BIWS DCF Questions with Correct Answers| New Update 100% Verified by Experts
What's the point of valuation? WHY do you value a company? You value a company to
determine its Implied Value according to your views of it.
If this Implied Value is very different from the company's Current Value, you might be able to
invest in the company and make money if its value changes.
If you are advising a client company, you might value it so you can tell management the price
that it might receive if the company sells, which is often different from its Current Value.
But public companies already have Market Caps and Share Prices. Why bother valuing them?
Because a company's Market Cap and Share Price reflect its Current Value according to "the
market as a whole" - but the market might be wrong!
You value companies to see if the market's views are correct or incorrect.
What are the advantages and disadvantages of the 3 main valuation methodologies? Public
Comps are useful because they're based on real market data, are quick to calculate and explain,
and do not depend on far-in-the-future assumptions.
However, there may not be truly comparable companies, the analysis will be less accurate for
volatile or thinly traded companies, and it may undervalue companies' long-term potential.
Precedent Transactions are useful because they're based on the real prices that companies
have paid for other companies, and they may better reflect industry trends than Public Comps.
However, the data is often spotty and misleading, there may not be truly comparable
transactions, and specific deal terms and market conditions might distort the multiples.
DCF Analysis is the most "correct" methodology according to finance theory, it's less subject to
market fluctuations, and it better reflects company-specific factors and long-term trends.
However, it's also very dependent on far-in-the-future assumptions, and there's disagreement
over the proper calculations for key figures like the Cost of Equity and WACC.
Which of the 3 main methodologies will produce the highest Implied Values? This is a trick
question because almost any methodology could produce the highest Implied Values
depending on the industry, time period, and assumptions.
Precedent Transactions often produce higher Implied Values than the Public Comps because of
the control premium - the extra amount that acquirers must pay to acquire sellers.
,But it's tough to say how a DCF stacks up because it's far more dependent on your assumptions.
The best answer is: "A DCF tends to produce the most variable output since it's so dependent
on your assumptions, and Precedent Transactions tend to produce higher values than the
Public Comps because of the control premium."
When is a DCF more useful than Public Comps or Precedent Transactions? You should pretty
much always build a DCF since it IS valuation - the other methodologies are supplemental.
But it's especially useful when the company you're valuing is mature and has stable, predictable
cash flows, or when you lack good Public Comps or Precedent Transactions.
When are Public Comps or Precedent Transactions more useful than the DCF? If the
company you're valuing is early-stage, and it is impossible to estimate its future cash flows, or if
the company has no path to positive cash flows, you have to rely on the other methodologies.
These other methodologies can also be more useful when you run into problems in the DCF,
such as an inability to estimate the Discount Rate or extremely volatile cash flows.
Which one should be worth more: A $500 million EBITDA healthcare company or a $500 million
EBITDA industrials company?
Assume the growth rates, margins, and all other financial stats are the same. In all
likelihood, the healthcare company will be worth more because healthcare is a less
assetintensive industry. That means the company's CapEx and Working Capital requirements
will be lower, and its Free Cash Flow will be higher (i.e., closer to EBITDA) as a result.
Healthcare, at least in some sectors, also tends to be more of a "growth industry" than
industrials.
The Discount Rate might also be higher for the healthcare company, but the lower asset
intensity and higher expected growth rates would likely make up for that.
However, this answer is an extreme generalization, so you would need more information to
make a real decision.
How do you value an apple tree? The same way you value a company: Comparables and a
DCF. You'd look at what similar apple trees have sold for, and then calculate the expected
future cash flows from this tree.
,You would then discount these cash flows to Present Value, discount the Terminal Value to PV,
and add up everything to determine the apple tree's Implied Value.
The Discount Rate would be based on your opportunity cost - what you might be able to earn
each year by investing in other, similar apple trees.
People say that the DCF is an intrinsic valuation methodology, while Public Comps and
Precedent Transactions are relative valuation.
Is that correct? No, not exactly. The DCF is based on the company's expected future cash
flows, so in that sense, it is "intrinsic valuation."
But the Discount Rate used in a DCF is linked to peer companies (market data), and if you use
the Multiples Method to calculate Terminal Value, the multiples are also linked to peer
companies.
The DCF depends less on the market than the other methodologies, but there is still some
dependency.
It's more accurate to say that the DCF is more of an intrinsic valuation methodology than the
others.
Why do you build a DCF analysis to value a company? You build a DCF analysis because a
company is worth the Present Value of its expected future cash flows:
Company Value = Cash Flow / (Discount Rate - Cash Flow Growth Rate), where Cash Flow
Growth Rate < Discount Rate
But you can't just use that single formula because a company's Cash Flow Growth Rate and
Discount Rate change over time.
