BIWS 400 QUESTIONS WITH COMPLETE SOLUTION 2023

BIWS 400 QUESTIONS WITH COMPLETE SOLUTION 2023BIWS 400 QUESTIONS WITH COMPLETE SOLUTION 2023 Let's say I'm working on an IPO for a client. Can you describe briefly what I would do? - correct answer You meet with the client and gather basic information - such as their financial details, an industry overview, and who their customers are. You meet with other bankers and the lawyers to draft the S-1 registration statement - which describes the company's business and markets it to investors. You receive some comments from the SEC and keep revising the document until it's acceptable. You spend a few weeks going on a "road show" where you present the company to institutional investors and convince them to invest. The company begins trading on an exchange once you've raised the capital from investors. How do companies select the bankers they work with? - correct answer Usually based on relationships. When it comes time to do a deal, the company calls different banks it has spoken with and asks them to "pitch" for the business. This is called a "bake-off" and the company selects the "winner" afterward Walk me through the process of a typical sell-side M&A deal. - correct answer 1. Meet with company, create initial marketing materials like the Executive Summary and Offering Memorandum (OM), and decide on potential buyers. 2. Send out Executive Summary to potential buyers to gauge interest. 3. Send NDAs (Non-Disclosure Agreements) to interested buyers along with more detailed information like the Offering Memorandum, and respond to any follow-up due diligence requests from the buyers. 4. Set a "bid deadline" and solicit written Indications of Interest (IOIs) from buyers. 5. Select which buyers advance to the next round. 6. Continue responding to information requests and setting up due diligence meetings between the company and potential buyers. 7. Set another bid deadline and pick the "winner." 8. Negotiate terms of the Purchase Agreement with the winner and announce the deal. Walk me through the process of a typical buy-side M&A deal. - correct answer 1. Spend a lot of time upfront doing research on dozens or hundreds of potential acquisition targets, and go through multiple cycles of selection and filtering with the company you're representing. 2. Narrow down the list based on their feedback and decide which ones to approach. 3. Conduct meetings and gauge the receptivity of each potential seller. 4. As discussions with the most likely seller become more serious, conduct more in-depth due diligence and figure out your offer price. 5. Negotiate the price and key terms of the Purchase Agreement and then announce the transaction. Walk me through a debt issuance deal. - correct answer 1. Meet with the client and gather basic financial, industry, and customer information. 2. Work closely with DCM / Leveraged Finance to develop a debt financing or LBO model for the company and figure out what kind of leverage, coverage ratios, and covenants might be appropriate. 3. Create an investor memorandum describing all of this. 4. Go out to potential debt investors and win commitments from them to finance the deal. What's the difference between DCM and Leveraged Finance? - correct answer They're similar and there is some overlap but Leveraged Finance is more "modeling-intensive" and does more of the deal execution with industry and M&A groups on LBOs and debt financings. DCM, by contrast, is more closely tied to the markets and tracks trends and relevant data. Explain what a divestiture is. - correct answer It's when a company decides to sell off a specific division rather than sell the entire company. The process is very similar to the sell-side M&A process, but it tends to be "messier" because you're dealing with a part of one company rather than the whole thing. Creating a "standalone operating model" for the particular division they're selling is extremely important, and the transaction structure and valuation are more complex than they would be for a "plain-vanilla" M&A deal. If you owned a small business and were approached by a larger company about an acquisition, how would you think about the offer, and how would you make a decision on what to do? - correct answer The key terms to consider would be: 1. Price 2. Form of payment - cash, stock, or debt 3. Future plans for the company vis-à-vis your own plans. Of course, there is much more to an M&A deal than this, but those are the key ones. To make a decision you'd have to weigh each one - there's no "magical" way to decide. You might also point out that if something is particularly important to you - such as retaining a role in the company - then a difference of intentions there could be a "deal-breaker." Let's say you could start any type of business you wanted, and you had $1 million in initial funds. What would you do? - correct answer You probably want to say that you'd think about some type of niche business with high margins that requires little startup capital ($1 million is not enough to build 10 factories) and ongoing maintenance - those make it harder to turn a profit and sell the business one day. Walk me through the 3 financial statements. - correct answer "The 3 major financial statements are the Income Statement, Balance Sheet and Cash Flow Statement. The Income Statement gives the company's revenue and expenses, and goes down to Net Income, the final line on the statement. The Balance Sheet shows the company's Assets - its resources - such as Cash, Inventory and PP&E, as well as its Liabilities - such as Debt and Accounts Payable - and Shareholders' Equity. Assets must equal Liabilities plus Shareholders' Equity. The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company's net change in cash." Can you give examples of major line items on each of the financial statements? - correct answer Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General & Administrative Expenses); Operating Income; Pretax Income; Net Income. Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment (PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders' Equity. Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations; Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities; Dividends Issued; Cash Flow From Financing. How do the 3 statements link together? - correct answer "To tie the statements together, Net Income from the Income Statement flows into Shareholders' Equity on the Balance Sheet, and into the top line of the Cash Flow Statement. Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, and investing and financing activities affect Balance Sheet items such as PP&E, Debt and Shareholders' Equity. The Cash and Shareholders' Equity items on the Balance Sheet act as "plugs," with Cash flowing in from the final line on the Cash Flow Statement." If I were stranded on a desert island, only had 1 statement and I wanted to review the overall health of a company - which statement would I use and why? - correct answer You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non-cash expenses you might have. And that's the #1 thing you care about when analyzing the overall financial health of any business - its cash flow. Let's say I could only look at 2 statements to assess a company's prospects - which 2 would I use and why? - correct answer You would pick the Income Statement and Balance Sheet, because you can create the Cash Flow Statement from both of those (assuming, of course that you have "before" and "after" versions of the Balance Sheet that correspond to the same period the Income Statement is tracking). Walk me through how Depreciation going up by $10 would affect the statements. - correct answer Income Statement: Operating Income would decline by $10 and assuming a 40% tax rate, Net Income would go down by $6. Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4. Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow Statement. Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders' Equity on the Liabilities & Shareholders' Equity side is down by $6 and both sides of the Balance Sheet balance. If Depreciation is a non-cash expense, why does it affect the cash balance? - correct answer Although Depreciation is a non-cash expense, it is tax-deductible. Since taxes are a cash expense, Depreciation affects cash by reducing the amount of taxes you pay. Where does Depreciation usually show up on the Income Statement? - correct answer It depends. It could be in a separate line item, or it could be embedded in Cost of Goods Sold or Operating Expenses - every company does it differently. Note that the end result for accounting questions is the same: Depreciation always reduces Pre-Tax Income. What happens when Inventory goes up by $10, assuming you pay for it with cash? - correct answer No changes to the Income Statement. On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow from Operations - it goes down by $10, as does the Net Change in Cash at the bottom. On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10, so the changes cancel out and Assets still equals Liabilities & Shareholders' Equity. Why is the Income Statement not affected by changes in Inventory? - correct answer This is a common interview mistake - incorrectly stating that Working Capital changes show up on the Income Statement. In the case of Inventory, the expense is only recorded when the goods associated with it are sold - so if it's just sitting in a warehouse, it does not count as a Cost of Good Sold or Operating Expense until the company manufactures it into a product and sells it. Let's say Apple is buying $100 worth of new iPod factories with debt. How are all 3 statements affected at the start of "Year 1," before anything else happens? - correct answer At the start of "Year 1," before anything else has happened, there would be no changes on Apple's Income Statement (yet). On the Cash Flow Statement, the additional investment in factories would show up under Cash Flow from Investing as a net reduction in Cash Flow (so Cash Flow is down by $100 so far). And the additional $100 worth of debt raised would show up as an addition to Cash Flow, canceling out the investment activity. So the cash number stays the same. On the Balance Sheet, there is now an additional $100 worth of factories in the Plants, Property & Equipment line, so PP&E is up by $100 and Assets is therefore up by $100. On the other side, debt is up by $100 as well and so both sides balance. Now let's look at a different scenario and assume Apple is ordering $10 of additional iPod inventory, using cash on hand. They order the inventory, but they have not manufactured or sold anything yet - what happens to the 3 statements? - correct answer No changes to the Income Statement. Cash Flow Statement - Inventory is up by $10, so Cash Flow from Operations decreases by $10. There are no further changes, so overall Cash is down by $10. On the Balance Sheet, Inventory is up by $10 and Cash is down by $10 so the Assets number stays the same and the Balance Sheet remains in balance. Let's say Apple is buying $100 worth of new iPod factories with debt. Now let's go out 1 year, to the start of Year 2. Assume the debt is high-yield so no principal is paid off, and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens? - correct answer After a year has passed, Apple must pay interest expense and must record the depreciation. Operating Income would decrease by $10 due to the 10% depreciation charge each year, and the $10 in additional Interest Expense would decrease the Pre-Tax Income by $20 altogether ($10 from the depreciation and $10 from Interest Expense). Assuming a tax rate of 40%, Net Income would fall by $12. On the Cash Flow Statement, Net Income at the top is down by $12. Depreciation is a non-cash expense, so you add it back and the end result is that Cash Flow from Operations is down by $2. That's the only change on the Cash Flow Statement, so overall Cash is down by $2. On the Balance Sheet, under Assets, Cash is down by $2 and PP&E is down by $10 due to the depreciation, so overall Assets are down by $12. On the other side, since Net Income was down by $12, Shareholders' Equity is also down by $12 and both sides balance. Let's say Apple is buying $100 worth of new iPod factories with debt. At the start of Year 3, the factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk me through the 3 statements. - correct answer After 2 years, the value of the factories is now $80 if we go with the 10% depreciation per year assumption. It is this $80 that we will write down in the 3 statements. First, on the Income Statement, the $80 write-down shows up in the Pre-Tax Income line. With a 40% tax rate, Net Income declines by $48. On the Cash Flow Statement, Net Income is down by $48 but the write-down is a non- cash expense, so we add it back - and therefore Cash Flow from Operations increases by $32. There are no changes under Cash Flow from Investing, but under Cash Flow from Financing there is a $100 charge for the loan payback - so Cash Flow from Investing falls by $100. Overall, the Net Change in Cash falls by $68. On the Balance Sheet, Cash is now down by $68 and PP&E is down by $80, so Assets have decreased by $148 altogether. On the other side, Debt is down $100 since it was paid off, and since Net Income was down by $48, Shareholders' Equity is down by $48 as well. Altogether, Liabilities & Shareholders' Equity are down by $148 and both sides balance Now let's say they sell the iPods for revenue of $20, at a cost of $10. Walk me through the 3 statements under this scenario. - correct answer Income Statement: Revenue is up by $20 and COGS is up by $10, so Gross Profit is up by $10 and Operating Income is up by $10 as well. Assuming a 40% tax rate, Net Income is up by $6. Cash Flow Statement: Net Income at the top is up by $6 and Inventory has decreased by $10 (since we just manufactured the inventory into real iPods), which is a net addition to cash flow - so Cash Flow from Operations is up by $16 overall. These are the only changes on the Cash Flow Statement, so Net Change in Cash is up by $16. On the Balance Sheet, Cash is up by $16 and Inventory is down by $10, so Assets is up by $6 overall. On the other side, Net Income was up by $6 so Shareholders' Equity is up by $6 and both sides balance. Could you ever end up with negative shareholders' equity? What does it mean? - correct answer Yes. It is common to see this in 2 scenarios: 1. Leveraged Buyouts with dividend recapitalizations - it means that the owner of the company has taken out a large portion of its equity (usually in the form of cash), which can sometimes turn the number negative. 2. It can also happen if the company has been losing money consistently and therefore has a declining Retained Earnings balance, which is a portion of Shareholders' Equity. It doesn't "mean" anything in particular, but it can be a cause for concern and possibly demonstrate that the company is struggling (in the second scenario). Note: Shareholders' equity never turns negative immediately after an LBO - it would only happen following a dividend recap or continued net losses. What is working capital? How is it used? - correct answer Working Capital = Current Assets - Current Liabilities. If it's positive, it means a company can pay off its short-term liabilities with its short- term assets. It is often presented as a financial metric and its magnitude and sign (negative or positive) tells you whether or not the company is "sound." Bankers look at Operating Working Capital more commonly in models, and that is defined as (Current Assets - Cash & Cash Equivalents) - (Current Liabilities - Debt) What does negative Working Capital mean? Is that a bad sign? - correct answer Not necessarily. It depends on the type of company and the specific situation - here are a few different things it could mean: 1. Some companies with subscriptions or longer-term contracts often have negative Working Capital because of high Deferred Revenue balances. 