400 Qs Flashcards

Question

How do you calculate Cash Flow from Financing

Answer 1

CFF= Cash from Debt/Equity Issuance - Debt Repayment - Dividend Payments - Stock Repurchasing

Answer 2

FCO - CapEx = FCF

Answer 3

Add them all together to get net change in cash flow

Answer 4

1. **Revenue - COGS = Gross Profit ** 2. **Gross Profit - Operating Expenses = Operating Income** Operating Expenses = SG&A and D&A. 3. **EBT = Opeating Income + (Non-Operating Income - Non-Operating Expenses)** Non-Operating Income and Expenses= * Interest Income, Interest Expense, Gains or Losses on Sale of Assets 4. **Net Income = EBT - Income Tax Expense**

Answer 5

Net income, from the Income statement, flows onto Shareholder's Equity on the Balance Sheet, and into the top line of the Cash Flow statement Balance sheet changes --> working capital changes on cash flow Investing and financing activities --> affect assets such as PP&E, Debt and Shareholder's Equity

Answer 6

As they are a placeholder to be adjusted according to the cash flowing in from the Cash Flow statement. Since cash is a part of the assets on the balance sheet, the ending cash balance on the balance sheet should match the ending cash balance from the cash flow statement. adjustments are made to shareholders' equity, particularly through retained earnings. The net income (or loss) for the period flows into retained earnings within shareholders' equity.

Answer 7

Retained earnings represent the cumulative amount of net income that has been retained in the company rather than distributed as dividends. Ending retained earnings = beginning retained earnings + net income - dividens paid.

Answer 8

Net income --> retained earnings retained earnings is a key part of shareholder's equity

Answer 9

Represents owners claim after (total assets - total liabilities). 1. **Common Stock** - par value of issued shares. 2. **Additional Paid in Capital (APIC)** - excess amount paid for shares 3. **Retained Earnings**- cumulative amount of net income retained 4. **Treasury Stock** - represents cost of shares repurchased, reduces shareholder's equity 5. **Accumulated Other Comprehensive Income (AOCI)** - other unrealised gains and losses not in net income

Answer 10

**Cash Flow Statement** Gives true picture of cash generation independent of all the non-cash expenses. #1 thing you care about when analysing financial health

Answer 11

Income Statement and Balance Sheet as you can then create the Cash Flow statement from both (assuming you have the before and after version of the Balance sheet that correspond to Income Statement time periods)

Answer 12

1. **Income Statement**- Operating income declines by $10 and assuming a 40% tax rate, Net Income goes down by $6 2. **Cash Flow Statement**- Net Income goes down by $6 but depreciation is a non-cash expense that gets added back so overallnet cash flow goes up by $4. 3. **Balance Sheet** - PP&E goes down by $10 on assets and Cash is up by $4. Thus assets are down by $6, since net income fell by $6 as well, SHareholder's equity on the liabilities and shareholders side fell by $6 too.

Answer 13

Always go in the order: 1. Income Statement 2. Cash Flow Statement 3. Balance Sheet Thus you can make sure the balance sheet balances.

Answer 14

Asset going up decreases cash flow Liability going up increases cash flow

Answer 15

* Depreciation is a non-cash expense, so it is tax-deductible as taxes are a cash expense. * Depreciation reduces to amount of taxes you pay.

Answer 16

Each company does it differently, could be: 1. COGS 2. Operating Expenses End result is the same, depreciation always reduces pre-tax income

Answer 17

Confirm that accrued compensation is now being recognised as an expense (rather than just changing non-accrued to accrued compensation) 1. **Income Statement**: operating expenses goe up by $10, Pre-Tax Income goes up by $10 and Net Income falls by $6 (assuming a 40% tax rate) 2. **Cash Flow Statement**: Net Income down by $6 and Accrued Compensation will increase Cash Flow by $10, so overall Cash Flow from Operations i up by $4 and the net change in cash is up by $4. 3. **Balance Sheet**: Cash is up by $4, so Assets are up by $4. Accrued compenisation is a liability so liabilities are up by $10 and Retained Earnings are down by $6 due to the Net Income, so both sides balanced.

Answer 18

Wages, salaries, bonuses and other forms of compensation that employees have earned but not been paid. Recongised as a current liability on balance sheet and an expense on the income statement.

Answer 19

a current asset that a business holds for resale or production. Types of inventory: 1. Raw Materials 2. Work-in-Progress (WIP). 3. Finished Goods 4. Maintenance, Repair and Operations (MRO) Inventory

Answer 20

**First-In, First-Out (FIFO):** * Assumes that the oldest inventory items are sold first. * In times of rising prices, FIFO results in lower cost of goods sold and higher ending inventory value. **Last-In, First-Out (LIFO):** * Assumes that the newest inventory items are sold first. * In times of rising prices, LIFO results in higher cost of goods sold and lower ending inventory value. **Weighted Average Cost:** This method averages the cost of all inventory items available for sale during the period and uses this average cost to value ending inventory and cost of goods sold. **Specific Identification:** This method tracks the actual cost of each specific item of inventory. It is practical for businesses with unique, high-value items.

Answer 21

1. **Income Statement**: no change 2. **Cash Flow Statement**: Decreases Cash Flow from Operations by $10, as does the Net Change in Cash at the bottom. 3. **Balance Sheet**: Inventory goes up by $10 but Cash Flow down by $10 so the changes cancel out

Answer 22

Working capital changes do not show up on the Income Statement Expense only recorded when goods associared with it are sold --> goes to COGS or Operating Expenses

Answer 23

At the start of 'Year 1': 1. **Income Statement**: no change 2. **Cash Flow Statement**: $100 reduction in cash flow from investing, $100 increase from debt raised. Net cash stays the same. 3. **Balance Sheet**: increase in $100 in PPE, increase in debt of $100. Cancel each other out.

Answer 24

**Income Statement**: Operating Income reduce by $10 by D&A and $10 in Interest. W tax, Net income would fall by $12 **Cash Flow Statement**: Net income down by $12, add back D&A to have CFO down by $2. **Balance Sheet**:Cash down by $2 and PPE down by $2 --> ASsets down by $12. Net Income down by $12 --> Shareholder's Equity down by $12 and balance.

Answer 25

**Income Statement**: $80 write down on pre-tax income, 40% tax--> Net income declines by $48 **Cash Flow Statement**: Net Income down by $48 but non-cash expense so added back, CFO increases by $32. Loan payback decreases CFI by $100 --> Net Change in Cash is a fall of $68. **Balance Sheet** - Cash down by $68, PPE down by $80 --> assets down by $148. Debt down $100 and Net Income down $48 --> Liabilites and Shareholders Eq. down by $148 so balance.

Answer 26

**Income Statement**: no changes **Cash Flow Statement**: Inventory up by $10 --> CFO decreases by $10 --> overall cash reduces by $10 **Balance Sheet**: inventory up by $10 --> Cash down by $10 --> balance :)

Answer 27

**Income Statement**: Revenue up by $20 and COGS up by $10 --> Gross Profit up by $10 --> w tax, Net Income up by $6 **Cash Flow Statement**: Net income up $6 and Inventory decreased by $10 --> CFO up by $16 **Balance Sheet:** Cash up by $16 and Inventory down by $10 vs Net Income up by $6 --> Balance.

