DCF
What is a DCF?
A discounted cash flow is a valuation method that estimates the present value of an investment, based on projections of future cash flows.
What is an LBO?
A leveraged buyout (LBO) occurs when the acquisition of another company is completed almost entirely with borrowed funds. A common example is a mortgage.
What are the three financial statements and how are they connected
Income statement --> net income flows to cash flow statement
Cash flow statement --> ending cash flows to balance sheet
Balance sheet --> cash is in assets
What does LTM EBITDA stand for?
Last Twelve Months Earnings Before Interest Taxes Depreciation and Amortization.
What is the sum of all numbers 1 to 100?
What is the first step in a DCF?
Forecasting the unlevered free cash flows. (Unlevered means it does NOT take into account a company's debt. It removes a companies capital structure and makes them more comparable)
What is the first step to an LBO?
Calculate the purchase price
When do you capitalize vs. expense items under accrual accounting?
Capitalized: Expenditures on assets benefit the firm for more than one year. Ex. PPE
Expensed: Expenditure on assets benefit the firm for less than one year. Ex. Inventory
What is an IPO?
Initial Public Offering: An IPO is a corporation's first sale of common shares to investors on a public stock exchange. It is usually done in order to raise capital for further expansion, growth, and/or development
You look at a clock. It is currently 3:15pm. What is the degree of the angle made between the minute hand and the hour hand?
7.5 degrees
How do you get from Enterprise Value to Equity Value?
Subtract net debt (or subtract debt and add cash)
What are the two most common return metrics used by private equity firms?
1. Internal Rate of Return (IRR) = [(FV/PV)^(1-t)] – 1
2. Multiple of Money (MoM): a.k.a. cash-on-cash return or multiple on invested capital (MOIC).
MoM = Total Cash Inflows/Total Cash Outflows
Let’s say I could only look at 2 statements to assess a company’s prospects – which 2 would I use and why?
You would pick the Income Statement and Balance Sheet, because you can create the Cash Flow Statement from both of those (assuming, of course that you have “before” and “after” versions of the Balance Sheet that correspond to the same period the Income Statement is tracking).
You are applying for an investment banking role and there are two sectors to pick from: DCM and ECM. What do these stand for and what to they mean?
-ECM (Equity Capital Markets): A division within an investment bank which focuses on raising equity capital
-DCM (Debt Capital Markets): A division within an investment bank which focuses on raising debt capital
You are given a 3-gallon jug and a 5-gallon jug. How do you use them to get 4 gallons of liquid?
1. Fill the 5-gallon jug and pour the contents into the 3-gallon jug, leaving 2 gallons of liquid in the 5-gallon jug.
2. Next, dump out the contents of the 3-gallon jug and pour the contents of the 2 gallons into the 3-gallon jug.
3. Fill up the 5-gallon jug and then pour the contents of the 5-gallon jug into the 3-gallon jug until the 3-gallon jug is full. You will have poured 1 gallon, (since there were already 2 in the jug) leaving 4 gallons in the 5-gallon jug.
How do you calculate WACC?
(cost of equity)(% of equity) + (cost of debt)(% of debt)(1-tax rate)
What are some characteristics of a company that would make them a great LBO candidate?
1. Stable + predictable cash flows
2. Mature + well-established business
3. Strong management team
4. Limited working capital requirements
A company has had positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen?
1. The company is spending too much on Capital Expenditures – these are not reflected at all in EBITDA, but it could still be cash-flow negative.
2. The company has high interest expense and is no longer able to afford its debt.
3. The company’s debt all matures on one date and it is unable to refinance it due to a “credit crunch” – and it runs out of cash completely when paying back the debt.
4. It has significant one-time charges (from litigation, for example) and those are high enough to bankrupt the company.
What is working capital?
Working Capital = Current Assets – Current Liabilities. If it’s positive, it means a company can pay off its short-term liabilities with its short term assets. It is often presented as a financial metric and its magnitude and sign (negative or positive) tells you whether or not the company is “sound.”
Two boats are going towards each other at 10 miles per hour. They are 5 miles apart. How long until they hit?
15 minutes.
The initial instinct is to say half an hour. However, both boats are moving at 10 miles per hour, so they are converging at 20 miles per hour, meaning they will crash in 1⁄4 of an hour.
Let's say I own a gold mine and want to make a DCF of how much the gold is valued at. What will my terminal value be if I have $100K of cash flow every year?
Zero. A gold mine has a finite amount of gold. The mine will not grow in value. When the gold has run out, the mine is worthless.
Why does an LBO typically give the lowest valuation out of all of the valuation methods?
You do not get any value from the cash flows of a company in between Year 1 and the final year – you’re only valuing it based on its terminal value.
Also, it is typically known as the "floor valuation," the lowest PE firms would pay to acquire the company. Investors want to pay as little as possible to maximize IRR!
How would a $10 increase in depreciation flow through the financial statements? (assuming a 30% tax rate)
IS: When depreciation increases by $10, EBIT would decrease by $10. Assuming a 30% tax rate, net income will decline by $7.
CFS: At the top of the CF statement, net income has decreased by $7, but the $10 depreciation will be added back since it's a non-cash expense. The impact on the ending cash balance will be a $3 increase.
BS: PP&E will decrease by $10 from the depreciation, while cash will be up by $3 on the assets side. On the L&E side, the $7 reduction in net income flows through retained earnings. The balance sheet remains in balance as both sides went down by $7.
What is a stock's Beta (β)?
Measures the expected move in a stock relative to movements in the overall market. 1 moves with the market. Less than 1 is less volatile to the market. More than 1 is more volatile to the market.
How many NYSE-listed companies have 1 letter ticker symbols?
26, but technically 24 because I & M are saved for Intel and Microsoft in case they change their minds.