VALUATION & DCF ANALYSIS (BIWS -->
400 IB Q'S AND ANSWERS 100%
CORRECT.
What's the point of valuation? Why do you value a company? - ANSWERTo determine
its Implied Value for one reason or another.
If Implied Value is different from Current Value, might be able to invest in the company
and make money if its value changes.
If you're advising a client company, you might value it to tell management the price that
it might receive if the company sells, which if often different from its Current Value.
But public companies already have Market Caps and Share Prices. Why bother valuing
them? - ANSWERBecause a company's Market Cap and Share Price reflect its
CURRENT Value according to "the market as a whole" - but the market might be wrong!
You value companies to see see if the market's views are correct or incorrect, to assess
a company's value vs. it's peers to determine whether it is undervalued or overvalued,
and to maximize client's goals.
What are the advantages and disadvantages of the 3 main valuation methodologies? -
ANSWERComparable Public Comps: based current metrics of public companies. Are
useful because they're based on real market data, are quick to calculate, and do not
depend on far-in-the-future assumptions. However, there may not be truly comparable
companies, the analysis will be less accurate for volatile or thinly traded companies, and
it may undervalue companies' long-term potential.
Precedent Transactions: are useful because they're based on the real prices that
companies have paid for similar companies, and they may better reflect industry trends
than Public Comps. Tend to reveal higher valuations than comps due to control
premiums (10-30%). However, data is often spotty and misleading, there may not be
truly comparable transactions, and specific deal terms, market conditions, & acquirer
motives might distort the multiples.
DCF Analysis: is the most "correct" methodology according to finance theory, it's less
subject to market fluctuation/volatility, and it reflects company-specific factors and long-
term trends. However, it's also very dependent on far-in-the-future assumptions, and
there's disagreement over the proper calculations for key figures like the Cost of Equity
& WACC.
,Which of the 3 main methodologies will produce the highest Implied Values? -
ANSWERTrick question because almost any methodology could product higher Implied
Values depending on the industry, time period, and assumptions. However:
Precedent transactions often produce higher Implied Values than public comps because
of the 10%-30% control premium (extra amount a buyer pays over current share price
or equity value). Tough to say how a DCF compares because it's so dependent on your
assumptions & long-term company strategy.
Safe answer: DCF tends to produce the most variable output since it's so dependent on
your assumptions, and precedent transaction tend to produce higher values than the
Public Comps because of the control premium
When is a DCF more useful than Public Comps or Precedent Transactions? -
ANSWERYou should pretty much always build a DCF since it is valuation. It's especially
useful when company you're valuing is healthy & mature; has stable, predictable cash
flows or if you lack good Public Comps & Precedent Transactions. (unless it's a startup
with unstable or unpredictable cash flow;tech or biotech; or a bank/financial institution
where debt & working capital serve different roles; banks don't re-invest debt and
working cap is huge part of their balance sheet)
When would you not use a DCF? - ANSWERStartup or companies with unstable or
unpredictable cash flow (tech or biotech) or or a bank/financial institution where debt &
working capital serve different roles; banks don't re-invest debt and working cap is huge
part of their balance sheet
When are Public Comps or Precedent Transactions more useful than the DCF? -
ANSWERIf company you're valuing is early-stage and you can't estimate or predict it's
future cash flows. Or if there's no pathway to positive cash flow, you must rely on other
methods. These other methodologies can be more useful when you run into problems in
the DCF such as the inability to estimate the discount rate.
Which one should be worth more: a $500M EBITDA healthcare company or a $500M
EBITDA industrials company? Assume growth rates & margins are the same? -
ANSWERIn all likelihood, the healthcare company will be worth more.
-less capital/asset intensive industry which means company's Capex & working capital
will be lower and Free Cash Flow will be higher (closer to EBITDA).
-healthcare, at least in some sectors, also tends to be more of a 'growth' industry vs.
industrials being pretty mature & cyclical.
-healthcare likely has better recurring revenue & less volatile to swings in the market vs.
industrials
-discount rate might be higher for healthcare company, but the lower asset
intensity/higher cash flow and higher expected growth rate makes up for it
-however, this is a generalization and we need more info
, How do you value an apple tree? - ANSWERSame way you value a company;
comparable apple trees, comparable transaction, & a DCF.