Answer 28

Yes; 1. LBO's with dividend recap: owner has taken out a large portion of equity, can turn number negative 2. Also if losing money --> declinign retained earnings --> negative shareholder's equity

Answer 29

Working Capital = Current Assets - Current Liabilities +ve shows company can pay off its short-term liabilities with it's short term assets Operating working capital more common in models: (Current Assets - Cash & Cash Equivalents) - (Current Liabilities - Debt)

Answer 30

not necessarily, dependent on: 1. Companies with subscriptions --> high defferred revenues --> -ve working capital 2. Retail and Restaurants --> upfront payment --> increased cash and large accounts payable --> -ve working capital 3. Could also be financial trouble or possible bankruptcy

Answer 31

**Income Statement**: $100 write-down on pre-tax Y --> 40% tax, Net Income declines by $60 **Cash Flow Statement**: Net Income down by $60, but write down is a non-cash expense so added back --> CFO and net changes increases by $40 **Balance Sheet** Cash is up by $40 and assets down by $100 --> Asset's down by $60 Net Income down by $60 --> Shareholder's Equity down by $60

Answer 32

Clarify the bailout; debt, equity, both? most common equity investment form gov. **Income Statement** - No Change **Cash Flow Statement** CFF up $100 --> net change up $100 **Balance Sheet** Cash up $100 --> Assets up $100 Shareholder's Equity up $100

Answer 33

**Income Statement** Written down liability --> pre-tax income goes up by $100 --> w tax, Net Income goes up by $60 **Cash Flow Statement** Net Income up by $60 --> debt write-down of $100 --> CFO and Net Cash down by $40 **Balance Sheet** Cash down $60 --> Assets down $60 Debt down $100, Net Income up $60 --> Shareholder's Equity up by $40

Answer 34

Companies that agree to perform services in the future collect cash upfront: 1. Web-based subscription software 2. Cell phone carriers that sell annual contracts 3. Magazine publishers that sell subcriptions per GAAP, only record revenue when you perform services

Answer 35

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.

Answer 36

* Cash based accounting recognises revenue and expenses when cash is **actually recieved** * Accrual recognises revenue when collection is **resonably certain** and expenses when they are **incurred rather than paid out in cash** most big companies use accrual due to credit card uses

Answer 37

Goes into Deferred Revenue on the Balance Sheet under Liabilities As the services performed, Deferred Revenue balance 'turns into' real revenue on the Income Statement

Answer 38

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 transactionvalue companies.

Answer 39

If the asset has a useful life of over 1 year, it is capitalised.

Answer 40

**Cash-based accounting**: Revenue would not show up until company charges the company card and deposits the funds in the bank account. **Accrual Accounting**: 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.

Answer 41

Expensing: * Immediate impact on income statement * Used for items with short-term benefits or low costs Capitalising: * Cost is recorded on the balance sheet as an asset and then depreciation/amortised over it's useful life * Used for larger purchases that provide long term benefits

Answer 42

Many companies have non-cash charges (A,Stock-based compensation, deferred revenue write down) in their income statements. GAAP underestimates the profitability of a company.

Answer 43

Possibilities: 1. Company spent too much on CapEx; these are not reflected in EBITDA 2. High interest expensure 3. Debt matures and unable to refinance, losing all the cash 4. Singificant one-time charges that bankrupt the company As EBITDA excludes investment (and depreciation) in long-term assets, interest and one-time charges

Answer 44

Happens when company is acquired and intangible assets (customers, brand, intellectual prop.) and values them much worse Can also happen when a company discontinues part of its operations and must impair the associated goodwill

Answer 45

1. Company is acquired, goodwill increases as a 'plug' for purchase price 2. Company acquires another company for more than it's assets worth, leading to net goodwill increase

Answer 46

1. GAAP accrual-based but tax is cash-based 2. GAAP normally uses straight line depreciation whereas tax accounting uses accelerated depreciation 3. GAAP more accurately tracks assets/liabilities whereas tax accounting only concerned with revenue/expenses in the current period and what income tax you owe.

Answer 47

Temporary difference between what a company can dedict with cash tax purposes vs what they can deduct for book tax purposes

Answer 48

Deferred Tax Liabilities: when you have a tax expense on the Income Statement but haven't paid that tax in cash Deferred Tax Assets: when you pay taxes in cash but haven't expensed them on the income statement

Answer 49

most common with asset write-ups and write-downs in M&A deals asset write-up --> produce a deferred tax liability asset write-down --> produce a deferred tax asset

Answer 50

Either bottoms up (more common and reliable) or tops-down builds: 1. **Bottom-Up**: Start with individual products/customers estimate the average sale value, and then the growth rate in sales 2. **Tops-Down**: Start with overall market size and then estimate company's market share to get revenue

Answer 51

Bottoms up: no. of employees by department --> avg. salary, benefits, bonuses --> assume growth rates based on revenue or other COGS tied to revenue CapEX and misc. epenses are related to a company's internal plans for expansion

Answer 52

Use estimates: * For revenue, assume a simple growth rate * For expenses, assume major expenses e.g. SG&A are a % of revenue

Answer 53

1. **Common Stock**: par value of issued stock 2. **Retained Earnings**: net income 'saved up' over time 3. **Additional Paid in Capital**: how much stock based compensation issues and new stock exercised by employee options (contra equity) 4. **Treasury Stock**: dollar amount of shares the company has bought back 5. **Accumulated other comprehensive income**: misc. income

Answer 54

**Retained Earnings = Old Retained Earnings Balance + Net Income – Dividends Issued**

Answer 55

Retained Earnings = Old Retained Earnings Balance + Net Income – Dividends Issued

Answer 56

APIC = Old APIC + Stock-Based Compensation + Value of Stock Created by Option Exercises Take the balance from last year, add this year’s stock-based compensation number, and then add in the value of new stock created by employees exercising options this year

Answer 57

Shows the major items that comprise Shareholder's Equity You don’t use it too much, but it can be helpful for analyzing companies with unusual stock-based compensation and stock option situations

Answer 58

* Restructuring Charges * Goodwill Impairment * Asset Write-Downs * Bad Debt Expenses * Legal Expenses * Disaster Expenses * Change in Accounting Procedures To be an “add-back” or “non-recurring” charge for EBITDA / EBIT purposes, **it needs to affect Operating Income on the Income Statement** Also note that you do add back Depreciation, Amortization, and sometimes Stock-Based Compensation for EBITDA / EBIT, but that these are not “non-recurring charges” because all companies have them every year – these are just non-cash charges.

