WALLSTREET PREP VALUATION QUESTIONS AND
ANSWERS
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.
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
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.
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.
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).
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.
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.
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.
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).
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
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
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
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).
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.
Relative Valuation: In relative valuation, a business's value is arrived at by looking at
comparable companies and applying the average or median multiples derived from the
peer group - often EV/EBITDA, P/E, or some other relevant multiple to value the target.
This valuation can be done by looking at the multiples of comparable public companies
using their current market values, which is called "trading comps," or by looking at the
multiples of comparable companies recently acquired, which is called "transaction
comps."
, What are the most common valuation methods used in finance? - Answers -
Comparable Company Analysis ("Trading Comps")
Comparable Transactions Analysis ("Transaction Comps")
Discounted Cash Flow Analysis ("DCF")
Leveraged Buyout Analysis ("LBO")
Liquidation Analysis
What is Comparable Company Analysis ("Trading Comps")? - Answers - Trading comps
value a company based on how similar publicly-traded companies are currently being
valued at by the market.
What is Comparable Transactions Analysis ("Transaction Comps")? - Answers -
Transaction comps value a company based on the amount buyers paid to acquire
similar companies in recent years.
What is Discounted Cash Flow Analysis ("DCF")? - Answers - DCFs value a company
based on the premise that its value is a function of its projected cash flows, discounted
at an appropriate rate that reflects the risk of those cash flows.
What is Leveraged Buyout Analysis ("LBO")? - Answers - An LBO will look at a potential
acquisition target under a highly leveraged scenario to determine the maximum
purchase price the firm would be willing to pay.
What is Liquidation Analysis? - Answers - Liquidation analysis is used for companies
under (or near) distress and values the assets of the company under a hypothetical,
worst-case scenario liquidation.
Among the DCF, comparable companies analysis, and transaction comps, which
approach yields the highest valuation? - Answers - Transaction comps analysis often
yields the highest valuation because it looks at valuations for companies that have been
acquired, which factor in control premiums. Control premiums can often be quite
significant and as high as 25% to 50% above market prices. Thus, the multiples derived
from this analysis and the resulting valuation are usually higher than a straight trading
comps valuation or a standalone DCF valuation.
Which of the valuation methodologies is the most variable in terms of output? - Answers
- Because of its reliance on forward-looking projections and discretionary assumptions,
the DCF is the most variable out of the different valuation methodologies. Relative
valuation methodologies such as trading and transaction comps are based on the actual
prices paid for similar companies. While there'll be some discretion involved, the
valuations derived from comps deviate to a lesser extent than DCF models.
Contrast the discounted cash flow (DCF) approach to the trading comps approach. -
Answers - Discounted Cash Flow (DCF)
Advantages
ANSWERS
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.
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
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.
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.
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).
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.
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.
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.
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).
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
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
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
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).
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.
Relative Valuation: In relative valuation, a business's value is arrived at by looking at
comparable companies and applying the average or median multiples derived from the
peer group - often EV/EBITDA, P/E, or some other relevant multiple to value the target.
This valuation can be done by looking at the multiples of comparable public companies
using their current market values, which is called "trading comps," or by looking at the
multiples of comparable companies recently acquired, which is called "transaction
comps."
, What are the most common valuation methods used in finance? - Answers -
Comparable Company Analysis ("Trading Comps")
Comparable Transactions Analysis ("Transaction Comps")
Discounted Cash Flow Analysis ("DCF")
Leveraged Buyout Analysis ("LBO")
Liquidation Analysis
What is Comparable Company Analysis ("Trading Comps")? - Answers - Trading comps
value a company based on how similar publicly-traded companies are currently being
valued at by the market.
What is Comparable Transactions Analysis ("Transaction Comps")? - Answers -
Transaction comps value a company based on the amount buyers paid to acquire
similar companies in recent years.
What is Discounted Cash Flow Analysis ("DCF")? - Answers - DCFs value a company
based on the premise that its value is a function of its projected cash flows, discounted
at an appropriate rate that reflects the risk of those cash flows.
What is Leveraged Buyout Analysis ("LBO")? - Answers - An LBO will look at a potential
acquisition target under a highly leveraged scenario to determine the maximum
purchase price the firm would be willing to pay.
What is Liquidation Analysis? - Answers - Liquidation analysis is used for companies
under (or near) distress and values the assets of the company under a hypothetical,
worst-case scenario liquidation.
Among the DCF, comparable companies analysis, and transaction comps, which
approach yields the highest valuation? - Answers - Transaction comps analysis often
yields the highest valuation because it looks at valuations for companies that have been
acquired, which factor in control premiums. Control premiums can often be quite
significant and as high as 25% to 50% above market prices. Thus, the multiples derived
from this analysis and the resulting valuation are usually higher than a straight trading
comps valuation or a standalone DCF valuation.
Which of the valuation methodologies is the most variable in terms of output? - Answers
- Because of its reliance on forward-looking projections and discretionary assumptions,
the DCF is the most variable out of the different valuation methodologies. Relative
valuation methodologies such as trading and transaction comps are based on the actual
prices paid for similar companies. While there'll be some discretion involved, the
valuations derived from comps deviate to a lesser extent than DCF models.
Contrast the discounted cash flow (DCF) approach to the trading comps approach. -
Answers - Discounted Cash Flow (DCF)
Advantages