-You'd look at what similar apple trees have sold for and calculate the expected future
cash flows from this tree.
-you would then discount the future cash flows to their present value, discount the
terminal value to PV, and add everything to determine the apple tree's implied value.
-discount rate would be based on your opportunity cost - what you might be able to earn
each year by investing in other, similar apple trees
People say that the DCF is intrinsic valuation, while Public Comps and Precedent
Transactions are relative valuation. Is that correct? - ANSWERNot necessarily. the DCF
is based on company's expected future cash flows, so in that sense, it is 'intrinsic
valuation'
-but the Discount Rate used in the DCF is usually linked to peer companies (market
data), and if you use the Multiples Method to calculate terminal value, the multiples are
also linked to peer companies.
-DCF depends less on the market than the other methodologies, but there's still some
dependency.
-More accurate to say that the DCF depends more on your views of the company's long-
term prospects and less on market data compared to other methodologies.
Why do you build a DCF analysis to value a company? - ANSWERRemember that a
company is worth the present value of its expected future cash flows (Cash
Flow/Discount Rate - Cash Flow Growth Rate)
-BUT, you can't just use that single formula because a company's cash flow growth rate
and Discount Rate change over time.
-so, in a DCF analysis, you divide the valuation into two periods; one where those
assumptions change (explicit forecast period) and one where they stay the same
(terminal period)
-you then project the company's cash flow in both periods and discount them to their
present value based on the appropriate discount rate(s).
-then, you compare this sum-the company's Implied Value-to the company's Current
value or 'asking price' to see if it's valued appropriately
Walk me through a DCF analysis - ANSWER-A DCF values a company based on the
Present Value of its cash flows in the explicit period plus the present value of its
terminal value.
-you start by projecting the company's Free Cash Flows over the next 5-10 years by
making assumptions for revenue growth, expenses, margins, non-cash adjustments,
working capital, & capex
-then, you discount the cash flows using the discount rate, usually the weighted average
cost of capital & sum them up.
-next, you estimate the company's Terminal Value using the Multiples Method or the
Gordon Growth Method; represents the company's value after those first 5-10 years into
perpetuity
400 IB Q'S AND ANSWERS 100%
CORRECT.
What's the point of valuation? Why do you value a company? - ANSWERTo determine
its Implied Value for one reason or another.
If Implied Value is different from Current Value, might be able to invest in the company
and make money if its value changes.
If you're advising a client company, you might value it to tell management the price that
it might receive if the company sells, which if often different from its Current Value.
But public companies already have Market Caps and Share Prices. Why bother valuing
them? - ANSWERBecause a company's Market Cap and Share Price reflect its
CURRENT Value according to "the market as a whole" - but the market might be wrong!
You value companies to see see if the market's views are correct or incorrect, to assess
a company's value vs. it's peers to determine whether it is undervalued or overvalued,
and to maximize client's goals.
What are the advantages and disadvantages of the 3 main valuation methodologies? -
ANSWERComparable Public Comps: based current metrics of public companies. Are
useful because they're based on real market data, are quick to calculate, and do not
depend on far-in-the-future assumptions. However, there may not be truly comparable
companies, the analysis will be less accurate for volatile or thinly traded companies, and
it may undervalue companies' long-term potential.
Precedent Transactions: are useful because they're based on the real prices that
companies have paid for similar companies, and they may better reflect industry trends
than Public Comps. Tend to reveal higher valuations than comps due to control
premiums (10-30%). However, data is often spotty and misleading, there may not be
truly comparable transactions, and specific deal terms, market conditions, & acquirer
motives might distort the multiples.
DCF Analysis: is the most "correct" methodology according to finance theory, it's less
subject to market fluctuation/volatility, and it reflects company-specific factors and long-
term trends. However, it's also very dependent on far-in-the-future assumptions, and
there's disagreement over the proper calculations for key figures like the Cost of Equity
& WACC.
,Which of the 3 main methodologies will produce the highest Implied Values? -
ANSWERTrick question because almost any methodology could product higher Implied
Values depending on the industry, time period, and assumptions. However:
Precedent transactions often produce higher Implied Values than public comps because
of the 10%-30% control premium (extra amount a buyer pays over current share price
or equity value). Tough to say how a DCF compares because it's so dependent on your
assumptions & long-term company strategy.