Answer 59

Assumption as %: * **Accounts Recieveable**: % of revenue * **Deferred Revenue**: % of revenue * **Accounts Payable**: % of COGS * **Accrued Expenses**: % of operating expenses or SG&A carry out same % into the future or assume slight changes

Answer 60

Simple way: project each one as a % of revenye or previous PP&E balance Complex: * PP&E Schedule that splits out different assets by useful lives. * Assume straight-line depreciation over useful life * Assumes CapEx based on historical investment

Answer 61

'Quick and dirty' - reduce taxable income by the portion of NOLs useable this year --> apply same tax rate and subtract new tax from old pretax income

Answer 62

Occurs when a company's tax-deductible expenses exceed its taxable revenues Can use this loss to offset taxable income in other years. Can also be carried forward to future years to reduce taxes

Answer 63

Create a book vs cash tax schedule --> calculate Taxable Income based on NOLs vs calculate taxable income without the NOLs Then book the difference as an increase to deffered tax liability on the balance sheet.

Answer 64

Operating leases: short-term leasing of equipment and property, do not involve any ownership. Capital leases: used for longer-term and give ownership rights --> they depreciate, incure interest and are counted as debt

Answer 65

1. transfer of ownership at the end of the term 2. option to purchase the asset at a bargain price at end of term 3. Term of lease is greater than 75% of the useful life of the asset 4. if PV of the lease payments is greater than 90% of the asset's fair market value

Answer 66

Enterprise Value = value of company attributale to all investors Equity value = portion avaliable to shareholders (equity investors)

Answer 67

Enterprise Value, as it's how much an acquirer really 'pays' and includes the mandatory debt repayments

Answer 68

EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash (formula not entire story and gets more complex)

Answer 69

Whenever a company owns over 50% of another company, it is required to report 100% of the financial performance of the other company as part of its own performance. Hence you must add minority interest to EV to reflect the subsidiary

Answer 70

Basic share county + dilutive effect of stock options + other dilutive securities (e.g. warrants, convertible debt or convertible preferred stock) To calculate dilutive effect of options you use the Treasury Stock Method

Answer 71

The dilutive effect of stock options refers to the reduction in the ownership percentage and earnings per share (EPS) for existing shareholders when new shares are issued as a result of employees or others exercising their stock options.

Answer 72

Financial instruments that can be converted into common stock, increasing outstanding shares and diluting ownership

Answer 73

* Warrants are similar to stock options but issued directly by the company and have a longer duration.

Answer 74

Type of bond/loan that can be converted into a predefined number of shares, at discretion of bondholder

Answer 75

Type of preferred share that gives the holder the option to convert the preferred shares into a certain number of common shares (usually at a fixed ratio)

Answer 76

RSUs are company shares given to employees as part of their conversion package, subject to vesting conditions.

Answer 77

Type of bond that can be converted into a predetermind number of common shares during the bond's life, at the bondholder's discretion

Answer 78

Basic Equity: 100 * $10= $1000 When options exercised share count increases from 100 --> 110 Company has additional cash of $50 (10 * $5), which is used to buy back 5 of the new shares Share count goes from 110 --> 105. Fully diluted equity value is $1,050

Answer 79

$1,000. In this case the options’ exercise price is above the current share price (out of the money), so they have no dilutive effect as they are not expected to be exercised.

Answer 80

Total equity of a company that would exist if all potential sources of equity were exercised or converted into common stock

Answer 81

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.

Answer 82

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.

Answer 83

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.

Answer 84

No. This is not possible because you cannot have a negative share count and you cannot have a negative share price.

Answer 85

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.

Answer 86

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.

Answer 87

convertible bonds are in-the-money because the company’s share price is $100 and conversion price is $50. So we count them as additional shares rather than debt. divide the value of the convertible bonds – $10 million – by the par value – $1,000 – to find no. of individual bonds: $10 million / $1,000 = 10,000 convertible bonds. figure out how many shares this number represents. The number of shares per bond is the par value divided by the conversion price: $1,000 / $50 = 20 shares per bond . So we have 200,000 new shares (20 * 10,000) created by the convertibles, giving us 1.2 million diluted shares outstanding.

Answer 88

We do not use the Treasury Stock Method with convertibles because the company is not “receiving” any cash from us.

Answer 89

Equity value = Market value Shareholders' Equity = 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.

Answer 90

Too simple, need to add: 1. **Net Operating Losses** - similar to cash 2. **Long-Term Investments** - similar to cash 3. **Equity Investments** - similar to cash, should be discounted 4. **Capital Leases** - also have interest payments so should be added in like debt 5. **(Some) Operating Leases** - sometimes need to convert operating leases to capital leases and add them as well 6. **Unfunded Pension Obligations** - counted as debt asw Enterprise Value = Equity Value – Cash + Debt + Preferred Stock + Minority Interest **– NOLs – Investments + Capital Leases + Unfunded Pension Obligations**

Answer 91

Technically, you should use market value for everything. In practice, use market value only for the Equity Value portion, because it’s almost impossible to establish market values for the rest of the items in the formula.

Answer 92

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.

Answer 93

Comparable Companies, Precedent Transactions and Discounted Cash Flow Analysis.

Answer 94

There is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium 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.

Answer 95

1. If the company has unstable or unpredictable cash flows (e.g. start ups) 2. When working capital and debt serve a fundamentally different role (e.g. banks and financial institutions do not re-invest debt and working capital is a huge part of their balance sheet)

Answer 96

1. **Liquidation Valuation**: Selling company's assets at fair market value - liabilities = determine capital that equity investors recieve 2. **Replacement Value** – Valuing a company based on the cost of replacing its assets 3. **LBO Analysis** – Determining how much a PE firm could pay for a company to hit a “target” IRR, usually in the 20-25% range 4. **Sum of the Parts** – Valuing each division of a company separately and adding them together at the end 5. **M&A Premiums Analysis** – Find the acquisition premium to establish what your company is worth 6. **Future Share Price Analysis** – Projecting a company’s share price based on the P / E multiples of comps, then discounting it back to its PV

Answer 97

Used to see wether equity shareholders will recieve any capital after debts have been paid off. Advise struggling business on wether to sell off assets or entire company

Answer 98

Used in conglomerates with unrelated divisions as can't use same comps and precedents for diff divisions.

Answer 99

Used to establish purchase price a PE firm could pay, which is usually lower than what companies will pay Often used as a 'floor' on a possible valuation

Answer 100

EV/Revenue, EV/EBITDA, EV/EBIT, P/E , and P/BV (Share Price / Book Value per Share)

Answer 101

Technology (Internet): EV / Unique Visitors, EV / Pageviews Retail / Airlines: EV / EBITDAR Energy: EV / EBITDAX, EV / Daily Production, EV / Proved Reserve Quantities Real Estate Investment Trusts (REITs): Price / FFO per Share, Price / AFFO per Share (Funds From Operations, Adjusted Funds From Operations) For REITs, Funds From Operations is a common metric that adds back Depreciation and subtracts gains on the sale of property. Depreciation is a non-cash yet extremely large expense in real estate, and gains on sales of properties are assumed to be non-recurring, so FFO is viewed as a “normalized” picture of the cash flow the REIT is generating.

Answer 102

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.

