net Income is almost always far lower than EBITDA, EBIT, and Revenue.
8. You are valuing a company that spends a lot on Capital Expenditures (CapEx) and has a high balance for Plants, Property & Equipment (PP&E). Which multiple below should you use when valuing companies in an industry like this? a. Enterprise Value / EBITDA b. Enterprise Value / EBIT
Explanation: The correct answer choice is B. The reason why EV/EBIT is more appropriate for valuing such a company is because the multiple leaves, in part, the effects of both Depreciation and Amortization from the PP&E balance and Capital Expenditures. Typically, EBITDA is viewed as a close proxy for cash flow; however, for companies with high CapEx spending and high D&A, EBIT will be much closer to cash flow than EBITDA.
3. All of the following are required inputs when calculating Levered Free Cash Flow (Free Cash Flow to Equity) EXCEPT: a. Operating income (EBIT) b. Depreciation & Amortization (D&A) c. (1 - Tax Rate) d. Changes in Operating Assets and Liabilities e. Capital Expenditures f. False and misleading question - all of the above are required
Explanation: The correct answer choice is B. This is a trick question because answer choice B is only needed when calculating Unlevered FCF (as opposed to Levered FCF) by taking EBIT and 'tax-affecting' it to end up with "after-tax EBIT," otherwise known as NOPAT (Net Operating Profit After Taxes). In this case, Net Income is already an after-tax metric and already includes the impact of interest income and expense, so we do not need to know the tax rate explicitly if we have Net Income. You could still use that tax rate depending on how you're calculating Levered FCF, but it is not an absolute requirement if you already have Net Income.
4. All of the following are required inputs when calculating Levered Free Cash Flow (Free Cash Flow to Equity) EXCEPT: a. Net Income b. (1 - Tax Rate) c. Depreciation & Amortization (D&A) d. Capital Expenditures e. Mandatory Debt Repayments f. False and misleading question - all of the above are required
Explanation: The correct answer choice is B. This is a trick question because answer choice B is only needed when calculating Unlevered FCF (as opposed to Levered FCF) by taking EBIT and 'tax-affecting' it to end up with "after-tax EBIT," otherwise known as NOPAT (Net Operating Profit After Taxes). In this case, Net Income is already an after-tax metric and already includes the impact of interest income and expense, so we do not need to know the tax rate explicitly if we have Net Income. You could still use that tax rate depending on how you're calculating Levered FCF, but it is not an absolute requirement if you already have Net Income.
10. All of the following valuation multiples are based on profitability EXCEPT: a. Enterprise Value / Unlevered FCF b. Equity Value / Levered FCF c. Enterprise Value / Revenue d. Enterprise Value / EBITDA
Explanation: The correct answer choice is C. All of the above are correct applications of valuation multiples (i.e. relative valuation). However, different multiples serve different purposes. The question asks for profitability multiples, which are also called 'cash-flow' multiples. Answer choices A, B, and D all represent profitability multiples, which estimate how much valuable a company is relative to its profits. Answer choice C, on the other hand, is not a profitability multiple but rather represents how valuable a company is with respect to its total sales. The key point to keep in mind is that different valuation multiples serve different purposes - that is, some exist to approximate cash flow, whereas others exist to compare different companies and normalize profitability metrics.
5. All of the following valuation multiples have the correct numerators EXCEPT: a. Enterprise Value / Revenue b. Enterprise Value / EBITDA c. Equity Value / Unlevered FCF d. Equity Value / Net Income
Explanation: The correct answer choice is C. Both answer choice A and B are correctly applied as both denominators (revenues and EBITDA, respectively) are cash flows available to both equity and debt investors, thereby making those multiples correspond to Enterprise Value figures. Answer choice D is also correctly applied, but is an example of an Equity Value figure as both the numerator and denominator are figures available only to equity investors. The reason answer choice C is incorrect is because of the use of Unlevered Free Cash Flow in the denominator, which itself is a cash flow metric available to both debt and equity investors, thereby making it an Enterprise Value figure. Hence, answer choice C would be correct if the numerator were replaced with EV, or alternatively, if the denominator was replaced with Levered FCF (which is an Equity Value figure in which cash flows are available only to equity investors), thus making both numerator and denominator of the multiple "apples-to-apples" comparison.
