Valuation & M&A exam checklist
What is the point of valuation?
Valuation links business economics (profitability, growth, capital efficiency) to value creation. DCF,
RIM, and multiples are different lenses on the same drivers.
1) Valuation frameworks
• EV vs Equity value
o EV = value of operating assets (enterprise claim). Indirect way to value equity
o Equity value = EV − Net Debt − other senior claims + non-operating assets (cash).
Direct way to value equity
• DCF vs Residual Income Model (RIM)
o Similarity: both value the same underlying business, rely on PV, produce EV, utilize
WACC.
o Difference:
▪ DCF discounts Enterprise Free Cash Flows at WACC, includes explicit forecast
+ Terminal Value (value of all cash flows after the explicit forecast period.)
▪ RIM uses accounting profits (NOPAT) minus capital charge (WACC x IC). It
values the firm as invested capital TODAY + PV of future residual income.
o Different valuation methods can be appropriate depending on assumptions, but they
are not all accurate; a valuation is only valid if its inputs and assumptions are
reasonable, consistent, and economically justified.
• Residual claim intuition
o Equity = Assets − Liabilities ⇒ if debt is unchanged, changes in operating asset value
(EV) flow mainly to equity.
o AKA: Equity is the residual claim meaning that any change in enterprise value will
cause the same change in equity value (ΔEV ≈ ΔEquity). (assuming debt and other
senior claims are unchanged)
o EV changes ask, “how much value is created”; equity answers “who gets it.”
2) Enterprise value mechanics + EV → Equity bridge
• Market cap
o Market cap (Equity value) = Price × Shares (diluted if relevant)
• Net debt
o Net Debt = Interest-bearing debt − Cash & cash equivalents
• EV build
, o EV = Market cap + Net Debt + Preferred + NCI + other debt-like items (leases,
pension deficit, etc.)
▪ NCI – portion of subsidiaries not owned by the parent. Because EV reflects the
value of the ENTIRE operating business, including subsidiaries, NCI is added to
EV to account for claims of minority shareholders.
• Equity from EV
o Equity value = EV − Net Debt − Preferred − NCI − other debt-like items + non-
operating assets
o Target price per share = Equity value / diluted shares
• Cash treatment rule
o Typically, cash is not treated as part of working capital and is treated as a non-
operating item; excess cash is added back in the EV→Equity bridge.
o Only the minimum operating cash required to run the business may be treated as an
operating item and included in working capital.
3) Multiples (concept + calculation + target price)
• Equity vs EV multiples
o EV – looks at the business before financing
▪ Advantage – not impacted by leverage, to compare relative valuation for
companies with different capital structures.
▪ Disadvantage – more difficult to calculate.
▪ EV/EBITDA
o Equity – looks at what is left after debt
▪ Advantage – easy to derive.
▪ Disadvantage – distorted by leverage, higher leverage generally means lower
equity multiples.
▪ P/E
• Trading vs transaction multiples
o Transaction multiples tend to be higher due to control premium / bid premium.
• Definitions
o P/E = Price / EPS = Market cap / Net income
o EV/EBITDA
o EBITDA is not formally defined in IFRS/US GAAP
, • Enterprise (EV-based) margins
o Numerator: EBIT (Operating profit, Tests: full operating efficiency), EBITDA (EBIT + D&A
– add back to exclude from consideration, helps compare capital intensive (careful:
overstates performance) vs asset light firms), Gross profit (Tests: pricing power +
production efficiency) → enterprise claim → to all capital providers
Denominator: Revenue
o These are before financing (before interest, which is the only channel through which
leverage affects profits)
o Measure operating performance of the business itself
o Not distorted by capital structure
• Equity margins
o (Net margin) = Net income / Revenue → equity claim → belongs to shareholders
o After interest and taxes
o Reflect how the business + financing affects shareholders
o Directly impacted by leverage
• Implied valuation steps
o Implied EV = (Target multiple) × (Target metric)
o Implied Equity = Implied EV − Net Debt + cash
o Implied Price = Implied Equity / shares
• Bid premium
o Premium % = (Offer price / Undisturbed price) − 1
4) Performance, returns, and value creation
• NOPAT
o NOPAT = EBIT × (1 − Tax rate)
o NOPAT margin = NOPAT / Sales
• ROE
o ROE = Net income / [Last year’s] Shareholder’s equity)
• Du Pont decomposition (3-step)
o ROE = (Net income / Revenue) × (Revenue / [Last year’s] Total Assets) × (Total
Assets / [Last year’s] Shareholder’s equity)
What is the point of valuation?