Answer 103

Could go either way, but mostly LBO will give a lower valuation This is as an LBO valuation only looks at the terminal value, while the DCF looks at both a company's cash flows throughout and it's terminal value. (NOte: LBO gives a price for a given IRR rather than a valuation)

Answer 104

Usually use a 'football field' chart where you show the valuation range

Answer 105

The same way you would value a company: 1. looking at what comparable apple trees are worth (relative valuation) 2. the value of the apple tree’s cash flows (intrinsic valuation).

Answer 106

EBITDA is avaliable to all investors, like Enterprise Value Equity Value/ EBITDA is comparing apples to oranges because Equity Value does not reflect the company's entire capital structure - only the part avaliable to equity investors

Answer 107

highly unusual, but it could happen if a company had substantial hard assets but the market was severely undervaluing it for a specific reason 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.

Answer 108

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. This is a very common wrong answer given by interviewees. When you can’t predict cash flow, use other metrics – don’t try to predict cash flow anyway!

Answer 109

**Unlevered FCF-Enterprise Value** **Levered FCF-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

Answer 110

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. MIght be used when using revenue multiples for non-financial institutions

Answer 111

3 main ways: 1. Industry 2. Financial Criteria (Revenue, EBITDA, etc.) 3. Geography For precedent, often only look at past 1-2 years.

Answer 112

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.

Answer 113

1. Beaten earnings expectation and stock price rose 2. Some type of competitive advantage not reflected in financials (e.g. key patent or intellectual property) 3. Won a favourable ruling in a major lawsuit 4. Market leader in industry and greater market share

Answer 114

* Never 100% comparable * Stock market 'emotional' * Share prices for small companies with low vol. trading, may not reflect their full value

Answer 115

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. In practice you rarely do all of the above – these are just possibilities

Answer 116

Not necessarily, if: Distressed company: use 25th percentile Competitive adv. company: 75th percentile

Answer 117

When big mismatch between M&A and public market e.g. no public companies has been acquired recently but there have been a lot of small private companies acquired at very low valuations.

Answer 118

* Rarely 100% comparable - transaction structure, coompany size and market sentiment all have huge effects. * Data on precedents is more difficult to find, especially for private small acquisitions

Answer 119

1. One process more competitive 2. One company had recent bad news or depressed stock price 3. In different industries with different median multiples

Answer 120

Warren Buffett once famously said, "Does management think the tooth fairy pays for capital expenditures?” He dislikes EBITDA because it hides the Capital Expenditures companies make and disguises how much cash they are actually using to finance their operations. In some industries there is also a large gap between EBIT and EBITDA –anything that is very capital-intensive, for example, will show a big disparity

Answer 121

P/E depends on **capital structure**, whereas EV/EBIT and EV/EBITDA are **capital-structure netural**. This ise P/E for banks, financial insts. and other companies where interest payments are critical. EV/EBIT includes D&A whereas EV/EBITDA excludes it --> use EV/EBIT where D&A is large, EV/EBITDA when fixed assets are less important.

Answer 122

EPS in P/**E** is derived from net income which is effected by capital structure. A higher debt causes the P/E to fall due to higher interest payments depressing net income and EPS EV/EBITDA: EV incl. both equity and debt (balancing both), while EBITDA excludes interest expeneses.

Answer 123

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

Answer 124

Same methodlogy; public comps, precdents and DCF. Differences: * Apply a 10-15% **discount** to public comp as private company not as liquid Valuation shows **Enterprise Value** rather than the implied per-share price as with public companies * DCF estimate WACC based on public comps

Answer 125

no discount because with precedent transactions, you’re acquiring the entire company – and once it’s acquired, the shares immediately become illiquid.

Answer 126

Only in the context of precedent transactions – it would make no sense to include them for public company comparables or as part of the Cost of Equity / WACC calculation in a DCF because they are not public and therefore have no values for market cap or Beta.

Answer 127

Utilise diff. multiples for public comps and precdents: * Screen based on assets or desposits * ROE, ROA, BV and TBV rather than EBITDA * Use multiples such as P/E, P/BV, and P/TBV rather than EV/EBITDA Rather than a traditional DCF, use different methodologies for **intrinsic valuation**: * **Dividend Discount Model (DDM)**: sum up the PV of a bank's dividends for the future and then addd it to terminal PV, based on a P/BV * **Residual Income Model**: take current BV and add the PV of the excess returns to that BV to value it. "Excess return" each year is (ROE * Book Value) - (Cost of Equity * Book Value)

Answer 128

We only care about relevant multiples with **public company comparables** to estimate the enterprise value. Work to Equity Value from Enterprise Value and also subtract IPO proceeds to get 'new' cash Divide by total number of shares to egt new share price If you were using P / E or any other “Equity Value-based multiple” for the multiple in step #2 here, then you would get to Equity Value instead and then subtract the IPO proceeds from there.

Answer 129

The “formula” to calendarize financial statements is as follows: TTM = Most Recent Fiscal Year + New Partial Period – Old Partial Period e.g. take company’s Q1 numbers, add the most recent fiscal year’s numbers, and then subtract the Q1 numbers from that most recent fiscal year.

Answer 130

Looking at similar transactions and seeing the premiums: 1. Screen precedents (industry, date and size) 2. Get the Seller's share price before announced transaction 3. Calculate the day premiums 4. Get medians for each set and apply to companys current share price

Answer 131

Projectin companies share price and then discounting back to PV: 1. Get the median historical P/E of public comps 2. Apply multiple to company's 1/2yr forward to projected EPS to get its implied future share price. 3. DIcount back to PV using a discount rate in line with Cost of Equity Norm do a sensitivity anlysis with a range of PE and discount rates

Answer 132

* All sellers in the M&A premiums must be **public** * Use a broader set of transactions for M&A premiums; +10 and less stringent.

Answer 133

Value each division of a company using separate comps and transactions, then add up each division's value to get the total for the company.

Answer 134

NOLs based on how much they'll save the company in taxes in future years and then the PV of the sum of tax savings. 1. Assume a company can use NOLs to completely offset taxable income until the NOLs run out 2. Im Acquisition scenario, use SEction 382, and multiply the adjusted long-term, published by the IRS, rate by the equity purchase price of the seller to determine the maximum allowed NOL useage in each year. You might look at NOLs in a valuation but you rarely add them in – if you did, they would be similar to cash and you would subtract NOLs to go from Equity Value to Enterprise Value, and vice versa

Answer 135

This varies by bank and group, but two common methods: 1. You pick the report with the most detailed information. 2. You pick the report with numbers in the middle of the range

Answer 136

1. Search online and see if you can find press releases or articles in the financial press with these numbers. 2. Failing that, look in equity research for the buyer around the time of the transaction and see if any of the analysts estimate the seller’s numbers. 3. Also look on online sources like Capital IQ and Factset and see if any of them disclose numbers or give estimates

Answer 137

Usually you look at the TTM (Trailing Twelve Months) period for both sets, and then you look forward either 1 or 2 years. Public Comps: More likely to look backward and foward more. Precedent transactions: odd to go forward more than 1 year because your information is more limited

Answer 138

Misleading to compare companies with v diff margins. One with higher margin will usually have a lower multiple. Consider screening based on margins.