5. Assume that you are a financial sponsor and you're looking to invest in the manufacturing sector of the economy for a potential take-private transaction. Which of the following multiples would you most likely utilize in valuing the potential target? a. Enterprise Value / Revenue b. Price Per Share / Sales Per Share c. Enterprise Value / EBITDA d. Price / Tangible Book Value e. Price / FFO Per Share f. BothAandD
Explanation: The correct answer choice is C. EV / Revenue would only be relevant for a company with negative operating income such as a high growth start-up company. Answer choice B is fundamentally the same multiple as EV / Revenue, except for the fact it corresponds to an Equity Value figure instead of a Enterprise Value figure. Answer choice D would be correct if we were valuing a financial institution, but the question made it clear we are focusing on an "old-economy" manufacturing LBO target. Answer choice E is relevant only for REITs. The majority of the time, financial sponsors investing in a manufacturing company would focus on EV/ EBITDA, as EBITDA or EBITDA - CapEx are the most common metrics used to assess how well a company can pay off its debt obligations. While CapEx is often very high for manufacturing companies, we can simply subtract it from EBITDA to get a better picture of its true debt repayment abilities.
3. You are valuing a company that is experiencing financial distress and is rumored to be pursuing bankruptcy protection. Which of the following valuation methodologies would be MOST useful? a. Comparable company analysis b. Precedent transaction analysis c. Liquidation valuation analysis d. Leveraged buyout analysis
Explanation: The correct answer choice is C. Public comps implicitly assume healthy public companies, or at the very least make the assumption that the company will not file for bankruptcy or be delisted from the exchange. Answer choice B could theoretically include an M&A transaction in which the target was in distress and was bought. However, in practice, precedent transaction analysis includes a 'control- premium' for the target companies; most likely, we would not want to factor in a 'control-premium' for a valuation of a company on the verse of bankruptcy in high levels of distress (the purchase would instead be a 'fire-sale' type of transaction). LBO analysis is not necessarily the best methodology for bankruptcy-type situations because distressed companies can rarely repay high debt balances. Liquidation valuation is the most applicable method here, because it models what really happens in many bankruptcy scenarios: the company's assets are sold off and are used to repay its liabilities, and any remaining cash goes to common shareholders.
4. Two companies with similar revenue, growth, profit margins, and industry focus were acquired recently. Company A was acquired for a 15x EBITDA multiple and Company B was acquired for a 12x EBITDA multiple. Why might that have been the case? a. Company A held a 'broad public auction' whereas Company B was sold in a 'privately negotiated sale.' b. Company B had announced disappointing earnings recently and its stock price was depressed. c. The acquirer of Company A paid a higher premium because it found more potential synergies in A's business. d. All of the above
Explanation: The correct answer choice is D. All of the answer choices listed above can help to explain how to seemingly identical companies can be purchased for significantly different valuation multiples. Answer choice A is specific to M&A process: a broad public auction would result in a much more competitive process with multiple bidders having to outbid each other for the target company. On the flip side, a privately negotiated sale means no other bidders were approached with regards to purchasing the target company up for sale. It is very likely in fact that the same company being sold via these two different M&A methods would each result in different EBITDA multiples. Answer B is related to current events and news, and explains why companies often trade at different valuation multiples despite having similar profiles: investor expectations play a huge role in public companies' valuations. Answer C is also very common and explains why 2 potential buyers might value the same company, or similar companies, very differently: the buyers' own businesses are quite different and may be more or less complementary with seller's businesses.