Valuation links business economics (profitability, growth, capital efficiency) to value creation. DCF,
RIM, and multiples are different lenses on the same drivers.
1) Valuation frameworks
• EV vs Equity value
o EV = value of operating assets (enterprise claim). Indirect way to value equity
o Equity value = EV − Net Debt − other senior claims + non-operating assets (cash).
Direct way to value equity
• DCF vs Residual Income Model (RIM)
o Similarity: both value the same underlying business, rely on PV, produce EV, utilize
WACC.
o Difference:
▪ DCF discounts Enterprise Free Cash Flows at WACC, includes explicit forecast
+ Terminal Value (value of all cash flows after the explicit forecast period.)
▪ RIM uses accounting profits (NOPAT) minus capital charge (WACC x IC). It
values the firm as invested capital TODAY + PV of future residual income.
o Different valuation methods can be appropriate depending on assumptions, but they
are not all accurate; a valuation is only valid if its inputs and assumptions are
reasonable, consistent, and economically justified.
• Residual claim intuition
o Equity = Assets − Liabilities ⇒ if debt is unchanged, changes in operating asset value
(EV) flow mainly to equity.
o AKA: Equity is the residual claim meaning that any change in enterprise value will
cause the same change in equity value (ΔEV ≈ ΔEquity). (assuming debt and other
senior claims are unchanged)
o EV changes ask, “how much value is created”; equity answers “who gets it.”
2) Enterprise value mechanics + EV → Equity bridge
• Market cap
o Market cap (Equity value) = Price × Shares (diluted if relevant)
• Net debt
o Net Debt = Interest-bearing debt − Cash & cash equivalents
• EV build
, o EV = Market cap + Net Debt + Preferred + NCI + other debt-like items (leases,
pension deficit, etc.)
▪ NCI – portion of subsidiaries not owned by the parent. Because EV reflects the
value of the ENTIRE operating business, including subsidiaries, NCI is added to
EV to account for claims of minority shareholders.
• Equity from EV
o Equity value = EV − Net Debt − Preferred − NCI − other debt-like items + non-
operating assets
o Target price per share = Equity value / diluted shares
• Cash treatment rule
o Typically, cash is not treated as part of working capital and is treated as a non-
operating item; excess cash is added back in the EV→Equity bridge.
o Only the minimum operating cash required to run the business may be treated as an
operating item and included in working capital.
3) Multiples (concept + calculation + target price)
• Equity vs EV multiples
o EV – looks at the business before financing
▪ Advantage – not impacted by leverage, to compare relative valuation for
companies with different capital structures.
▪ Disadvantage – more difficult to calculate.
▪ EV/EBITDA
o Equity – looks at what is left after debt
▪ Advantage – easy to derive.
▪ Disadvantage – distorted by leverage, higher leverage generally means lower
equity multiples.
▪ P/E
• Trading vs transaction multiples
o Transaction multiples tend to be higher due to control premium / bid premium.
• Definitions
o P/E = Price / EPS = Market cap / Net income
o EV/EBITDA
o EBITDA is not formally defined in IFRS/US GAAP
, • Enterprise (EV-based) margins
o Numerator: EBIT (Operating profit, Tests: full operating efficiency), EBITDA (EBIT + D&A
– add back to exclude from consideration, helps compare capital intensive (careful:
overstates performance) vs asset light firms), Gross profit (Tests: pricing power +
production efficiency) → enterprise claim → to all capital providers
Denominator: Revenue
o These are before financing (before interest, which is the only channel through which
leverage affects profits)
o Measure operating performance of the business itself
o Not distorted by capital structure
• Equity margins
o (Net margin) = Net income / Revenue → equity claim → belongs to shareholders
o After interest and taxes
o Reflect how the business + financing affects shareholders
o Directly impacted by leverage
• Implied valuation steps
o Implied EV = (Target multiple) × (Target metric)
o Implied Equity = Implied EV − Net Debt + cash
o Implied Price = Implied Equity / shares
• Bid premium
o Premium % = (Offer price / Undisturbed price) − 1
4) Performance, returns, and value creation
• NOPAT
o NOPAT = EBIT × (1 − Tax rate)
o NOPAT margin = NOPAT / Sales
• ROE
o ROE = Net income / [Last year’s] Shareholder’s equity)
• Du Pont decomposition (3-step)
o ROE = (Net income / Revenue) × (Revenue / [Last year’s] Total Assets) × (Total
Assets / [Last year’s] Shareholder’s equity)