Answer 139

Public comps and precedents similar but: * Might screen on metrics like Proved Reserves or Daily Production --> R/P (Proved Reserves/ Last Years Production), EBITDAX Could also use unlevered DCf or NAV (Net Asset Value) Model. ALso different accounting models may effect valuation.

Answer 140

REITs asset intensive and dep. on cash generation of assets: * Price/FFO per Share (Funds from Operations) and Price/AFFO (Adjusted FFO), which adds back Depreciation and substact gains on property sales * Value properties through NOI/cap rate * Replacement Valuation is more common because can estimate the cost of buying new land and building new properties

Answer 141

DCF values a company based on PV of its cash flows and PV of it's terminal value FIrst project company's financials using assumptions for re. growth, expenses, working capital; then get down to free cash flow for each year, sum and discount to NPV based on WACC Determine the company's Termial Value using Multiples or Gordon Growth, discount back to NPV using WACC Add NPV of Terminal Value + NPV of Projected FCF

Answer 142

Revenue - COGS - Operating Expenses = Operating Income (EBIT) EBIT * (1-Tax Rate) = NOPAT (Net Operating Profit After Taxes) NOPAT + Depreciation + non-cash charges + Net Working Capital -CapEx = Unlevered Free Cash Flow Note: This gets you to Unlevered Free Cash Flow since you went off EBIT rather than EBT. You should confirm that this is what the interviewer is asking for.

Answer 143

CapEx is a cash outflow necessary to both sustain and grow operations. Hence for FCF to be truly 'free' it must have no CapEx charge

Answer 144

Cash Flow from Operations - CapEx = Levered Cash Flow To get to Unlevered Cash Flow, you then need to add back the tax-adjusted Interest Expense and subtract the tax-adjusted Interest Income.

Answer 145

NWC = Current Assets - Current Liabiliites Increase in working capital indicates more cash is tied up in operating the business Decrease in working capital means company is freeing up cash from operations.

Answer 146

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.

Answer 147

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 (e.g. LFCF)

Answer 148

Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) + Cost of Preferred * (% Preferred) Cost of Equity derived from the CAPM, others look at comparable companies

Answer 149

Interest is Tax-Deductible, creating a tax shield and an after-tax cost of debt. After Tax Cost of Debt = Cost of Debt * (1- tax rate) Ensure the WACC appropiately reflects after tax costs of all forms of capital

Answer 150

Cost of Equity = Risk-Free Rate + Beta * Equity Risk Premium Pull equity risk premium from *Ibbotson's* Can also include a size, industry and country premium to account for performance

Answer 151

1. Look up the Beta for each Comparable Company (usually on Bloomberg) 2. un-lever each one, take the median of the set and then lever it based on your company’s capital structure. 3. Then you use this Levered Beta in the Cost of Equity calculation

Answer 152

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)))

Answer 153

'Apples-to-Apples' theme Betas levered to reflect debt/equity mix of that company --> need to unlever and relever to reflect our company

Answer 154

A technology company, because technology is viewed as a “riskier” industry than manufacturing.

Answer 155

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).

Answer 156

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.

Answer 157

1. Apply exit multiple to Y5 EBITDA, EBIT or FCF 2. Gordon's Growth Terminal Value = Y5 FCF * (1+Growth Rate)/(Discount Rate - Growth Rate)

Answer 158

Normally always use comps Use Gordon Growth if no good comps or have reason to believe multiples will change sig. If v. cyclical might use long-term growth rates rather than exit multiples.

Answer 159

Normally you use the country’s long-term GDP growth rate, the rate of inflation, or something similarly conservative.

Answer 160

Look at comps and pick median Show a range of exit multiples and Terminal Values over that range

Answer 161

Hard to generalise as dep. on assumptions Multiples more variable than the Gordon Growth method, as multiples span a wider range than possible long-term growth rates.

Answer 162

median multiples may change greatly in the next 5-10 years normally look at a wide range of multiples and do a sensitivity Multiples is particularly problematic with cyclical industries (e.g. semiconductors).

Answer 163

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…

Answer 164

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”).

Answer 165

trick question because it depends on whether the capital structure is the same for both companies. If the capital structure is the same: WACC should be higher for the $500 million company If capital structure is not the same: Could go either way depending on how much debt/preffered stock each one has and what the interest rates are.

Answer 166

Weighted Average Interest Rate = Pre-Tax cost of debt After Tax-Cost of Debt = Pre-Tax cost of debt * (1-Tax Rate)

Answer 167

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

Answer 168

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

Answer 169

Cost of Equity = (Dividends per Share / Share Price) + Growth Rate of Dividends Use when dividends are v important or lack info on beta or other variables in CAPM

Answer 170

One without debt will have a higher WACC **up to a certain point** then it increases First Phase debt is 'cheaper' as: * Interest on debt is tax-deductible * Debt is senior to equity in capital structure, so get paid first. * Interest rates on debt are lower than Cost of Equity, so Cost of Debt portion of WACC will contribute less than the Cost of Equity portion Once debt is high enough, IR rises dramatically --> Cost of Debt increases to higher than Cost of Equity and additional debt increases WACC Creates U-Shape graph.

Answer 171

You should start by saying, “it depends” but most of the time the 10% difference in revenue will have more of an impact. That change in revenue doesn’t affect only the current year’s revenue, but also the revenue/EBITDA far into the future and even the terminal value.

Answer 172

The discount rate is likely to have a bigger impact on the valuation, though the correct answer should start with, “It could go either way, but most of the time…”

Answer 173

estimate WACC based on work done by auditors or valuation specialists, or based on what WACC for comparable public companies is.

Answer 174

* Create your own projections. * Modify management’s projections to make them more conservative. * sensitivity table based on management and more conservative growth rates and margins

Answer 175

Banks use debt differently and do not re-invest it in the business; use it to create loans Interest is a critical part of banks’ business models and changes in working capital can be much larger than a bank’s net income – so traditional measures of cash flow don’t tell you much. For financial institutions, it’s more common to use a Dividend Discount Model or Residual Income Model instead of a DCF

Answer 176

Example sensitivities: * Revenue Growth vs. Terminal Multiple * EBITDA Margin vs. Terminal Multiple * Terminal Multiple vs. Discount Rate * Long-Term Growth Rate vs. Discount Rate

Answer 177

Trick question. You don’t account for this at all in a DCF, because paying off debt principal shows up in Cash Flow from Financing on the Cash Flow Statement – but we only go down to Cash Flow from Operations and then subtract Capital Expenditures to get to Free Cash Flow. If we were looking at Levered Free Cash Flow, then our interest expense would decline in future years due to the principal being paid off – but we still wouldn’t count the principal repayments themselves anywhere.

Answer 178

Adjustment to DCF that assumes cash flows are recieved evenly throughout the year --> thus can be treated as if recieved in the middle of the year

Answer 179

You use it to represent the fact that a company’s cash flow does not come 100% at the end of each year – instead, it comes in evenly throughout each year. In a DCF without mid-year convention, we would use discount period numbers of 1 for the first year, 2 for the second year, 3 for the third year, and so on. With mid-year convention, we would instead use 0.5 for the first year, 1.5 for the second year, 2.5 for the third year, and so on

Answer 180

Stub period refers to a partial period at the start or end of the forecast timeline shorter than a full year.

