400 IB QUESTIONS AND ANSWERS
100% CORRECT.
Walk me through a DCF - 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.
Small company stocks are expected to out-perform large company stocks and certain
industries are expected to out-perform others, and these premiums reflect these
expectations.
What's an alternate way to calculate Free Cash Flow aside from taking Net Income,
adding back Depreciation, and subtracting Changes in Operating Assets / Liabilities and
CapEx? - ANSWERTake Cashflow From Operations and subtract CapEx and
mandatory debt repayments - that gets you to Levered Cash Flow. To get to Unlevered
Cash flow, you then need to add back the tax-adjusted intrest Expense and subtract the
tax-adjusted Intrest Income
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 -
ANSWERSubtract cost of goods sold 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.
How do you calculate Cost of Equity? - ANSWERCost 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.
100% CORRECT.
Walk me through a DCF - 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.
Small company stocks are expected to out-perform large company stocks and certain
industries are expected to out-perform others, and these premiums reflect these
expectations.
What's an alternate way to calculate Free Cash Flow aside from taking Net Income,
adding back Depreciation, and subtracting Changes in Operating Assets / Liabilities and
CapEx? - ANSWERTake Cashflow From Operations and subtract CapEx and
mandatory debt repayments - that gets you to Levered Cash Flow. To get to Unlevered
Cash flow, you then need to add back the tax-adjusted intrest Expense and subtract the
tax-adjusted Intrest Income
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 -
ANSWERSubtract cost of goods sold 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.
How do you calculate Cost of Equity? - ANSWERCost 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.