2. Retail and restaurant companies like Amazon, Wal-Mart, and McDonald's often have negative Working Capital because customers pay upfront - so they can use the cash generated to pay off their Accounts Payable rather than keeping a large cash balance on-hand. This can be a sign of business efficiency. 3. In other cases, negative Working Capital could point to financial trouble or possible bankruptcy (for example, when customers don't pay quickly and upfront and the company is carrying a high debt balance). Recently, banks have been writing down their assets and taking huge quarterly losses. Walk me through what happens on the 3 statements when there's a write- down of $100. - correct answer First, on the Income Statement, the $100 write-down shows up in the Pre-Tax Income line. With a 40% tax rate, Net Income declines by $60. On the Cash Flow Statement, Net Income is down by $60 but the write-down is a non- cash expense, so we add it back - and therefore Cash Flow from Operations increases by $40. Overall, the Net Change in Cash rises by $40. On the Balance Sheet, Cash is now up by $40 and an asset is down by $100 (it's not clear which asset since the question never stated the specific asset to write-down). Overall, the Assets side is down by $60. On the other side, since Net Income was down by $60, Shareholders' Equity is also down by $60 - and both sides balance. Walk me through a $100 "bailout" of a company and how it affects the 3 statements. - correct answer First, confirm what type of "bailout" this is - Debt? Equity? A combination? The most common scenario here is an equity investment from the government, so here's what happens: No changes to the Income Statement. On the Cash Flow Statement, Cash Flow from Financing goes up by $100 to reflect the government's investment, so the Net Change in Cash is up by $100. On the Balance Sheet, Cash is up by $100 so Assets are up by $100; on the other side, Shareholders' Equity would go up by $100 to make it balance. Walk me through a $100 write-down of debt - as in OWED debt, a liability - on a company's balance sheet and how it affects the 3 statements. - correct answer This is counter-intuitive. When a liability is written down you record it as a gain on the Income Statement (with an asset write-down, it's a loss) - so Pre-Tax Income goes up by $100 due to this write-down. Assuming a 40% tax rate, Net Income is up by $60. On the Cash Flow Statement, Net Income is up by $60, but we need to subtract that debt write-down - so Cash Flow from Operations is down by $40, and Net Change in Cash is down by $40. On the Balance Sheet, Cash is down by $40 so Assets are down by $40. On the other side, Debt is down by $100 but Shareholders' Equity is up by $60 because the Net Income was up by $60 - so Liabilities & Shareholders' Equity is down by $40 and it balances. When would a company collect cash from a customer and not record it as revenue? - correct answer Three examples come to mind: 1. Web-based subscription software 2. Cell phone carriers that cell annual contracts 3. Magazine publishers that sell subscriptions Companies that agree to services in the future often collect cash upfront to ensure stable revenue - this makes investors happy as well since they can better predict a company's performance. Per the rules of GAAP (Generally Accepted Accounting Principles), you only record revenue when you actually perform the services - so the company would not record everything as revenue right away. If cash collected is not recorded as revenue, what happens to it? - correct answer Usually it goes into the Deferred Revenue balance on the Balance Sheet under Liabilities. Over time, as the services are performed, the Deferred Revenue balance "turns into" real revenue on the Income Statement. What's the difference between accounts receivable and deferred revenue? - correct answer Accounts receivable has not yet been collected in cash from customers, whereas deferred revenue has been. Accounts receivable represents how much revenue the company is waiting on, whereas deferred revenue represents how much it is waiting to record as revenue. How long does it usually take for a company to collect its accounts receivable balance? - correct answer Generally the accounts receivable days are in the 40-50 day range, though it's higher for companies selling high-end items and it might be lower for smaller, lower transaction- value companies. What's the difference between cash-based and accrual accounting? - correct answer Cash-based accounting recognizes revenue and expenses when cash is actually received or paid out; accrual accounting recognizes revenue when collection is reasonably certain (i.e. after a customer has ordered the product) and recognizes expenses when they are incurred rather than when they are paid out in cash. Most large companies use accrual accounting because paying with credit cards and lines of credit is so prevalent these days; very small businesses may use cash-based accounting to simplify their financial statements. Let's say a customer pays for a TV with a credit card. What would this look like under cash-based vs. accrual accounting? - correct answer In cash-based accounting, the revenue would not show up until the company charges the customer's credit card, receives authorization, and deposits the funds in its bank account - at which point it would show up as both Revenue on the Income Statement and Cash on the Balance Sheet. In accrual accounting, it would show up as Revenue right away but instead of appearing in Cash on the Balance Sheet, it would go into Accounts Receivable at first. Then, once the cash is actually deposited in the company's bank account, it would "turn into" Cash. How do you decide when to capitalize rather than expense a purchase? - correct answer If the asset has a useful life of over 1 year, it is capitalized (put on the Balance Sheet rather than shown as an expense on the Income Statement). Then it is depreciated (tangible assets) or amortized (intangible assets) over a certain number of years. Purchases like factories, equipment and land all last longer than a year and therefore show up on the Balance Sheet. Employee salaries and the cost of manufacturing products (COGS) only cover a short period of operations and therefore show up on the Income Statement as normal expenses instead. A company has had positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen? - correct answer Several possibilities: 1. The company is spending too much on Capital Expenditures - these are not reflected at all in EBITDA, but it could still be cash-flow negative. 