Answer 181

1. **Multiples Method** add 0.5 to the final year discoutn number, to reflect the fact the company gets sold at the end of the year. 2. **Gordon Growth Method** no adjustment as assuming cash flows grow into prepetuity and recieved throughout the year

Answer 182

Enterprise Value --> + Cash, - Debt,- Preferred Stock, - Minority interests (and other debt like items) = Equity Value Use circular calculation that takes into account basic shares outstanding, options, warrants, convertibles, and other dilutive securities. It’s circular because the dilution from these depends on the per-share price – but the per-share price depends on number of shares outstanding, which depends on the per-share price.

Answer 183

Mechanically same as DCF but dividends rather than FCF: 1. Project out the company’s earnings, down to EPS 2. Assume a dividend payout ratio of EPS based on historicals and how much regulatory capital it needs. 3. Use this to calculate dividends over the next 5-10 years. 4. Check to make sure that the firm still meets its target Tier 1 Capital and other capital ratios – if not, reduce dividends. 5. Discount the dividend in each year to its present value based on Cost of Equity and then sum these up. 6. Calculate terminal value based on P / BV and BV in the final year, and then discount this to its PV based on Cost of Equity. 7. Sum the PV of the terminal value and the PV of the dividends to get the company’s net present per-share value.

Answer 184

a loan that a company receives, which gives the bondholder the option to convert the debt into a specified number of shares of the company's common stock at a predetermined conversion price and under certain conditions.

Answer 185

Trick question. If the convertible debt is **in-the-money** then you do not count it as debt but instead assume that it contributes to dilution, so the company’s Equity Value is higher. **out-of-the-money** then you count it as debt and use the interest rate on the convertible for Cost of Debt.

Answer 186

add CapEx spending of $100 in year 4 of the DCF, which would reduce Free Cash Flow for that year by $100. The Enterprise Value, in turn, would fall by the present value of that $100 decrease in Free Cash Flow. The actual math here is messy but you would calculate the present value by dividing $100 by ((1 + Discount Rate)^4) – the “4” just represents year 4 here. Then you would subtract this amount from the Enterprise Value.

Answer 187

You don’t need to understand merger models as well as an M&A banker does, but you do need to more than just the basics, especially if you’ve had a finance internship or fulltime job before. It’s important to know the effects of an acquisition, and understand concepts such as synergies and why Goodwill & Other Intangibles actually get created. One thing that’s not important? Walking through how all 3 statements apre affected by an acquisition. In 99% of cases, you **only care about the Income Statement in a merger model** (despite rumors to the contrary).

Answer 188

Analyses: financial profiles of 2 companies, purchase price, how purchase is made, determines wether buyer EPS increases or decreases 1. Make assumption about the acquisition - price, cash or debt combination, valuations and shares of buyer and seller, project out an Income Statement for each one 2. Combine income statements, adjust for Foregone Interest on Cash and Interest Paid on Debt in the Combined Pre-Tax Income line; you apply the buyer’s Tax Rate to get the Combined Net Income, and then divide by the new share count to determine the combined EPS

Answer 189

difference between “merger” and “acquisition” is more semantic than anything. In a merger the companies are close to the same size, whereas in an acquisition the buyer is significantly larger.

Answer 190

Possible reasons: * Gain market share * Grow quicker * Seller undervalued or has critical tech/IP e.g. medical patents * Significant synergies

Answer 191

An acquisition is dilutive if the additional amount of Net Income the seller contributes is not enough to offset the buyer’s foregone interest on cash, additional interest paid on debt, and the effects of issuing additional shares. Acquisition effects – such as amortization of intangibles – can also make an acquisition dilutive.

Answer 192

Foregone interest on cash - interest income that a company loses when it uses its cash reserves to finance an acquisition instead of leaving that cash invested in interest-bearing accounts or securities. Interest Paid on Debt: If the acquisition is financed with debt, the combined company's income statement must reflect the new interest expenses.

Answer 193

Financial consequences from an acquisition: changes in operating expenses, new costs related to integration, changes in capital structure, and the amortization of intangible assets, among others.

Answer 194

Amortization of intangibles is the process of gradually expensing the value of intangible assets over their useful lives. During an acquisition, it often pays more than the fair market value of the tangible assets. The excess amount paid is allocated to various intangible assets or goodwill. Intangible assets are a non-cash expense with a finite life are then amortized over time, reducing the combined company's earnings. This can be significant in the context of a merger, especially if the acquired company has substantial intangible assets. The reduction in net income due to amortization can make an acquisition appear dilutive.

Answer 195

Just cash and debt: sum up the interest expense for debt and the foregone interest on cash, then compare it against the seller’s Pre-Tax Income. All-stock: If acquirer PE higher than target --> accretive as acquirere is paying less for the earning of the targen than its own earnings are valued. Cash, stock, and debt: there’s no quick rule-of-thumb

Answer 196

Trick question. You can’t tell unless you also know that it’s an all-stock deal. If it’s an all-cash or all-debt deal, the P/E multiples of the buyer and seller don’t matter because no stock is being issued. Sure, generally getting more earnings for less is good and is more likely to be accretive but there’s no hard-and-fast rule unless it’s an all-stock deal.

Answer 197

In an all-stock deal, if the buyer has a higher P/E than the seller, it will be accretive; if the buyer has a lower P/E, it will be dilutive. On an intuitive level if you’re paying more for earnings than what the market values your own earnings at, you can guess that it will be dilutive; and likewise, if you’repaying less for earnings than what the market values your own earnings at, you can guess that it would be accretive.

Answer 198

1. Foregone Interest on Cash - buyer loses interest on cash it would've earned w/o acquisition 2. Additional Interest on Debt 3. Additional Shares Outstanding - 4. Combined financial statements 5. Creation of Goodwill & other intangibles - Balane Sheet items that represent a 'premium' paid to a company's 'fair value' also get created more than this

Answer 199

Saving its cash for something else Stock may be at an all time high using debt allows for higher IRR

Answer 200

Because the strategic acquirer can realize revenue and cost synergies that the privateequity firm cannot unless it combines the company with a complementary portfolio company. Those synergies boost the effective valuation for the target company.

Answer 201

represent the value over the “fair market value” of the seller that the buyer has paid. You calculate the number by subtracting the book value of a company from its equity purchase price. Goodwill and Other Intangibles represent things like the value of customer relationships, brand names and intellectual property – valuable, but not true financial Assets that show up on the Balance Sheet

Answer 202

Goodwill typically stays the same over many years and is not amortized. It changes only if there’s goodwill impairment Other Intangible Assets, by contrast, are amortized over several years and affect the Income Statement by hitting the Pre-Tax Income line.