So, in a Discounted Cash Flow analysis, you divide the valuation into two periods: One where
those assumptions change (the explicit forecast period) and one where they stay the same (the
Terminal Period).
You then project the company's cash flows in both periods and discount them to their Present
Values based on the appropriate Discount Rate(s).
Then, you compare this sum - the company's Implied Value - to the company's Current Value or
"Asking Price" to see if it's valued appropriately
, Walk me through a DCF analysis. A DCF values a company based on the Present Value of its
Cash Flows in the explicit forecast period plus the Present Value of its Terminal Value.
You start by projecting the company's Free Cash Flows over the next 5-10 years by making
assumptions for revenue growth, margins, Working Capital, and CapEx.
Then, you discount the cash flows using the Discount Rate, usually the Weighted Average Cost
of Capital, and sum up everything.
Next, you estimate the company's Terminal Value using the Multiples Method or the Gordon
Growth Method; it represents the company's value after those first 5-10 years into perpetuity.
You then discount the Terminal Value to Present Value using the Discount Rate and add it to
the sum of the company's discounted cash flows.
Finally, you compare this Implied Value to the company's Current Value, usually its Enterprise
Value, and you'll often calculate the company's Implied Share Price so you can compare it to
the Current Share Price.
How do you move from Revenue to Free Cash Flow in a DCF? First, confirm that the
interviewer is asking for Unlevered Free Cash Flow (AKA Free Cash Flow to Firm). If so:
Subtract COGS and Operating Expenses from Revenue to reach Operating Income (EBIT).
Then, multiply Operating Income by (1 - Tax Rate), add back Depreciation & Amortization, and
factor in the Change in Working Capital.
If the company spends extra cash as it grows, the Change in Working Capital will be negative; if
it generates extra cash flow as a result of its growth, it will be positive.
Finally, subtract Capital Expenditures to calculate Unlevered Free Cash Flow.
Levered Free Cash Flow (Free Cash Flow to Equity) is similar, but you subtract the Net Interest
Expense before multiplying by (1 - Tax Rate), and you also factor in changes in Debt principal
What does the Discount Rate mean? The Discount Rate represents the opportunity cost for
the investors - what they could earn by investing in other, similar companies in this industry.
A higher Discount Rate means the risk and potential returns are both higher; a lower Discount
Rate means lower risk and lower potential returns.
A higher Discount Rate makes a company less valuable because it means the investors have
better options elsewhere; a lower Discount Rate makes a company more valuable.
What's the point of valuation? WHY do you value a company? You value a company to
determine its Implied Value according to your views of it.
If this Implied Value is very different from the company's Current Value, you might be able to
invest in the company and make money if its value changes.
If you are advising a client company, you might value it so you can tell management the price
that it might receive if the company sells, which is often different from its Current Value.
But public companies already have Market Caps and Share Prices. Why bother valuing them?
Because a company's Market Cap and Share Price reflect its Current Value according to "the
market as a whole" - but the market might be wrong!
You value companies to see if the market's views are correct or incorrect.
What are the advantages and disadvantages of the 3 main valuation methodologies? Public
Comps are useful because they're based on real market data, are quick to calculate and explain,
and do not depend on far-in-the-future assumptions.
However, there may not be truly comparable companies, the analysis will be less accurate for
volatile or thinly traded companies, and it may undervalue companies' long-term potential.
Precedent Transactions are useful because they're based on the real prices that companies
have paid for other companies, and they may better reflect industry trends than Public Comps.
However, the data is often spotty and misleading, there may not be truly comparable
transactions, and specific deal terms and market conditions might distort the multiples.
DCF Analysis is the most "correct" methodology according to finance theory, it's less subject to
market fluctuations, and it better reflects company-specific factors and long-term trends.
However, it's also very dependent on far-in-the-future assumptions, and there's disagreement
over the proper calculations for key figures like the Cost of Equity and WACC.
Which of the 3 main methodologies will produce the highest Implied Values? This is a trick
question because almost any methodology could produce the highest Implied Values
depending on the industry, time period, and assumptions.
Precedent Transactions often produce higher Implied Values than the Public Comps because of
the control premium - the extra amount that acquirers must pay to acquire sellers.
,But it's tough to say how a DCF stacks up because it's far more dependent on your assumptions.
The best answer is: "A DCF tends to produce the most variable output since it's so dependent
on your assumptions, and Precedent Transactions tend to produce higher values than the
Public Comps because of the control premium."
When is a DCF more useful than Public Comps or Precedent Transactions? You should pretty
much always build a DCF since it IS valuation - the other methodologies are supplemental.
But it's especially useful when the company you're valuing is mature and has stable, predictable
cash flows, or when you lack good Public Comps or Precedent Transactions.