2. The company has high interest expense and is no longer able to afford its debt. 3. The company's debt all matures on one date and it is unable to refinance it due to a "credit crunch" - and it runs out of cash completely when paying back the debt. 4. It has significant one-time charges (from litigation, for example) and those are high enough to bankrupt the company. Remember, EBITDA excludes investment in (and depreciation of) long-term assets, interest and one-time charges - and all of these could end up bankrupting the company. Normally Goodwill remains constant on the Balance Sheet - why would it be impaired and what does Goodwill Impairment mean? - correct answer Usually this happens when a company has been acquired and the acquirer re-assesses its intangible assets (such as customers, brand, and intellectual property) and finds that they are worth significantly less than they originally thought. It often happens in acquisitions where the buyer "overpaid" for the seller and can result in a large net loss on the Income Statement (see: eBay/Skype). It can also happen when a company discontinues part of its operations and must impair the associated goodwill. Under what circumstances would Goodwill increase? - correct answer Technically Goodwill can increase if the company re-assesses its value and finds that it is worth more, but that is rare. What usually happens is 1 of 2 scenarios: 1. The company gets acquired or bought out and Goodwill changes as a result, since it's an accounting "plug" for the purchase price in an acquisition. 2. The company acquires another company and pays more than what its assets are worth - this is then reflected in the Goodwill number. What are deferred tax assets/liabilities and how do they arise? - correct answer Deferred Tax Liabilities arise when you have a tax expense on the Income Statement but haven't actually paid that tax in cold, hard cash yet; Deferred Tax Assets arise when you pay taxes in cash but haven't expensed them on the Income Statement yet. The most common way they occur is with asset write-ups and write-downs in M&A deals - an asset write-up will produce a deferred tax liability while a write-down produces a deferred tax asset Walk me through the major items in Shareholders' Equity. - correct answer Common Stock - Simply the par value of however much stock the company has issued. Retained Earnings - How much of the company's Net Income it has "saved up" over time. Additional Paid in Capital - This keeps track of how much stock-based compensation has been issued and how much new stock employees exercising options have created. It also includes how much over par value a company raises in an IPO or other equity offering. Treasury Stock - The dollar amount of shares that the company has bought back. Accumulated Other Comprehensive Income - This is a "catch-all" that includes other items that don't fit anywhere else, like the effect of foreign currency exchange rates changing. Walk me through what flows into Retained Earnings. - correct answer Retained Earnings = Old Retained Earnings Balance + Net Income - Dividends Issued If you're calculating Retained Earnings for the current year, take last year's Retained Earnings number, add this year's Net Income, and subtract however much the company paid out in dividends. How do you project Balance Sheet items like Accounts Receivable and Accrued Expenses in a 3-statement model? - correct answer Normally you make very simple assumptions here and assume these are percentages of revenue, operating expenses, or cost of goods sold. Examples: • Accounts Receivable: % of revenue. • Deferred Revenue: % of revenue. • Accounts Payable: % of COGS. • Accrued Expenses: % of operating expenses or SG&A. Then you either carry the same percentages across in future years or assume slight changes depending on the company. How should you project Depreciation & Capital Expenditures? - correct answer The simple way: project each one as a % of revenue or previous PP&E balance. The more complex way: create a PP&E schedule that splits out different assets by their useful lives, assumes straight-line depreciation over each asset's useful life, and then assumes capital expenditures based on what the company has invested historically. What's the difference between capital leases and operating leases? - correct answer Operating leases are used for short-term leasing of equipment and property, and do not involve ownership of anything. Operating lease expenses show up as operating expenses on the Income Statement. Capital leases are used for longer-term items and give the lessee ownership rights; they depreciate and incur interest payments, and are counted as debt. A lease is a capital lease if any one of the following 4 conditions is true: 1. If there's a transfer of ownership at the end of the term. 2. If there's an option to purchase the asset at a bargain price at the end of the term. 3. If the term of the lease is greater than 75% of the useful life of the asset. 4. If the present value of the lease payments is greater than 90% of the asset's fair market value. Why would the Depreciation & Amortization number on the Income Statement be different from what's on the Cash Flow Statement? - correct answer This happens if D&A is embedded in other Income Statement line items. When this happens, you need to use the Cash Flow Statement number to arrive at EBITDA because otherwise you're undercounting D&A. Why do we look at both Enterprise Value and Equity Value? - correct answer Enterprise Value represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise Value represents its true value. When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity Value? - correct answer Enterprise Value, because that's how much an acquirer really "pays" and includes the often mandatory debt repayment. What's the formula for Enterprise Value? - correct answer EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash (This formula does not tell the whole story and can get more complex - see the Advanced Questions. Most of the time you can get away with stating this formula in an interview, though). Why do you need to add Minority Interest to Enterprise Value? - correct answer Whenever a company owns over 50% of another company, it is required to report the financial performance of the other company as part of its own performance. So even though it doesn't own 100%, it reports 100% of the majority-owned subsidiary's financial performance. In keeping with the "apples-to-apples" theme, you must add Minority Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary. How do you calculate fully diluted shares? - correct answer Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities, such as warrants, convertible debt or convertible preferred stock. To calculate the dilutive effect of options, you use the Treasury Stock Method (detail on this below). Let's say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each - what is its fully diluted equity value? - correct answer Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all "in-the-money" - their exercise price is less than the current share price. When these options are exercised, there will be 10 new shares created - so the share count is now 110 rather than 100. However, that doesn't tell the whole story. In order to exercise the options, we had to "pay" the company $5 for each option (the exercise price). As a result, it now has $50 in additional cash, which it now uses to buy back 5 of the new shares we created. So the fully diluted share count is 105, and the fully diluted equity value is $1,050. Let's say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each - what is its fully diluted equity value? - correct answer $1,000. In this case the options' exercise price is above the current share price, so they have no dilutive effect. Why do you subtract cash in the formula for Enterprise Value? Is that always accurate? - correct answer The "official" reason: Cash is subtracted because it's considered a non-operating asset and because Equity Value implicitly accounts for it. The way I think about it: In an acquisition, the buyer would "get" the cash of the seller, so it effectively pays less for the company based on how large its cash balance is. Remember, Enterprise Value tells us how much you'd really have to "pay" to acquire another company. It's not always accurate because technically you should be subtracting only excess cash - the amount of cash a company has above the minimum cash it requires to operate. Is it always accurate to add Debt to Equity Value when calculating Enterprise Value? - correct answer In most cases, yes, because the terms of a debt agreement usually say that debt must be refinanced in an acquisition. And in most cases a buyer will pay off a seller's debt, so it is accurate to say that any debt "adds" to the purchase price. However, there could always be exceptions where the buyer does not pay off the debt. These are rare and I've personally never seen it, but once again "never say never" applies. Could a company have a negative Enterprise Value? What would that mean? - correct answer Yes. It means that the company has an extremely large cash balance, or an extremely low market capitalization (or both). You see it with: 1. Companies on the brink of bankruptcy. 