Accounting
Walk me through how Depreciation going up by $10 would affect the statements
IS: Operating Income decline by $10, assuming a 40% tax rate, NI down by $6
CFS: NI down by $6, $10 non cash add back, cash overall up by $4
BS: Assets down $10, Cash up by $4, NI down by $6, both sides balance
Company A and Company B have identical EV/EBITDA. Company A has a higher P/E multiple. Why might this be the case?
- Different capital structures (e.g. one has more debt and thus more interest expense) - Different Depreciation / Amortization - Different tax rates
What is a DCF/can you walk me through a DCF in under 60 seconds?
No need to write answer
Walk me through a basic merger model.
"A merger model is used to analyze the financial profiles of 2 companies, the purchase price and how the purchase is made, and determines whether the buyer's EPS increases or decreases. Step 1 is making assumptions about the acquisition - the price and whether it was cash, stock or debt or some combination of those. Next, you determine the valuations and shares outstanding of the buyer and seller and project out an Income Statement for each one. Finally, you combine the Income Statements, adding up line items such as Revenue and Operating Expenses, and adjusting for Foregone Interest on Cash and Interest Paid on Debt in the Combined Pre-Tax Income line; you apply the buyer's Tax Rate to get the Combined Net Income, and then divide by the new share count to determine the combined EPS."
What actions or strategies can you take to improve the IRR in an LBO?
IRR (internal rate of return) is one of the most used metrics to determine the success of an LBO. There are several actions that a firm can take to improve the IRR, which include:
● Lowering the initial purchase price of the company, which reduces the cash investment ● Improving the exit multiple, which increases the funds received ● Increasing leverage, which reduces the amount of upfront investment required ● Conducting a dividend recapitalization ● Exiting the investment earlier ● Accelerating the company's growth, which should increase EBITDA and the exit multiple ● Improving margins, which has the same effects as faster growth ● Realizing synergies with other portfolio companies or rolling in new acquisitions
Does a $10 reduction in SG&A or $10 reduction in Capex affect FCF more
A $10 reduction in Capex increases Free Cash Flow (FCF) directly by the full $10 since Capex is subtracted from Operating Cash Flow. In contrast, a $10 reduction in SG&A increases FCF by $10 × (1 - Tax Rate), making Capex reductions typically have a greater immediate impact on FCF.
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. EBITDA / EV EV / Revenue = .1 2 = .2
If you are valuing a coal mine company, would you use the Gordon Growth Method or the Multiples Method to calculate the TV? Explain.
Would use multiples method, since Gordon Growth assumes cash flows exist into perpetuity and coal is a depleting resource
Why would a company want to acquire another company?
Several possible reasons:
• The buyer wants to gain market share by buying a competitor.
• The buyer needs to grow more quickly and sees an acquisition as a way to do that.
• The buyer believes the seller is undervalued.
• The buyer wants to acquire the seller's customers so it can up-sell and cross-sell to them.
• The buyer thinks the seller has a critical technology, intellectual property or some other "secret sauce" it can use to significantly enhance its business.
• The buyer believes it can achieve significant synergies and therefore make the deal accretive for its shareholders.
100 Term loan B at 50 cents. 500 senior notes at 25 cents. 200 subordinated notes at 10 cent. Minimum EV required for an investor to invest in the second tranche?
To determine the minimum enterprise value (EV) required for an investor to invest in the subordinated notes, we first calculate the amounts needed to fully cover the more senior tranches. The Term Loan B requires $50 of recovery at 50 cents on the dollar, and the Senior Notes require $125 of recovery at 25 cents on the dollar. Together, these total $175. For the subordinated notes to have any recovery, the EV must exceed $175. Thus, the minimum EV required is $175 for an investor to consider investing in the second tranche.
5 things a company can do with cash?
1) Finance future project / CapEx 2) Pay back debt 3) Acquisitions 4) Stock buy-backs 5) Issue cash dividends
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?
