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Transaction comps modeling wall street prep exam
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Transaction comps modeling wall street prep exam
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Wallstreet Prep Valuation Questions1. Could 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.
2. 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
3. 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.
4. 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 5.
How do you calculate equity value from enterprise value?: To get to equity
, Wallstreet Prep Valuation Questions
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
6. 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
7. 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.
8. 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).
9. 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
, Wallstreet Prep Valuation Questions
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.
10. 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.
11. 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.
12. Why do we add minority interest to equity value in the calculation of
enterprise value?: Minority interest represents the portion of a subsidiary in
which the parent company doesn't own. Under US GAAP, if a company has
ownership over
50% of another company but below 100% (called a "minority interest" or "non-
controlling investment"), it must include 100% of the subsidiary's financials in their
financial statements despite not owning 100%.
When calculating multiples using EV, the numerator will be the consolidated metric,
thus minority interest must be added to enterprise value for the multiple to be
compatible (i.e., no mismatch between the numerator and denominator).
13. How are convertible bonds and preferred equity with a convertible
feature accounted for when calculating enterprise value?: If the convertible
bonds and the preferred equities are "in-the-money" as of thevaluation date (i.e.,
the current stock price is greater than their strike price), then the treatment will be
the same as additional dilution from equity. However, if they're "out-of-the-money,"
they would be treated as a financial liability (similar to debt).
14. What are the two main approaches to valuation?: Intrinsic Valuation: For
an intrinsic valuation, the value of a business is arrived at by looking at the
business's ability to generate cash flows. The discounted cash flow method is the
, Wallstreet Prep Valuation Questions
most common type of intrinsic valuation and is based on the notion that a
business's value equals the present value of its future free cash flows.
Relative Valuation: In relative valuation, a business's value is arrived at by looking
at comparable companies and applying the average or median multiples derived
from the peer group - often EV/EBITDA, P/E, or some other relevant multiple to
value the target. This valuation can be done by looking at the multiples of
comparable public companies using their current market values, which is called
"trading comps," or by looking at the multiples of comparable companies recently
acquired, which is called "transaction comps."
15. What are the most common valuation methods used in finance?:
Comparable Company Analysis ("Trading Comps")
Comparable Transactions Analysis ("Transaction Comps")
Discounted Cash Flow Analysis ("DCF")
Leveraged Buyout Analysis ("LBO")
Liquidation Analysis
16. What is Comparable Company Analysis ("Trading Comps")?: Trading
comps value a company based on how similar publicly-traded companies are
currently being valued at by the market.
17. What is Comparable Transactions Analysis ("Transaction Comps")?:
Transaction comps value a company based on the amount buyers paid to acquire
similar companies in recent years.
18. What is Discounted Cash Flow Analysis ("DCF")?: DCFs value a
company based on the premise that its value is a function of its projected cash
flows, discounted at an appropriate rate that reflects the risk of those cash flows.
19. What is Leveraged Buyout Analysis ("LBO")?: An LBO will look at a
potential acquisition target under a highly leveraged scenario to determine the
maximum purchase price the firm would be willing to pay.
20. What is Liquidation Analysis?: Liquidation analysis is used for companies
under (or near) distress and values the assets of the company under a
hypothetical, worst-case scenario liquidation.
21. Among the DCF, comparable companies analysis, and transaction
comps, which approach yields the highest valuation?: Transaction comps
analysis often yields the highest valuation because it looks at valuations for
companies that have been acquired, which factor in control premiums. Control
premiums can often be quite significant and as high as 25% to 50% above market
prices. Thus, the multiples derived from this analysis and the resulting valuation
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