2. Financial institutions, such as banks, that have large cash balances. Could a company have a negative Equity Value? What would that mean? - correct answer No. This is not possible because you cannot have a negative share count and you cannot have a negative share price. Why do we add Preferred Stock to get to Enterprise Value? - correct answer Preferred Stock pays out a fixed dividend, and preferred stock holders also have a higher claim to a company's assets than equity investors do. As a result, it is seen as more similar to debt than common stock. How do you account for convertible bonds in the Enterprise Value formula? - correct answer If the convertible bonds are in-the-money, meaning that the conversion price of the bonds is below the current share price, then you count them as additional dilution to the Equity Value; if they're out-of-the-money then you count the face value of the convertibles as part of the company's Debt. What's the difference between Equity Value and Shareholders' Equity? - correct answer Equity Value is the market value and Shareholders' Equity is the book value. Equity Value can never be negative because shares outstanding and share prices can never be negative, whereas Shareholders' Equity could be any value. For healthy companies, Equity Value usually far exceeds Shareholders' Equity. What percentage dilution in Equity Value is "too high?" - correct answer There's no strict "rule" here but most bankers would say that anything over 10% is odd. If your basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check your calculations - it's not necessarily wrong, but over 10% dilution is unusual for most companies. What are the 3 major valuation methodologies? - correct answer Comparable Companies, Precedent Transactions and Discounted Cash Flow Analysis. Rank the 3 valuation methodologies from highest to lowest expected value. - correct answer Trick question - there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it's best to say that it's more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions. When would you not use a DCF in a Valuation? - correct answer You do not use a DCF if the company has unstable or unpredictable cash flows (tech or bio-tech startup) or when debt and working capital serve a fundamentally different role. For example, banks and financial institutions do not re-invest debt and working capital is a huge part of their Balance Sheets - so you wouldn't use a DCF for such companies. What other Valuation methodologies are there? - correct answer Other methodologies include: • Liquidation Valuation - Valuing a company's assets, assuming they are sold off and then subtracting liabilities to determine how much capital, if any, equity investors receive • Replacement Value - Valuing a company based on the cost of replacing its assets • LBO Analysis - Determining how much a PE firm could pay for a company to hit a "target" IRR, usually in the 20-25% range • Sum of the Parts - Valuing each division of a company separately and adding them together at the end • M&A Premiums Analysis - Analyzing M&A deals and figuring out the premium that each buyer paid, and using this to establish what your company is worth • Future Share Price Analysis - Projecting a company's share price based on the P / E multiples of the public company comparables, then discounting it back to its present value When would you use a Liquidation Valuation? - correct answer This is most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the company's debts have been paid off. It is often used to advise struggling businesses on whether it's better to sell off assets separately or to try and sell the entire company. When would you use Sum of the Parts? - correct answer This is most often used when a company has completely different, unrelated divisions - a conglomerate like General Electric, for example. If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division and a technology division, you should not use the same set of Comparable Companies and Precedent Transactions for the entire company. Instead, you should use different sets for each division, value each one separately, and then add them together to get the Combined Value. When do you use an LBO Analysis as part of your Valuation? - correct answer Obviously you use this whenever you're looking at a Leveraged Buyout - but it is also used to establish how much a private equity firm could pay, which is usually lower than what companies will pay. It is often used to set a "floor" on a possible Valuation for the company you're looking at. What are the most common multiples used in Valuation? - correct answer The most common multiples are EV/Revenue, EV/EBITDA, EV/EBIT, P/E (Share Price / Earnings per Share), and P/BV (Share Price / Book Value). What are some examples of industry-specific multiples? - correct answer Technology (Internet): EV / Unique Visitors, EV / Pageviews Retail / Airlines: EV / EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization & Rent) Energy: P / MCFE, P / MCFE / D (MCFE = 1 Million Cubic Foot Equivalent, MCFE/D = MCFE per Day), P / NAV (Share Price / Net Asset Value) Real Estate Investment Trusts (REITs): Price / FFO, Price / AFFO (Funds From Operations, Adjusted Funds From Operations) Technology and Energy should be straightforward - you're looking at traffic and energy reserves as value drivers rather than revenue or profit. For Retail / Airlines, you often remove Rent because it is a major expense and one that varies significantly between different types of companies. When you're looking at an industry-specific multiple like EV / Scientists or EV / Subscribers, why do you use Enterprise Value rather than Equity Value? - correct answer You use Enterprise Value because those scientists or subscribers are "available" to all the investors (both debt and equity) in a company. The same logic doesn't apply to everything, though - you need to think through the multiple and see which investors the particular metric is "available" to. Would an LBO or DCF give a higher valuation? - correct answer Technically it could go either way, but in most cases the LBO will give you a lower valuation. Here's the easiest way to think about it: with an LBO, you do not get any value from the cash flows of a company in between Year 1 and the final year - you're only valuing it based on its terminal value. With a DCF, by contrast, you're taking into account both the company's cash flows in between and its terminal value, so values tend to be higher. How would you present these Valuation methodologies to a company or its investors? - correct answer Usually you use a "football field" chart where you show the valuation range implied by each methodology. You always show a range rather than one specific number. As an example, see page 10 of this document (a Valuation done by Credit Suisse for the Leveraged Buyout of Sungard Data Systems in 2005): Why can't you use Equity Value / EBITDA as a multiple rather than Enterprise Value / EBITDA? - correct answer EBITDA is available to all investors in the company - rather than just equity holders. Similarly, Enterprise Value is also available to all shareholders so it makes sense to pair them together. Equity Value / EBITDA, however, is comparing apples to oranges because Equity Value does not reflect the company's entire capital structure - only the part available to equity investors. When would a Liquidation Valuation produce the highest value? - correct answer This is highly unusual, but it could happen if a company had substantial hard assets but the market was severely undervaluing it for a specific reason (such as an earnings miss or cyclicality). As a result, the company's Comparable Companies and Precedent Transactions would likely produce lower values as well - and if its assets were valued highly enough, Liquidation Valuation might give a higher value than other methodologies. Let's go back to 2004 and look at Facebook back when it had no profit and no revenue. How would you value it? - correct answer You would use Comparable Companies and Precedent Transactions and look at more "creative" multiples such as EV/Unique Visitors and EV/Pageviews rather than EV/Revenue or EV/EBITDA. You would not use a "far in the future DCF" because you can't reasonably predict cash flows for a company that is not even making money yet. What would you use in conjunction with Free Cash Flow multiples - Equity Value or Enterprise Value? - correct answer Trick question. For Unlevered Free Cash Flow, you would use Enterprise Value, but for Levered Free Cash Flow you would use Equity Value. Remember, Unlevered Free Cash Flow excludes Interest and thus represents money available to all investors, whereas Levered already includes Interest and the money is therefore only available to equity investors. Debt investors have already "been paid" with the interest payments they received. You never use Equity Value / EBITDA, but are there any cases where you might use Equity Value / Revenue? - correct answer It's very rare to see this, but sometimes large financial institutions with big cash balances have negative Enterprise Values - so you might use Equity Value / Revenue instead. You might see Equity Value / Revenue if you've listed a set of financial and non- financial companies on a slide, you're showing Revenue multiples for the non-financial companies, and you want to show something similar for the financials. Note, however, that in most cases you would be using other multiples such as P/E and P/BV with banks anyway. How do you select Comparable Companies / Precedent Transactions? - correct answer The 3 main ways to select companies and transactions: 1. Industry classification 2. Financial criteria (Revenue, EBITDA, etc.) 3. Geography For Precedent Transactions, you often limit the set based on date and only look at transactions within the past 1-2 years. The most important factor is industry - that is always used to screen for companies/transactions, and the rest may or may not be used depending on how specific you want to be. How do you apply the 3 valuation methodologies to actually get a value for the company you're looking at? - correct answer Sometimes this simple fact gets lost in discussion of Valuation methodologies. You take the median multiple of a set of companies or transactions, and then multiply it by the relevant metric from the company you're valuing. Example: If the median EBITDA multiple from your set of Precedent Transactions is 8x and your company's EBITDA is $500 million, the implied Enterprise Value would be $4 billion. To get the "football field" valuation graph you often see, you look at the minimum, maximum, 25th percentile and 75th percentile in each set as well and create a range of values based on each methodology. What do you actually use a valuation for? - correct answer Usually you use it in pitch books and in client presentations when you're providing updates and telling them what they should expect for their own valuation. It's also used right before a deal closes in a Fairness Opinion, a document a bank creates that "proves" the value their client is paying or receiving is "fair" from a financial point of view. Valuations can also be used in defense analyses, merger models, LBO models, DCFs (because terminal multiples are based off of comps), and pretty much anything else in finance. Why would a company with similar growth and profitability to its Comparable Companies be valued at a premium? - correct answer This could happen for a number of reasons: • The company has just reported earnings well-above expectations and its stock price has risen recently. • It has some type of competitive advantage not reflected in its financials, such as a key patent or other intellectual property. • It has just won a favorable ruling in a major lawsuit. • It is the market leader in an industry and has greater market share than its competitors. What are the flaws with public company comparables? - correct answer No company is 100% comparable to another company. The stock market is "emotional" - your multiples might be dramatically higher or lower on certain dates depending on the market's movements. Share prices for small companies with thinly-traded stocks may not reflect their full value. How do you take into account a company's competitive advantage in a valuation? - correct answer 1. Look at the 75th percentile or higher for the multiples rather than the Medians. 2. Add in a premium to some of the multiples. 3. Use more aggressive projections for the company. Do you ALWAYS use the median multiple of a set of public company comparables or precedent transactions? - correct answer There's no "rule" that you have to do this, but in most cases you do because you want to use values from the middle range of the set. But if the company you're valuing is distressed, is not performing well, or is at a competitive disadvantage, you might use the 25th percentile or something in the lower range instead - and vice versa if it's doing well. You mentioned that Precedent Transactions usually produce a higher value than Comparable Companies - can you think of a situation where this is not the case? - correct answer Sometimes this happens when there is a substantial mismatch between the M&A market and the public market. For example, no public companies have been acquired recently but there have been a lot of small private companies acquired at extremely low valuations. For the most part this generalization is true but keep in mind that there are exceptions to almost every "rule" in finance. What are some flaws with precedent transactions? - correct answer Past transactions are rarely 100% comparable - the transaction structure, size of the company, and market sentiment all have huge effects. Data on precedent transactions is generally more difficult to find than it is for public company comparables, especially for acquisitions of small private companies. Two companies have the exact same financial profile and are bought by the same acquirer, but the EBITDA multiple for one transaction is twice the multiple of the other transaction - how could this happen? - correct answer Possible reasons: 1. One process was more competitive and had a lot more companies bidding on the target. 2. One company had recent bad news or a depressed stock price so it was acquired at a discount. 