3. You have just created a set of Public Comps and Precedent Transactions for a company. Why would you choose NOT to use the median multiples from the set to estimate the company's implied value? a. The company has a higher revenue growth rate than competitors b. The company has a key patent or IP that gives it an advantage c. The company has the highest market share and is the #1 player in the industry d. All of the above
Explanation: The correct answer choice is D. What this question is trying to get at is that when doing relative valuation, you do NOT always apply the median (or mean) multiple from the peer group to your subject company in all situations. A majority of the times it is a safe and conservative assumption to apply the median of the multiples calculated to the company you are trying to value. However, sometimes the subject company will trade at a premium relative to peers and other times at a discount. For instance, in the situation of answer choice A one might reasonably conclude that the subject company should not trade at the median multiple but rather at the 75th percentile. In fact, answer choices A, B, and C would all logically imply that the subject company should be trading at a premium to peers. If that were the case, instead of applying the median multiple to Subject Company's financial metric, we would apply the multiple from the 75th percentile to reflect Subject Company's perceived superiority over the peer group. Of course, in reality, you would almost always look at the full range of values and focus on the 25th percentile to 75th percentile in a real valuation.
1. All of the following represent criteria for selecting BOTH Public Comps and Precedent Transactions EXCEPT: a. Geography b. Industry c. Financial Metrics d. Time Period
Explanation: The correct answer choice is D. When spreading both Public Trading comps as well as Precedent Transaction comps, the selection criteria are usually identical - in both types of relative valuation analysis we screen for peer companies along the lines of geography, industry classification, and financial metrics. However, in the case of Precedent Transaction comps, there is the additional screening criterion of time period (e.g. only deals from the past 2 years). For M&A deals the time period is very important because markets change a lot over time.
1. When calculating Unlevered Free Cash Flow, all of the following are examples of non-cash charges that get added back to EBIT * (1 - Tax Rate) EXCEPT: a. Restructuring charges b. Depreciation & Amortization c. Stock-based compensation expense d. Goodwill Impairment e. All of the above - i.e. they all get added back
Explanation: The correct answer choice is E. All of the listed options are considered non-cash charges, which would be added back to determine Unlevered Free Cash Flow. Restructuring charges often get recognized for GAAP books but cash is not paid out thereby making it a non-cash expense that gets added back. Finally, Goodwill Impairment is a common non-cash charge that should be added back here as well since it just represents the loss of value in Goodwill, an Asset on the Balance Sheet.
2. Unlevered Free Cash Flow is defined as: EBIT + Non-Cash Charges - Change in Operating Assets and Liabilities - Capital Expenditures. a. True b. False
Explanation: There are many ways to calculate Free Cash Flow to Firm, and the above definition is almost accurate. The missing component is that EBIT needs to be "tax- affected", meaning it needs to be multiplied by (1 - Tax Rate). Therefore, the reason the definition above is incorrect is because it takes the gross amount of EBIT rather than the 'after-tax' EBIT amount. Aside from this, the rest of the formula is correct.
1. When using valuation methodologies to estimate a company's value, a Discounted Cash Flow Analysis will always produce a higher valuation for the company than a Leveraged Buyout analysis, since the DCF is based heavily on future period assumptions. a. True b. False
Explanation: This is a trick question based on a common misunderstanding of the DCF methodology. The correct answer is False. There is no clear "rule-of-thumb" that works in every case; in other words, the DCF can result in either a higher or lower valuation than the LBO analysis and thus can go either way on a case-by-case basis. The trick part of this question has to do with the rationale provided for why a DCF results in a higher valuation; a DCF can result in a higher valuation than LBO, but that is not necessarily because it is heavily based on future assumptions. In fact, both of these analyses are heavily based on future assumptions. The real difference here is that the DCF is based on, "What could happen in the future if all goes well?" whereas the LBO valuation is based on, "What can we pay to achieve a return of XX%?" If you set the required return to a low enough value, you could get a case where the LBO valuation actually exceeds the DCF valuation.