Answer 203

Yes, could also have: **Purchased In-Process R&D Write-off** any Research & Development projects that were purchased in the acquisition but which have not been completed yet. **Deferred Revenue Write-off. ** seller has collected cash for a service but not yet recorded it as revenue, and the buyer must write-down the value of the Deferred Revenue to avoid “double-counting” revenue

Answer 204

when a buyer gets more value than out of an acquisition than what the financials would predict. 2 types: **Revenue Synergies**: The combined company can cross-sell or up-sell products to customers. Access new markets. **Cost Synergies**: Combined company can consolidate buidling and admibistrative staff --> lay off redunancies

Answer 205

**Revenue Synergies** Normally add these to the Revenue figures for the combined company and then assume a certain margin on the Revenue **Cost Synergies** Normally you reduce COGS or OpEx

Answer 206

No one in M&A takes revenue synergies seriously because they’re so hard to predict. Cost synergies are taken a bit more seriously because it’s more straightforward to see how buildings and locations might be consolidated and how many redundant employees might be eliminated That said, the chances of any synergies actually being realized are almost 0 so few take them seriously at all

Answer 207

Always prefers to use cash: * Cash is “cheaper” than debt because interest rates on cash are usually under 5% * Cash is also less “risky” than debt because there’s no chance the buyer might fail to raise sufficient funds from investors. * General stock most expensive way to finance a transaction and risky due to price volatility

Answer 208

Find Company LTM EBITDA Find median comps of Debt/EBITDA Apply to find debt

Answer 209

You use the same Valuation methodologies we already discussed. If the seller is a public company, you would pay more attention to the premium paid over the current share price to make sure it’s “sufficient” (generally in the 15-30% range) to win shareholder approval. For private sellers, more weight is placed on the traditional methodologies.

Answer 210

High amount of Goodwill & Other Intangibles created Large goodwill impairment later if company decides it overpaid

Answer 211

The buyer’s share price would fall by whatever per-share dollar amount corresponds to the $50 million loss in value. Note that it would not necessarily be cut in half. Depending on how the deal was structured, the seller would effectively only be receiving half of what it had originally negotiated. This illustrates one of the major risks of all-stock deals: sudden changes in share price could dramatically impact valuation.

Answer 212

it’s very difficult to acquire and integrate a different company, actually realize synergies and also turn the acquired company into a profitable division. Many deals are also done for the wrong reasons, such as CEO ego or pressure from shareholders. Any deal done without both parties’ best interests in mind is likely to fail.

Answer 213

Model is a sanity check, just an indication It might say, “Ok, the model tells us this deal could work and be moderately accretive – it’s worth exploring more.” It would never say, “Aha! This model predicts 21% accretion – we should definitely acquire them now!” Emotions, ego and personalities play a far bigger role in M&A (and any type of negotiation) than numbers do

Answer 214

most common variables: * Purchase Price, % Stock/Cash/Debt, Revenue Synergies, and Expense Synergies. Could also look at different operating sensitivities: * Revenue Growth or EBITDA Margin Sensitivity tables showing the EPS accretion/dilution at different ranges for the Purchase Price vs. Cost Synergies, Purchase Price vs. Revenue Synergies, or Purchase Price vs. % Cash (and so on).

Answer 215

Purchase Accounting: seller’s shareholders’ equity number is wiped out and the premium paid over that value is recorded as Goodwill on the combined balance sheet post-acquisition. Pooling Accounting: Combine the 2 shareholders’ equity numbers rather than worrying about Goodwill and the related items that get created. specific requirements for using pooling accounting, so in 99% of M&A deals you will use purchase accounting

Answer 216

“Let’s say that Microsoft is going to acquire Yahoo. Yahoo makes money from search advertising online, and they make a certain amount of revenue per search (RPS). Let’s say this RPS is $0.10 right now. If Microsoft acquired it, we might assume that they could boost this RPS by $0.01 or $0.02 because of their superior monetization. So to calculate the additional revenue from this synergy, we would multiply this $0.01 or $0.02 by Yahoo’s total # of searches, get the total additional revenue, and then select a margin on it to determine how much flows through to the combined company’s Operating Income.”

Answer 217

“Let’s say that Microsoft still wants to acquire Yahoo!. Microsoft has 5,000 SG&A-related employees, whereas Yahoo has around 1,000. Microsoft calculates that post-transaction, it will only need about 200 of Yahoo’s SG&A employees, and its existing employees can take over the rest of the work. To calculate the Operating Expenses the combined company would save, we would multiply these 800 employees Microsoft is going to fire post-transaction by their average salary.”

Answer 218

Apply Section 382 to determine how much of the seller’s NOLs are usable each year. Allowable NOLs = Equity Purchase Price * Highest of Past 3 Months’ Adjusted Long Term Rates

Answer 219

Created when you write up and down assets in a transaction: asset write-up creates a deferred tax liability, and an asset write-down creates a deferred tax asset. An asset write-up creates a deferred tax liability because you’ll have a higher depreciation expense on the new asset, which means you save on taxes in the short-term – but eventually you’ll have to pay them back, hence the liability. The opposite applies for an asset write-down and a deferred tax asset.

Answer 220

Paying Back Taxes: During the period when book depreciation is higher, the company pays less tax than it otherwise would have if tax depreciation were also higher. This creates a deferred tax liability. As the temporary difference reverses (e.g., book depreciation falls to the same level as tax depreciation or lower), the company loses the earlier tax savings it gained. Now, since there's no longer a discrepancy (or the discrepancy is smaller), the taxes paid reflect the full taxable income without the earlier benefit from higher book depreciation. The company doesn't pay "extra" tax per se; rather, it pays the tax it had deferred. The DTL is essentially a recognition that the tax savings taken in earlier periods will lead to higher taxes in future periods compared to what would have been paid if there had been no write-up. Final Reconciliation: When the temporary difference is fully reversed (e.g., when the asset is fully depreciated or sold), the deferred tax liability is fully paid off. This reconciliation ensures that over the life of the asset, the total tax paid is consistent with what it would have been without the timing differences, but the timing of when those taxes are paid is different.

Answer 221

Take them into account with everything else when calculating the amount of Goodwill & Other Intangibles to create on your pro-forma balance sheet. Deferred Tax Asset = Asset Write-Down * Tax Rate Deferred Tax Liability = Asset Write-Up * Tax Rate

Answer 222

First, you simply add the seller’s Assets and Liabilities (but NOT Shareholders’ Equity – it is wiped out) to the buyer’s to get your “initial” balance sheet. * Assets are up by $200 million and Liabilities are down by $150 million. * Then, Cash on the Assets side goes down by $500 million. * You have an asset write-up of $100 million, so Assets go up by $100 million. * Debt on the Liabilities & Equity side goes up by $500 million. * You get a new Deferred Tax Liability of $40 million ($100 million * 40%) on the Liabilities & Equity side. * Assets are down by $200 million total and Liabilities & Shareholders’ Equity are up by $690 million ($500 + $40 + $150). * So you need Goodwill & Intangibles of $890 million on the Assets side to make both sides balance.

Answer 223

No, because in an asset purchase the book basis of assets always matches the tax basis. They get created in a stock purchase because the book values of assets are written up or written down, but the tax values are not.