When are Public Comps or Precedent Transactions more useful than the DCF? If the
company you're valuing is early-stage, and it is impossible to estimate its future cash flows, or if
the company has no path to positive cash flows, you have to rely on the other methodologies.
These other methodologies can also be more useful when you run into problems in the DCF,
such as an inability to estimate the Discount Rate or extremely volatile cash flows.
Which one should be worth more: A $500 million EBITDA healthcare company or a $500 million
EBITDA industrials company?
Assume the growth rates, margins, and all other financial stats are the same. In all
likelihood, the healthcare company will be worth more because healthcare is a less
assetintensive industry. That means the company's CapEx and Working Capital requirements
will be lower, and its Free Cash Flow will be higher (i.e., closer to EBITDA) as a result.
Healthcare, at least in some sectors, also tends to be more of a "growth industry" than
industrials.
The Discount Rate might also be higher for the healthcare company, but the lower asset
intensity and higher expected growth rates would likely make up for that.
However, this answer is an extreme generalization, so you would need more information to
make a real decision.
How do you value an apple tree? The same way you value a company: Comparables and a
DCF. You'd look at what similar apple trees have sold for, and then calculate the expected
future cash flows from this tree.
,You would then discount these cash flows to Present Value, discount the Terminal Value to PV,
and add up everything to determine the apple tree's Implied Value.
The Discount Rate would be based on your opportunity cost - what you might be able to earn
each year by investing in other, similar apple trees.
People say that the DCF is an intrinsic valuation methodology, while Public Comps and
Precedent Transactions are relative valuation.
Is that correct? No, not exactly. The DCF is based on the company's expected future cash
flows, so in that sense, it is "intrinsic valuation."
But the Discount Rate used in a DCF is linked to peer companies (market data), and if you use
the Multiples Method to calculate Terminal Value, the multiples are also linked to peer
companies.
The DCF depends less on the market than the other methodologies, but there is still some
dependency.
It's more accurate to say that the DCF is more of an intrinsic valuation methodology than the
others.
Why do you build a DCF analysis to value a company? You build a DCF analysis because a
company is worth the Present Value of its expected future cash flows:
Company Value = Cash Flow / (Discount Rate - Cash Flow Growth Rate), where Cash Flow
Growth Rate < Discount Rate
But you can't just use that single formula because a company's Cash Flow Growth Rate and
Discount Rate change over time.
So, in a Discounted Cash Flow analysis, you divide the valuation into two periods: One where
those assumptions change (the explicit forecast period) and one where they stay the same (the
Terminal Period).
You then project the company's cash flows in both periods and discount them to their Present
Values based on the appropriate Discount Rate(s).
Then, you compare this sum - the company's Implied Value - to the company's Current Value or
"Asking Price" to see if it's valued appropriately
, Walk me through a DCF analysis. A DCF values a company based on the Present Value of its
Cash Flows in the explicit forecast period plus the Present Value of its Terminal Value.
You start by projecting the company's Free Cash Flows over the next 5-10 years by making
assumptions for revenue growth, margins, Working Capital, and CapEx.
Then, you discount the cash flows using the Discount Rate, usually the Weighted Average Cost
of Capital, and sum up everything.
Next, you estimate the company's Terminal Value using the Multiples Method or the Gordon
Growth Method; it represents the company's value after those first 5-10 years into perpetuity.
You then discount the Terminal Value to Present Value using the Discount Rate and add it to
the sum of the company's discounted cash flows.
Finally, you compare this Implied Value to the company's Current Value, usually its Enterprise
Value, and you'll often calculate the company's Implied Share Price so you can compare it to
the Current Share Price.
How do you move from Revenue to Free Cash Flow in a DCF? First, confirm that the
interviewer is asking for Unlevered Free Cash Flow (AKA Free Cash Flow to Firm). If so:
Subtract COGS and Operating Expenses from Revenue to reach Operating Income (EBIT).
Then, multiply Operating Income by (1 - Tax Rate), add back Depreciation & Amortization, and
factor in the Change in Working Capital.
If the company spends extra cash as it grows, the Change in Working Capital will be negative; if
it generates extra cash flow as a result of its growth, it will be positive.
Finally, subtract Capital Expenditures to calculate Unlevered Free Cash Flow.
Levered Free Cash Flow (Free Cash Flow to Equity) is similar, but you subtract the Net Interest
Expense before multiplying by (1 - Tax Rate), and you also factor in changes in Debt principal
What does the Discount Rate mean? The Discount Rate represents the opportunity cost for
the investors - what they could earn by investing in other, similar companies in this industry.
A higher Discount Rate means the risk and potential returns are both higher; a lower Discount
Rate means lower risk and lower potential returns.
A higher Discount Rate makes a company less valuable because it means the investors have
better options elsewhere; a lower Discount Rate makes a company more valuable.
