Wallstreet Prep Valuation Wall Street
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Correct Answers
\Q\.Could you explain the concept of present value and how it relates to company valuations? -
ANSWERS✔-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.
\Q\.What is equity value and how is it calculated? - ANSWERS✔-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
\Q\.How do you calculate the fully diluted number of shares outstanding? - ANSWERS✔-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.
,\Q\.What is enterprise value and how do you calculate it? - ANSWERS✔-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
\Q\.How do you calculate equity value from enterprise value? - ANSWERS✔-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
\Q\.Which line items are included in the calculation of net debt? - ANSWERS✔-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
\Q\.When calculating enterprise value, why do we add net debt? - ANSWERS✔-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.
,\Q\.What is the difference between enterprise value and equity value? - ANSWERS✔-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).
\Q\.Could a company have a negative net debt balance and have an enterprise value lower than
its equity value? - ANSWERS✔-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.
\Q\.Can the enterprise value of a company turn negative? - ANSWERS✔-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.
, \Q\.If a company raises $250 million in additional debt, how would its enterprise value change?
- ANSWERS✔-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.
\Q\.Why do we add minority interest to equity value in the calculation of enterprise value? -
ANSWERS✔-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).
\Q\.How are convertible bonds and preferred equity with a convertible feature accounted for
when calculating enterprise value? - ANSWERS✔-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).
\Q\.What are the two main approaches to valuation? - ANSWERS✔-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 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.
Prep Premium Exam Questions Complete With
Correct Answers
\Q\.Could you explain the concept of present value and how it relates to company valuations? -
ANSWERS✔-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.
\Q\.What is equity value and how is it calculated? - ANSWERS✔-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
\Q\.How do you calculate the fully diluted number of shares outstanding? - ANSWERS✔-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.
,\Q\.What is enterprise value and how do you calculate it? - ANSWERS✔-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
\Q\.How do you calculate equity value from enterprise value? - ANSWERS✔-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
\Q\.Which line items are included in the calculation of net debt? - ANSWERS✔-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
\Q\.When calculating enterprise value, why do we add net debt? - ANSWERS✔-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.
,\Q\.What is the difference between enterprise value and equity value? - ANSWERS✔-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).
\Q\.Could a company have a negative net debt balance and have an enterprise value lower than
its equity value? - ANSWERS✔-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.
\Q\.Can the enterprise value of a company turn negative? - ANSWERS✔-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.
, \Q\.If a company raises $250 million in additional debt, how would its enterprise value change?
- ANSWERS✔-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.
\Q\.Why do we add minority interest to equity value in the calculation of enterprise value? -
ANSWERS✔-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).
\Q\.How are convertible bonds and preferred equity with a convertible feature accounted for
when calculating enterprise value? - ANSWERS✔-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).
\Q\.What are the two main approaches to valuation? - ANSWERS✔-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 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.
