Accounting Conceptuals
What are the three statements and how do they link?
IS, CFS, BS
Basic Linkage: IS: Rev --> NI --> CFS (CFO) --> Net Change in Cash --> BS
Other linkages: D&A, working capital, retained earnings, etc
Walk me through a $200 increase in Revenue (20% tax)
IS: Revenue $200, pre-tax income $200, 20% tax --> Net income $160.
CFS: CFO: Net income $160, no other changes, net change in cash $160
BS: Assets: Cash $160, no change to Liabilities, SE: Retained Earnings $160
What are the definitions of Equity Value and Enterprise Value
Eq Val: The value of the company to only its equity investors.
EV: The value of the company's core, operational assets to ALL investor groups
Besides DCF, what are the two most common valuation methodologies? Explain them
Comps Analysis: Valuing your company based on a set of comparable/peer companies
Precedent Transactions: Valuing your company based on the purchase price of similar companies
What is a DCF?
A DCF, or a discounted cash flows analysis, is an intrinsic method of valuation that values a company based on the present value of its future cash flows
This concept states that revenue can not be recognized until the product/service has been delivered.
Accrual Accounting
Walk me through a $100 increase in D&A (40% Tax)
IS: Pretax income down $100, tax rate 40% --> Net income down $60
CFS: CFO: Net income -$60, add back D&A $100 (non-cash), so CFO +$40. No other changes to CFS so net change in cash = $40
BS: Assets: Cash $40, PPE down $100 (b/c it depreciated), Assets down $60
No changes to Liabilities
SE: Retained earnings down $60 (from net income)
What is the bridge to go from Equity Value to Enterprise Value? For each addition and subtraction, explain why each one is done.
Bridge: EV = Eq Val - Cash + Debt + Pref Stock + NCI
Why add cash? Cash is not a core operational asset and is subtracted because EV is value of core, operational assets
Why subtract Debt, Pref Stock, and NCI? They're all "other investor groups"
Size, Geography, Industry
Walk me through a DCF
1. UFCF calculation/projection
2. Terminal Value calculation
3. WACC
The difference between interest expense and debt repayments
Interest expense must be paid in addition to the debt, while debt repayments are just paying off the debt
Walk me through the three statements when a company raises $100 of debt to purchase a $50 factory
IS: No change
CFS: CFO: N/A, CFI: down $50 from the PPE/Capex, CFF: up $100 from the debt (cash inflow), Net change in cash = $50
BS: Assets: Cash up $50, PPE up $50, Liabilities: Debt up $100, SE: N/A
How would paying $100 dividend affect Eq Val and EV?
EV: no change
Eq Val: Retained earnings down $100, CSE down $100, so Eq Val down $100
Between Public Comps and Precedent Transactions, which one typically gives a higher valuation and why?
Precedent transactions b/c of the "control premium"
What does the value of DCF give you
Implied Enterprise Value
This optional payment is paid regularly by companies to its shareholders out of its profits (or reserves).
Dividend
Walk me through the three statements when a company has $100 in revenue, which is 50% cash, 50% credit, and also has (they already bought) a factory worth $100, 10-year useful life.
10% tax rate
CFS: CFO: Net income $81, add back Dep $10, CFO: up $91, no other changes on CFS
BS: Assets: Cash up $91, PPE down $10 (depreciation), Assets up $81. Liabilities: N/A. SE: up $81 (retained earnings)
How would raising $500 in debt to buy a $500 factory affect EV and Eq Val
EV up $500 b/c factory is core/operational
Eq Val: No change
Which of the following multiples do not work and why?
1. Equity Value / Net income
2. EV / Sales
3. Equity Value / EBIT
4. EV / EBITDA
3. Eq Val / EBIT doesn't work bc the numerator (eq val) does not include debt holders, but the denominator (EBIT) includes interest expense
What is the definition and the formula for WACC? Hint: the definition "discount rate for DCF" does not count
Definition: The opportunity cost of investing in a company with a similar debt/equity
WACC = [Kd * %debt * (1-tax)] + [Ke * %Equity]
How are Prepaid Expenses, Accounts Payable and Accrued Expenses different, and why are Prepaid Expenses an Asset?
Accounts Payable: Product/service that you receive but have not paid in cash yet
Accrued Expenses: Similar to A/P but are more related to monthly, recurring items (rent, utilities, etc)
Prepaid Expenses: Opposite of Accrued Expenses - pay for certain expenses in advance and you will receive them later on.
A company has a factory shown at $200 on its Balance Sheet, but a hurricane hits the factory and destroys part of it, so the company records a $100 PP&E Write-Down. Walk me through the statements.
IS: $100 Write-down is an "expense", so pre tax is down $100, Assume 20% tax, Net income down $80
CFS: CFO: Net income down $80, write-down is non cash so add back $100, net change in cash is $20
BS: A: cash up $20, PPE down $100, assets down $80. SE: Retained earnings down $80
Can Enterprise Value ever be negative? Can equity value?
Equity value can never be negative in the real world b/c it is shares outstanding * stock price, and neither of those can be negative.
EV can be negative --> if a company has a lot of cash and not a lot of debt/pref stock/NCI, the bridge will make EV negative
LBO, Net Asset Value, Liquidation, Sum of the Parts, Dividend discount
Is debt always cheaper than equity? Why or why not?
Yes, debt will always be cheaper than equity b/c it is higher on the capital structure meaning that debt investors will always be paid out first