Diluted Equity Value = 11,100 * 20 = 222,000 (see below) Options: - Company receives $1000, 100 new shares created, company able to buy back 50 shares (50 new shares) RSU: - 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 three ways that lowering tax can affect a DCF valuation?
Lowering the tax rate may seem beneficial for a business by increasing net income and free cash flow, which would improve valuation. However, it also reduces the tax shield, leading to an increased after-tax cost of debt and a higher Weighted Average Cost of Capital (WACC), which lowers valuation. Additionally, a lower tax rate increases the levered beta, making equity riskier and further raising WACC, thereby reducing valuation. The overall impact depends on the combined effects of these changes, requiring a thorough analysis to determine the net effect on the Discounted Cash Flow (DCF) valuation.
Under what circumstances would $100M in revenue synergies be a straight addition to the pro forma company's EBITDA?
The synergies would be a full $100M if they were driven by a price increase and not additional unit sales. The logic here is that if you are only increasing the pricing of previous products, you will not generate any additional COGS. This could be possible if an acquisition improved your pricing power or competitive positioning in the market. It is also possible that a service or software company may be able to convert 100% of the revenue synergies into EBITDA even with higher unit sales, though less likely
There are two companies with identical growth prospects, margins, business models, etc. The only difference is that one company has 50% debt-to-total capitalization, while the other has 0%. If you were a PE firm and were going to bring the company's debt-to-total capitalization to 70%, which investment would yield a higher IRR (assuming that the equity purchase price is the same)?
First, we make the assumption that the ability to service debt is the same for both companies, so the interest rates, covenants and debt tolerance for both firms is identical. With that out of the way, we recognize that the two company's initial debt-to-total capitalization is irrelevant from a returns basis. It does not matter if you are the firm who raised the debt or if the debt was refinanced from before, the IRR and returns will be the same mathematically. At 70% debt-to-total capitalization, the EV of the two companies would be the same, implying that the IRR would be the same as well. However, this assumes that the purchase EV is the same in both situations. This is not entirely correct because sponsors typically have to pay a premium on equity (control premium), which does not apply to debt. In this case, the company with the higher debt will result in a higher IRR because it will have a lower purchase price.
Walk me through how you create a revenue model for a company.
1) Bottoms-Up Build - Start with individual products/customers - estimate the average sale value or customer value - and then the growth rate in sales and sales values to tie everything together
2) Tops-Down Build - Start with the "big-picture" metrics like overall market size - then estimate the company's market share and how that will change in the coming years - and then multiply to get their revenue Of these two methods, Bottoms-Up is more common and is taken more seriously because estimating "big-picture" numbers is almost impossible.
Let's say a company has 100 Shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each - what is its fully diluted equity value?
$1050
Basic Equity Value = $1,000 (100 * $10) To calculate the dilutive effect of the options: - First note that the 10 options are all "in-the-money" - i.e. their exercise price is less than the current share price. -When these options are exercised, there will be 10 new shares created - so the share count is now 110 rather than 100. However, this doesn't tell the whole story. In order to exercise the options, we had to "pay" the company $5 for each option (the exercise price) As a result it now has $50 in additional cash, which it now uses to buy back 5 of the new shares we created. So the fully diluted share is $105 and the fully diluted equity value is $1,050
In a DCF valuation, which of the following 3 actions increases the valuation the most: a $10 decrease in capital expenditures, a $10 decrease in expenses or a $10 increase in revenues?
● First would be a decrease in capital expenditures because it is a direct cash use and there is no tax deduction component. Decreasing capital expenditures by $10 directly improves the value of a company by $10, although it is arguable that it may hurt the ability to generate cash flows in the future
● Second would be a decrease in expenses because is only affected by tax. Flowing through an income statement, you would get a direct increase in value equal to $10 * (1-t)
● Third would be an increase in revenues because any generation of revenues requires associated COGS. In addition to COGS, gross profit would also be subject to tax, making this impact on valuation lower
Seller: 20x P/E, Buyer 25x P/E, Buyer pays a 30% premium, is this accretive or dilutive
Company XYZ has $50M EBITDA, a 6X EBITDA multiple, $200M in bank debt and $200M in high yield debt. What is the value of the debt? What dollar value is the debt trading at?