Safe answer: DCF tends to produce the most variable output since it's so dependent on
your assumptions, and precedent transaction tend to produce higher values than the
Public Comps because of the control premium
When is a DCF more useful than Public Comps or Precedent Transactions? -
ANSWERYou should pretty much always build a DCF since it is valuation. It's especially
useful when company you're valuing is healthy & mature; has stable, predictable cash
flows or if you lack good Public Comps & Precedent Transactions. (unless it's a startup
with unstable or unpredictable cash flow;tech or biotech; or a bank/financial institution
where debt & working capital serve different roles; banks don't re-invest debt and
working cap is huge part of their balance sheet)
When would you not use a DCF? - ANSWERStartup or companies with unstable or
unpredictable cash flow (tech or biotech) or or a bank/financial institution where debt &
working capital serve different roles; banks don't re-invest debt and working cap is huge
part of their balance sheet
When are Public Comps or Precedent Transactions more useful than the DCF? -
ANSWERIf company you're valuing is early-stage and you can't estimate or predict it's
future cash flows. Or if there's no pathway to positive cash flow, you must rely on other
methods. These other methodologies can be more useful when you run into problems in
the DCF such as the inability to estimate the discount rate.
Which one should be worth more: a $500M EBITDA healthcare company or a $500M
EBITDA industrials company? Assume growth rates & margins are the same? -
ANSWERIn all likelihood, the healthcare company will be worth more.
-less capital/asset intensive industry which means company's Capex & working capital
will be lower and Free Cash Flow will be higher (closer to EBITDA).
-healthcare, at least in some sectors, also tends to be more of a 'growth' industry vs.
industrials being pretty mature & cyclical.
-healthcare likely has better recurring revenue & less volatile to swings in the market vs.
industrials
-discount rate might be higher for healthcare company, but the lower asset
intensity/higher cash flow and higher expected growth rate makes up for it
-however, this is a generalization and we need more info
, How do you value an apple tree? - ANSWERSame way you value a company;
comparable apple trees, comparable transaction, & a DCF.
-You'd look at what similar apple trees have sold for and calculate the expected future
cash flows from this tree.
-you would then discount the future cash flows to their present value, discount the
terminal value to PV, and add everything to determine the apple tree's implied value.
-discount rate would be based on your opportunity cost - what you might be able to earn
each year by investing in other, similar apple trees
People say that the DCF is intrinsic valuation, while Public Comps and Precedent
Transactions are relative valuation. Is that correct? - ANSWERNot necessarily. the DCF
is based on company's expected future cash flows, so in that sense, it is 'intrinsic
valuation'
-but the Discount Rate used in the DCF is usually linked to peer companies (market
data), and if you use the Multiples Method to calculate terminal value, the multiples are
also linked to peer companies.
-DCF depends less on the market than the other methodologies, but there's still some
dependency.
-More accurate to say that the DCF depends more on your views of the company's long-
term prospects and less on market data compared to other methodologies.
Why do you build a DCF analysis to value a company? - ANSWERRemember that a
company is worth the present value of its expected future cash flows (Cash
Flow/Discount Rate - Cash Flow Growth Rate)
-BUT, you can't just use that single formula because a company's cash flow growth rate
and Discount Rate change over time.
-so, in a DCF analysis, you divide the valuation into two periods; one where those
assumptions change (explicit forecast period) and one where they stay the same
(terminal period)
-you then project the company's cash flow in both periods and discount them to their
present value based on the appropriate discount rate(s).
-then, you compare this sum-the company's Implied Value-to the company's Current
value or 'asking price' to see if it's valued appropriately
Walk me through a DCF analysis - ANSWER-A DCF values a company based on the
Present Value of its cash flows in the explicit period plus the present value of its
terminal value.
-you start by projecting the company's Free Cash Flows over the next 5-10 years by
making assumptions for revenue growth, expenses, margins, non-cash adjustments,
working capital, & capex
-then, you discount the cash flows using the discount rate, usually the weighted average
cost of capital & sum them up.
-next, you estimate the company's Terminal Value using the Multiples Method or the
Gordon Growth Method; represents the company's value after those first 5-10 years into
perpetuity
