Accounting
What are the 3 statements and what do they each include?
he three main financial statements are:
What are the three main valuation methodologies?
The three primary approaches are Comparable Companies, Precedent Transactions, and Discounted Cash Flow Analysis.
Can you explain, in simple terms, how a DCF provides a company's value?
A DCF values a company by forecasting its cash flows and determining how much those cash flows are worth today.
You project free cash flow each year and discount it at an appropriate rate, then estimate a terminal value at the end and discount that as well.
Summing these discounted values yields the company’s total present value.
Why would 2 companies merge?
If benefits of the transactions outweigh the costs
What is Beta, what would have a beta of -1, 0, 1
Beta tells you how volatile this stock is relative to the market as a whole, factoring in both the intrinsic business risk and the risk introduced by leverage (i.e., Debt).
-1 - restructuring business, gold
0 - slot machine
1 - stock market
If depreciation expense increases by $10 and the tax rate is 30%, how is net income impacted?
Pre-tax income falls by $10, so tax expense is $3 lower (30% of $10).
Net income decreases by $7 overall.
Rank the 3 valuation methods from lowest to highest expected valution
Typically, Precedent Transactions might yield the highest valuations due to control premiums.
Comparable Companies often yield a bit lower valuation.
A DCF can be higher or lower depending on assumptions, so there's no absolute ranking.
Walk me through the components of a DCF
Cash flows - Use un levered free cash flow
Discount Rate - WACC
Terminal Value - Gordon Growth Model, Multiples Method
Can you summarize the basic steps you'd follow when creating a simple merger model?
First, project the buyer and seller's income statements separately.
Next, decide on the purchase price and how it will be financed (cash, debt, stock, or a mix).
Then, combine their statements, adjusting for interest expense, foregone interest on cash, new shares, and any deal-related fees.
Finally, calculate the combined net income and divide by the new share count to see the post-deal EPS and compare it to the buyer’s standalone EPS.
What is cash vs accrual accounting? Who would use both traditionally
Cash - accounts for cash once its in, small businesses
accrual - revenue recognized when product is delivered, GAAP
If a company raises $100 of debt to purchase manufacturing equipment, how does that affect the statements immediately?
Balance Sheet: Cash up by $100, Debt up by $100. If the equipment is purchased right away, PP&E increases while cash decreases.
Income Statement: Initially, no direct impact on net income.
Cash Flow Statement: $100 inflow from financing, $100 outflow for investing (equipment), net zero change in cash.
What is Equity Value?
Value of a business that is available to equity holders, market caps
Walk me from revenue to free cash flow
Start with revenue and subtract operating costs to get EBIT.
Then multiply by (1 – Tax Rate), add back depreciation and other non-cash items.
Finally, subtract CapEx and any increases in working capital.
What are the two main types of synergies? Which would you prefer?
Revenue synergies, where combined sales or cross-selling opportunities increase total revenues.
Cost synergies, where operations are streamlined, overhead is reduced, or redundant functions are cut, lowering expenses.
cost synergies are preferred because they flow directly to profit, whereas revenue have COGS associated
What are some other valuation methods?
dditional methods include:
Besides losses, what else might cause retained earnings to decrease?
Retained earnings can also decrease due to dividends paid or certain accounting restatements that lower previously reported net income.
What is the formula for enterprise value?
Enterprise Value = Equity Value + Debt + Preferred Stock + Minority Interest – Cash
How do you calculation terminal value?
The first is the Multiples Method, applying an exit multiple to the final year's EBITDA or EBIT.
The second is the Gordon Growth Method, using a perpetual growth rate formula.
Company A has an Equity Value of $1000 and Net Income of $100. Company B has an Equity Value of $2000 and Net Income of $50. How would this all-stock deal be accretive?
Company A’s P/E is 10x, Company B’s is 40x. To be accretive, the effective seller’s yield must exceed 10%. You’d need sufficient after-tax synergies (e.g., $150) to bring the seller’s yield above 10% of the purchase price.
What is the market capitalization of a company with the following attributes?
The market capitalization is $1 billion.
Here’s the calculation:
A company raises $100 of debt to purchase manufacturing equipment.
One year later, that equipment has 10% depreciation, and the debt carries 5% interest (no principal repayment).
Walk through the changes to the 3 statements after the one year has passed. Assume a 40% tax rate.
Starting on the IS...
Moving onto the SCF...
Finally, on the BS...
A company has 100 shares at $10 each and 10 options at a $5 strike. What is its fully diluted Equity Value?
Basic Equity Value is 100 × $10 = $1,000.
Those 10 in-the-money options generate $5 × 10 = $50 if exercised. The company uses that $50 to repurchase 5 shares at $10 each, so net new shares = 5.
Fully diluted share count is 105. Fully diluted Equity Value is 105 × $10 = $1,050.
What are the ways that taxes effect a DCF
Reduction in Free Cash Flow (FCF)
Higher taxes reduce net income, which directly lowers the FCF available to investors.
Since DCF valuation is based on discounted future cash flows, a lower FCF decreases valuation.
Decrease in the After-Tax Cost of Debt (Lower WACC)
The after-tax cost of debt is calculated as: Cost of Debt×(1−Tax Rate)
A higher tax rate increases the tax shield, reducing the effective cost of debt.
This lowers the WACC, which increases valuation.
Decrease in Levered Beta (Lower WACC)
Using CAPM A higher tax rate increases the tax shield, reducing the impact of debt on risk.
This lowers the levered beta, which lowers the WACC and increases valuation.
Terminal value is calculated using the Gordon Growth Model:
Higher taxes lower FCF, reducing the numerator.
Lower WACC (from tax shield effects) increases valuation, raising the denominator.
The net effect depends on the magnitude of FCF reduction vs. WACC decrease.
Company A has a P / E of 10x, a Debt Interest Rate of 10%, a Cash Interest Rate of 5%, and
a tax rate of 40%.
It wants to acquire Company B at a purchase P / E multiple of 16x using 1/3 Stock, 1/3 Debt,
and 1/3 Cash. Will the deal be accretive?
Company A’s After-Tax Cost of Stock is 1/10, or 10%, its After-Tax Cost of Debt is 10% * (1 –
40%) = 6%, and its After-Tax Cost of Cash is 5% * (1 – 40%) = 3%.
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Company B’s Yield is 1 / 16, or 6.25%.
The Weighted Cost of Acquisition is 10% * 1/3 + 6% * 1/3 + 3% * 1/3 = 3.33% + 2% + 1% =
6.33%.
Since the Weighted Cost is slightly above Company B’s Yield, the deal will be dilutive.
How much money will I have in 7 years if I invest $100 and earn 10% a year?
Using compound interest: Future Value = Present Value * (1 + r)^n.
So here, FV = $100 * (1 + 0.10)^7 ≈ $100 * 1.9487 = ~$195.