First, we can determine that the EV of the company is $300M ($50M EBITDA x 6X EBITDA multiple). We can also determine that the total debt of the company is $400M ($200M bank debt + $200M high yield debt). It is clear at this point that the company is undergoing bankruptcy. Based on this, market capitalization and cash are $0 so we allocate the EV to the different tranches of debt by their seniority. We know that bank debt has a higher priority than high yield debt so we allocate $200M from the EV to it. The remaining $100M in EV ($300M EV - $200M bank debt) represents the value of the high yield debt. The dollar value is $0.50 because it is trading at half of its full value ($100M / $200M)
How do Net Operating Losses (NOLs) affect a company's 3 financial statements?
The "quick and dirty" way to do this: 1) Reduce the Taxable Income by the portion of the NOLs that you can use each year 2) Apply the same tax rate 3) Subtract that new Tax number from your old Pretax Income number (which should stay the same
How it should be done: 1) Create a book vs cash tax schedule where you calculate the Taxable Income based on NOLs 2) Look at what you would pay in taxes without the NOLs 3) Book the difference as an increase to the Deferred Tax Liability on the Balance Sheet
Why do you add unfunded pension obligations to enterprise value?
You might add back Unfunded Pension Obligations to enterprise value during valuation because they represent a financial liability that functions like debt. These obligations reflect future payments the company is committed to making, and incorporating them ensures a more accurate representation of the company's total obligations when calculating enterprise value, which accounts for both equity and debt-like liabilities.
We're creating a DCF for a company that is planning to buy a factory for $100 in cash (no debt or other financing) in Year 4. Currently the present value of its Enterprise Value according to the DCF is $200. How would we change the DCF to account for the factory purchase, and what would our new Enterprise Value be?
In this scenario, you would add CapEx spending of $100 in year 4 of the DCF, which would reduce Free Cash Flow in that year by $100. The Enterprise Value, in turn, would fall by the present value of that $100 decrease in Free Cash Flow. The actual math here is messy but you would calculate the present value by dividing $100 by ((1 + Discount Rate)^4 - the "4" just represents year 4 here. Then you would subtract this amount from the Enterprise Value.
Company C has a net income of 200, share price of $6 and has 10 shares outstanding. Company B has a net income of 200, share price of $5 and has 6 shares outstanding. If Company C purchases Company D in an all stock deal at a 20% premium, what is the % change in accretion or dilution?
Here, we have to calculate the actual % change in accretion or dilution, so we must flow through the actual calculations to determine the change in pro forma EPS. We must first determine the EPS of Company C by dividing the net income of $200 by the 10 shares outstanding, resulting in an EPS of $20. Next, we determine the purchase price of Company D. We can accomplish this by calculating the market capitalization (share price of $5 x 6 shares outstanding equaling a $30 market cap) and applying the premium of 20% ($30 market cap. x 120% = $36 purchase price). Because this is an all stock deal, we divide the Company D's $36 purchase by Company C's $6 share price. This implies that 6 new shares will be created and given to Company D's shareholders ($36/$6 = 6). We add this number to Company C's existing share count of 10 to get to a pro forma share total of 16 shares. Next, we get the pro forma earnings by simply adding the net income from both companies: $200 + $200 = $400. We then divide this by the pro forma shares of 16 to arise at an EPS of $25 ($400 / 16). This is higher than the original EPS of $20 so we know that the deal is accretive. To determine the actual % change, we divide $25 by $20 to determine that the deal is 25% accretive.
Tell me about all the different kinds of debt you could use in an LBO and the differences between everything
Revolver, Term Loan A, Term Loan B, Senior Notes, Subordinated Notes, Mezzanine