3. They were in industries with different median multiples. The EV / EBIT, EV / EBITDA, and P / E multiples all measure a company's profitability. What's the difference between them, and when do you use each one? - correct answer P / E depends on the company's capital structure whereas EV / EBIT and EV / EBITDA are capital structure-neutral. Therefore, you use P / E for banks, financial institutions, and other companies where interest payments / expenses are critical. EV / EBIT includes Depreciation & Amortization whereas EV / EBITDA excludes it - you're more likely to use EV / EBIT in industries where D&A is large and where capital expenditures and fixed assets are important (e.g. manufacturing), and EV / EBITDA in industries where fixed assets are less important and where D&A is comparatively smaller (e.g. Internet companies). If you were buying a vending machine business, would you pay a higher multiple for a business where you owned the machines and they depreciated normally, or one in which you leased the machines? The cost of depreciation and lease are the same dollar amounts and everything else is held constant. - correct answer You would pay more for the one where you lease the machines. Enterprise Value would be the same for both companies, but with the depreciated situation the charge is not reflected in EBITDA - so EBITDA is higher, and the EV / EBITDA multiple is lower as a result. For the leased situation, the lease would show up in SG&A so it would be reflected in EBITDA, making EBITDA lower and the EV / EBITDA multiple higher. How do you value a private company? - correct answer You use the same methodologies as with public companies: public company comparables, precedent transactions, and DCF. But there are some differences: • You might apply a 10-15% (or more) discount to the public company comparable multiples because the private company you're valuing is not as "liquid" as the public comps. • You can't use a premiums analysis or future share price analysis because a private company doesn't have a share price. • Your valuation shows the Enterprise Value for the company as opposed to the implied per-share price as with public companies. • A DCF gets tricky because a private company doesn't have a market capitalization or Beta - you would probably just estimate WACC based on the public comps' WACC rather than trying to calculate it. How far back and forward do we usually go for public company comparable and precedent transaction multiples? - correct answer Usually you look at the TTM (Trailing Twelve Months) period for both sets, and then you look forward either 1 or 2 years. You're more likely to look backward more than 1 year and go forward more than 2 years for public company comparables; for precedent transactions it's odd to go forward more than 1 year because your information is more limited. How do you value banks and financial institutions differently from other companies? - correct answer You mostly use the same methodologies, except: • You look at P / E and P / BV (Book Value) multiples rather than EV / Revenue, EV / EBITDA, and other "normal" multiples, since banks have unique capital structures. • You pay more attention to bank-specific metrics like NAV (Net Asset Value) and you might screen companies and precedent transactions based on those instead. • Rather than a DCF, you use a Dividend Discount Model (DDM) which is similar but is based on the present value of the company's dividends rather than its free cash flows. You need to use these methodologies and multiples because interest is a critical component of a bank's revenue and because debt is part of its business model rather than just a way to finance acquisitions or expand the business. Walk me through a Sum-of-the-Parts analysis - correct answer In a Sum-of-the-Parts analysis, you value each division of a company using separate comparables and transactions, get to separate multiples, and then add up each division's value to get the total for the company. Example: We have a manufacturing division with $100 million EBITDA, an entertainment division with $50 million EBITDA and a consumer goods division with $75 million EBITDA. We've selected comparable companies and transactions for each division, and the median multiples come out to 5x EBITDA for manufacturing, 8x EBITDA for entertainment, and 4x EBITDA for consumer goods. Our calculation would be $100 * 5x + $50 * 8x + $75 * 4x = $1.2 billion for the company's total value. Walk me through a DCF. - correct answer "A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value. First, you project out a company's financials using assumptions for revenue growth, expenses and Working Capital; then you get down to Free Cash Flow for each year, which you then sum up and discount to a Net Present Value, based on your discount rate - usually the Weighted Average Cost of Capital. Once you have the present value of the Cash Flows, you determine the company's Terminal Value, using either the Multiples Method or the Gordon Growth Method, and then also discount that back to its Net Present Value using WACC. Finally, you add the two together to determine the company's Enterprise Value." Walk me through how you get from Revenue to Free Cash Flow in the projections. - correct answer Subtract COGS and Operating Expenses to get to Operating Income (EBIT). Then, multiply by (1 - Tax Rate), add back Depreciation and other non-cash charges, and subtract Capital Expenditures and the change in Working Capital. Note: This gets you to Unlevered Free Cash Flow since you went off EBIT rather than EBT. You might want to confirm that this is what the interviewer is asking for. Why do you use 5 or 10 years for DCF projections? - correct answer That's usually about as far as you can reasonably predict into the future. Less than 5 years would be too short to be useful, and over 10 years is too difficult to predict for most companies. What do you usually use for the discount rate? - correct answer Normally you use WACC (Weighted Average Cost of Capital), though you might also use Cost of Equity depending on how you've set up the DCF. How do you calculate WACC? - correct answer The formula is: Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 - Tax Rate) + Cost of Preferred * (% Preferred). In all cases, the percentages refer to how much of the company's capital structure is taken up by each component. For Cost of Equity, you can use the Capital Asset Pricing Model and for the others you usually look at comparable companies/debt issuances and the interest rates and yields issued by similar companies to get estimates. How do you calculate the Cost of Equity? - correct answer Cost of Equity = Risk-Free Rate + Beta * Equity Risk Premium The risk-free rate represents how much a 10-year or 20-year US Treasury should yield; Beta is calculated based on the "riskiness" of Comparable Companies and the Equity Risk Premium is the % by which stocks are expected to out-perform "risk-less" assets. Normally you pull the Equity Risk Premium from a publication called Ibbotson's. Note: This formula does not tell the whole story. Depending on the bank and how precise you want to be, you could also add in a "size premium" and "industry premium" to account for how much a company is expected to out-perform its peers is according to its market cap or industry. How do you get to Beta in the Cost of Equity calculation? - correct answer You look up the Beta for each Comparable Company (usually on Bloomberg), un-lever each one, take the median of the set and then lever it based on your company's capital structure. Then you use this Levered Beta in the Cost of Equity calculation. For your reference, the formulas for