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Wallstreet Prep Valuation Questions
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Wallstreet Prep Valuation Questions
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Wallstreet Prep Valuation QuestionsCould you explain the concept of present value and how it relates to company valuations?
The present value concept is based on the premise that "a dollar in the present is worth
more than a dollar in the future" due to the time value of money. The reason being money
currently in possession has the potential to earn interest by being invested today.
For intrinsic valuation methods, the value of a company will be equal to the sum of
thepresent value of all the future cash flows it generates. Therefore, a company with a high
valuation would imply it receives high returns on its invested capital by investing in positive
net present value ("NPV") projects consistently while having low risk associated with its cash
flows.
What is equity value and how is it calculated?
Often used interchangeably with the term market capitalization (“market cap”), equity value
represents a company's value to its equity shareholders. A company's equity value is
calculated by multiplying its latest closing share price by its total diluted shares outstanding,
as shown below:
Equity Value = Latest Closing Share Price × Total Diluted Shares Outstanding
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How do you calculate the fully diluted number of shares outstanding?
The treasury stock method ("TSM") is used to calculate the fully diluted number of shares
outstanding based on the options, warrants, and other dilutive securities that are currently
"in-the-money" (i.e., profitable to exercise).
The TSM involves summing up the number of in-the-money ("ITM") options and warrants
and then adding that figure to the number of basic shares outstanding.
,In the proceeding step, the TSM assumes the proceeds from exercising those dilutive
options will go towards repurchasing stock at the current share price to reduce the net
dilutive impact.
What is enterprise value and how do you calculate it?
Conceptually, enterprise value ("EV") represents the value of the operations of a company to
all stakeholders including common shareholders, preferred shareholders, and debt lenders.
Thus, enterprise value is considered capital structure neutral, unlike equity value, which is
affected by financing decisions.
Enterprise value is calculated by taking the company's equity value and adding net debt,
preferred stock, and minority interest.
Enterprise Value = Equity Value + Net Debt + Preferred Stock + Minority Interest
How do you calculate equity value from enterprise value?
To get to equity value from enterprise value, you would first subtract net debt, where net debt
equals the company’s gross debt and debt-like claims (e.g., preferred stock), net of cash,
and non-operating assets.
Equity Value = Enterprise Value – Net Debt – Preferred Stock – Minority Interest
Which line items are included in the calculation of net debt?
The calculation of net debt accounts for all interest-bearing debt, such as short-term and
long- term loans and bonds, as well as non-equity financial claims such as preferred stock
and non- controlling interests. From this gross debt amount, cash and other non-operating
assets such as short-term investments and equity investments are subtracted to arrive at net
debt.
Net Debt = Total Debt – Cash & Equivalents
When calculating enterprise value, why do we add net debt?
The underlying idea of net debt is that the cash on a company's balance sheet could pay
down the outstanding debt if needed. For this reason, cash and cash equivalents are netted
against the company's debt, and many leverage ratios use net debt rather than the gross
amount.
, What is the difference between enterprise value and equity value?
Enterprise value represents all stakeholders in a business, including equity shareholders,
debt lenders, and preferred stock owners. Therefore, it's independent of the capital structure.
In addition, enterprise value is closer to the actual value of the business since it accounts for
all ownership stakes (as opposed to just equity owners).
To tie this to a recent example, many investors were astonished that Zoom, a video
conferencing platform, had a higher market capitalization than seven of the largest airlines
combined at one point. The points being neglected were:
1. The equity values of the airline companies were temporarily deflated given the travel
restrictions, and the government bailout had not yet been announced.
2. The airlines are significantly more mature and have far more debt on their balance sheet
(i.e., more non- equity stakeholders).
Could a company have a negative net debt balance and have an enterprise value lower than
its equity value?
Yes, negative net debt just means that a company has more cash than debt. For example,
both Apple and Microsoft have massive negative net debt balances because they hoard
cash. In these cases, companies will have enterprise values lower than their equity value.
If it seems counter-intuitive that enterprise value can be lower than equity value, remember
that enterprise value represents the value of a company's operations, which excludes any
non-operating assets. When you think about it this way, it should come as no surprise that
companies with much cash (which is treated as a non-operating asset) will have a higher
equity value than enterprise value.
Can the enterprise value of a company turn negative?
While negative enterprise values are a rare occurrence, it does happen from time to time. A
negative enterprise value means a company has a net cash balance (total cash less total
debt) that exceeds its equity value.
If a company raises $250 million in additional debt, how would its enterprise value change?
Theoretically, there should be no impact as enterprise value is capital structure neutral. The
new debt raised shouldn't impact the enterprise value, as the cash and debt balance would
increase and offset the other entry.
However, the cost of financing (i.e., through financing fees and interest expense) could
negatively impact the company's profitability and lead to a lower valuation from the higher
cost of debt.
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