Valuations Interview Prep

What is the most important financial statement to have if you only had one?

Cash Flow Statement because cash is always king. The cash flow statement is the best tool to evaluate the health of an organization because it showcases how much cash goes into and out of the company.

What are the 4 major valuation methodologies used?

Comparable companies analysis, precedent transaction, Discounted Cash Flow, and a leverage buyout. Make sure to google the steps of each of these valuations.

What is the formula for enterprise value?

EV = Equity Value + Debt + Minority Interest + Preferred Shares - Cash

How do you arrive at an unlevered FCF (Free Cash Flow) from revenues?

From revenue, you would have to deduct cost of goods sold and operating expenses to arrive at operating profits or EBIT, then you will have to tax adjust so EBIAT add back non cash expenses, deduct capital expenses and changes in networking capital.

What is the difference between horizontal and vertical integration?

Horizontal Integration is an expansion strategy adopted by a company that involves the acquisition of another company in the same business line. Vertical Integration refers to an expansion strategy where one company takes control over one or more stages in the production or distribution of product. This is important when thinking through the universe of potential buyers.

When should you value a company using a revenue multiple vs. EBITDA?

If a company has no profits then you value it using Revenue. Typically early stage startup companies are all valued using Revenue multiples.

Walk me through an additional $10 in depreciation?

If we increase depreciation by $10, that would come up in the Income Statement. There would be a $10 decrease in your operating profit, considering a 20% tax rate, the net profits would be down $8. On the Cash Flow Statement this -8 figure would be the first line item, but we'll have to adjust for non-cash expenses such as depreciation. Our net change in cash will be +2. When we move to the balance sheet, out cash is up by $2, but our asset is down by $10. Assets represent a -8 figure and the net income -8 will flow into retained earnings on the shareholders' side of the balance sheet. Everything balances.

Walk me through a DCF?

In a DCF the banker will make assumptions as to a company's revenue growth and expenses. Then they will project out unlevered free cash flows 5, 7, 10 years into the future and discount these projected cash flows using a discount rate known as WACC. Then they will calculate a terminal value using either the multiples method of Gordon Grow Method and once again discount this terminal value back down to the present value. You add both the present value cash flows and the present value terminal value to arrive at an enterprise value

How do the three financial statements link?

The Net Income figure will flow into the first line item of the cash flow statement and will flow into retained earning line item of the balance sheet. The net change in cash at the bottom of the cash flow statement will affect our cash position on the balance sheet. Debt raised will come up in financial activities of our Cash Flow Statement, and Interest on debt will be made evident by the interest expense figure shown on the Income Statement. Capital Expense figure will be reflected on the Balance Sheet assets under PP&E (Property, Plant & Equipment).

What is the cost of debt?

The cost of debt is how much it costs the company to take on debt. Typically, it is the blended yield to return of all debt instruments a company may have, the rate they pay on bonds.

Can you explain the cost of equity?

The cost of equity is calculated by using CAPM model which states that the cost of equity is = Risk-free rate + Beta * Market Risk Premium (expected return on the market - risk free rate). Beta would be the risk a company takes on, typically it is between 0-1 but it can definitely be higher than that. The risk premium is the spread equity investors demand for taking on additional risk.

Can you rank the valuation methodologies from highest to lowest?

There is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it's best to say it's more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions. The LBO will generally provide the lowest ("floor") valuation given financial sponsor cannot always extract synergies and are looking to hit IRR targets.

What is WACC?

WACC stands for Weighted Average Cost of Capital, the formula is cost of equity * percent of equity in the capital structure + after-tax cost of debt * percentage of debt in the capital structure. You can find the cost of equity by using the CAPM which is the Risk-Free Rate + Levered Beta * Market Risk Premium.

Could a company have a negative Enterprise Value?

Yes. It can mean that a company has an extremely large cash balance, or an extremely low market capitalization or both. An example would be companies on the brink of bankruptcy or a financial institution with large sums of cash