un-levering and re-levering Beta are below: Un-Levered Beta = Levered Beta / (1 + ((1 - Tax Rate) x (Total Debt/Equity))) Levered Beta = Un-Levered Beta x (1 + ((1 - Tax Rate) x (Total Debt/Equity))) Why do you have to un-lever and re-lever Beta? - correct answer Again, keep in mind our "apples-to-apples" theme. When you look up the Betas on Bloomberg (or from whatever source you're using) they will be levered to reflect the debt already assumed by each company. But each company's capital structure is different and we want to look at how "risky" a company is regardless of what % debt or equity it has. To get that, we need to un-lever Beta each time. But at the end of the calculation, we need to re-lever it because we want the Beta used in the Cost of Equity calculation to reflect the true risk of our company, taking into account its capital structure this time. Would you expect a manufacturing company or a technology company to have a higher Beta? - correct answer A technology company, because technology is viewed as a "riskier" industry than manufacturing. Let's say that you use Levered Free Cash Flow rather than Unlevered Free Cash Flow in your DCF - what is the effect? - correct answer Levered Free Cash Flow gives you Equity Value rather than Enterprise Value, since the cash flow is only available to equity investors (debt investors have already been "paid" with the interest payments). If you use Levered Free Cash Flow, what should you use as the Discount Rate? - correct answer You would use the Cost of Equity rather than WACC since we're not concerned with Debt or Preferred Stock in this case - we're calculating Equity Value, not Enterprise Value. How do you calculate the Terminal Value? - correct answer You can either apply an exit multiple to the company's Year 5 EBITDA, EBIT or Free Cash Flow (Multiples Method) or you can use the Gordon Growth method to estimate its value based on its growth rate into perpetuity. The formula for Terminal Value using Gordon Growth is: Terminal Value = Year 5 Free Cash Flow * (1 + Growth Rate) / (Discount Rate - Growth Rate). Why would you use Gordon Growth rather than the Multiples Method to calculate the Terminal Value? - correct answer In banking, you almost always use the Multiples Method to calculate Terminal Value in a DCF. It's much easier to get appropriate data for exit multiples since they are based on Comparable Companies - picking a long-term growth rate, by contrast, is always a shot in the dark. However, you might use Gordon Growth if you have no good Comparable Companies or if you have reason to believe that multiples will change significantly in the industry several years down the road. For example, if an industry is very cyclical you might be better off using long-term growth rates rather than exit multiples. What's an appropriate growth rate to use when calculating the Terminal Value? - correct answer Normally you use the country's long-term GDP growth rate, the rate of inflation, or something similarly conservative. For companies in mature economies, a long-term growth rate over 5% would be quite aggressive since most developed economies are growing at less than 5% per year. How do you select the appropriate exit multiple when calculating Terminal Value? - correct answer Normally you look at the Comparable Companies and pick the median of the set, or something close to it. As with almost anything else in finance, you always show a range of exit multiples and what the Terminal Value looks like over that range rather than picking one specific number. So if the median EBITDA multiple of the set were 8x, you might show a range of values using multiples from 6x to 10x. Which method of calculating Terminal Value will give you a higher valuation? - correct answer It's hard to generalize because both are highly dependent on the assumptions you make. In general, the Multiples Method will be more variable than the Gordon Growth method because exit multiples tend to span a wider range than possible long-term growth rates. What's the flaw with basing terminal multiples on what public company comparables are trading at? - correct answer The median multiples may change greatly in the next 5-10 years so it may no longer be accurate by the end of the period you're looking at. This is why you normally look at a wide range of multiples and do a sensitivity to see how the valuation changes over that range. This method is particularly problematic with cyclical industries (e.g. semiconductors). How do you know if your DCF is too dependent on future assumptions? - correct answer The "standard" answer: if significantly more than 50% of the company's Enterprise Value comes from its Terminal Value, your DCF is probably too dependent on future assumptions. In reality, almost all DCFs are "too dependent on future assumptions" - it's actually quite rare to see a case where the Terminal Value is less than 50% of the Enterprise Value. But when it gets to be in the 80-90% range, you know that you may need to re-think your assumptions... Should Cost of Equity be higher for a $5 billion or $500 million market cap company? - correct answer It should be higher for the $500 million company, because all else being equal, smaller companies are expected to outperform large companies in the stock market (and therefore be "more risky"). Using a Size Premium in your calculation would also ensure that Cost of Equity is higher for the $500 million company. What about WACC - will it be higher for a $5 billion or $500 million company? - correct answer This is a bit of a trick question because it depends on whether or not the capital structure is the same for both companies. If the capital structure is the same in terms of percentages and interest rates and such, then WACC should be higher for the $500 million company for the same reasons as mentioned above. If the capital structure is not the same, then it could go either way depending on how much debt/preferred stock each one has and what the interest rates are. What's the relationship between debt and Cost of Equity? - correct answer More debt means that the company is more risky, so the company's Levered Beta will be higher - all else being equal, additional debt would raise the Cost of Equity, and less debt would lower the Cost of Equity. Cost of Equity tells us what kind of return an equity investor can expect for investing in a given company - but what about dividends? Shouldn't we factor dividend yield into the formula? - correct answer Trick question. Dividend yields are already factored into Beta, because Beta describes returns in excess of the market as a whole - and those returns include dividends. Two companies are exactly the same, but one has debt and one does not - which one will have the higher WACC? - correct answer This is tricky - the one without debt will have a higher WACC up to a certain point, because debt is "less expensive" than equity. Why? • Interest on debt is tax-deductible (hence the (1 - Tax Rate) multiplication in the WACC formula). • Debt is senior to equity in a company's capital structure - debt holders would be paid first in a liquidation or bankruptcy. • Intuitively, interest rates on debt are usually lower than the Cost of Equity numbers you see (usually over 10%). As a result, the Cost of Debt portion of WACC will contribute less to the total figure than the Cost of Equity portion will. However, the above is true only to a certain point. Once a company's debt goes up high enough, the interest rate will rise dramatically to reflect the additional risk and so the Cost of Debt would start to increase - if it gets high enough, it might become higher than Cost of Equity and additional debt would increase WACC. It's