Answer 224

create a book vs. cash tax schedule and figure out what the company owes in taxes based on the Pretax Income on its books, and then you determine what it actually pays in cash taxes based on its NOLs and newly created amortization and depreciation expenses Anytime“cash” tax expense > “book” tax expense, you record this as an decrease to the DTL on the Balance Sheet; if the “book” expense is higher, then you record that as an increase to the DTL

Answer 225

Goodwill = Equity Purchase Price - Seller Book Value + Seller's Existing Goodwill - Asset Write-Ups - Seller's Existing DTL + Write-Down of Seller's Existing DTA + New DTL

Answer 226

* Seller Book Value is just the Shareholders’ Equity number. * You add the Seller’s Existing Goodwill because it gets written down to $0 in an M&A deal. * You subtract the Asset Write-Ups because these are additions to the Assets side of the Balance Sheet. * Normally you assume 100% of the Seller’s existing DTL is written down. * The seller’s existing DTA may or may not be written down completely (see the next question).

Answer 227

Write it down to reflect that DTA include NOLs, and you might use these NOLs post-transaction to offset the combined entity's taxable income. In asset or 338(h)(10) purchase, assume that the entire NOL balance goes to $0 in the transaction, and then you write down the existing Deferred Tax Asset by this NOL write-down

Answer 228

DTA Write-Down = Buyer Tax Rate * MAX(0, NOL Balance – Allowed Annual NOL Usage * Expiration Period in Years) This formula is saying, “If we’re going to use up all these NOLs post transaction, let’s not write anything down. Otherwise, let’s write down the portion that we cannot actually use post-transaction, i.e. whatever our existing NOL balance is minus the amount we can use per year times the number of years.”

Answer 229

Why might a company want to use a Section 338(h)(10) in an M&A deal?A Section 338(h)(10) election blends the benefits of a stock purchase and an asset purchase: * Legally it is a stock purchase, but accounting-wise it’s treated like an asset purchase. * The seller is still subject to double-taxation – on its assets that have appreciated and on the proceeds from the sale. * But the buyer receives a step-up tax basis on the new assets it acquires, and it can depreciate/amortize them so it saves on taxes.

Answer 230

Even though the seller still gets taxed twice, buyers will often pay more in a 338(h)(10) deal because of the tax-savings potential. It’s particularly helpful for: * Sellers with high NOL balances (more tax-savings for the buyer because this NOL balance will be written down completely – and so more of the excess purchase price can be allocated to asset write-ups). * If the company has been an S-corporation for over 10 years – in this case it doesn’t have to pay a tax on the appreciation of its assets. The requirements to use 338(h)(10) are complex and bankers don’t deal with this – that is the role of lawyers and tax accountants.

Answer 231

An exchange ratio is an alternate way of structuring a 100% stock M&A deal, or any M&A deal with a portion of stock involved Exchange ratios tie the number of new shares to the buyers own shares rather than a specific dollar amount. Buyer prefer this is f their stock price is believed to decline post-transaction - sellers prefer a fixed dollar amount unless stock rises.

Answer 232

Most important ones: * Purchase Price: Stated as a per-share amount for public companies. * Form of Consideration: Cash, Stock, Debt… * Transaction Structure: Stock, Asset, or 338(h)(10) * Treatment of Options: Assumed by the buyer? Cashed out? Ignored? * Employee Retention: Do employees have to sign non-solicit or non-compete agreements? What about management? * Reps & Warranties: What must the buyer and seller claim is true about their respective businesses? No-Shop / Go-Shop: Can the seller “shop” this offer around and try to get a better deal, or must it stay exclusive to this buyer?

Answer 233

An Earnout is a form of “deferred payment” in an M&A deal – it’s most common with private companies and start-ups, and is highly unusual with public sellers. It is usually contingent on financial performance or other goals – for example, the buyer might say, “We’ll give you an additional $10 million in 3 years if you can hit $100 million in revenue by then.” Buyers use it to incentivize sellers to continue to perform well and to discourage management teams from taking the money and running off to an island in the South Pacific once the deal is done.

Answer 234

The mechanics are the same, but the transaction structure is more likely to be an asset purchase or 338(h)(10) election; private sellers also don’t have Earnings Per Share so you would only project down to Net Income on the seller’s Income Statement. Note that accretion / dilution makes no sense if you have a private buyer because private companies do not have Earnings Per Share.

Answer 235

To do this, you would set the EPS accretion / dilution to $0.00 and then back-solve in Excel to get the required synergies to make the deal neutral to EPS. It’s important because you want an idea of whether or not a deal “works” mathematically, and a high number for the break-even synergies tells you that you’re going to need a lot of cost savings or revenue synergies to make it work.

Answer 236

1. Combine the buyer’s and seller’s balance sheets (except for the seller’s Shareholders’ Equity number). 2. Make the necessary Pro-Forma Adjustments (cash, debt, goodwill/intangibles, etc.). 3. Project the combined Balance Sheet using standard assumptions for each item (see the Accounting section). 4. Then project the Cash Flow Statement and link everything together as you normally would with any other 3-statement model.

Answer 237

The exact treatment depends on the terms of the Purchase Agreement – the buyer might assume them or it might allow the seller to “cash them out” assuming that the per-share purchase price is above the exercise prices of these dilutive securities. If you assume they’re exercised, then you calculate dilution to the equity purchase price in the same way you normally would – Treasury Stock Method for options, and assume that convertibles convert into normal shares using the conversion price.

Answer 238

Stock Purchase, Asset Purchase, and 338(h)(10) Election.

Answer 239

* Buyer acquires all asset and liabilities of the seller as well as off-balance sheet items. * The seller is taxed at the capital gains tax rate. * The buyer receives no step-up tax basis for the newly acquired assets, and it can’t depreciate/amortize them for tax purposes. * A Deferred Tax Liability gets created as a result of the above. * Most common for public companies and larger private companies.

Answer 240

* Buyer acquires only certain assets and assumes only certain liabilities of the seller and gets nothing else. * Seller is taxed on the amount its assets have appreciated (what the buyer is paying for each one minus its book value) and also pays a capital gains tax on the proceeds. * The buyer receives a step-up tax basis for the newly acquired assets, and it can depreciate/amortize them for tax purposes. * No Deferred Tax Liability is created as a result of the above. * Most common for private companies, divestitures, and distressed public companies.

Answer 241

* Buyer acquires all asset and liabilities of the seller as well as off-balance sheet items. * Seller is taxed on the amount its assets have appreciated (what the buyer is paying for each one minus its book value) and also pays a capital gains tax on the proceeds. * The buyer receives a step-up tax basis for the newly acquired assets, and it can depreciate/amortize them for tax purposes. * No Deferred Tax Liability is created as a result of the above * Most common for private companies, divestitures, and distressed public companies. * To compensate for the buyer’s favourable tax treatment, the buyer usually agrees to pay more than it would in an Asset Purchase.

Answer 242

Buyer receives a "stepped-up" tax basis in the acquired assets, meaning the tax basis of the assets is reset to their fair market value (FMV) as of the acquisition date. This step-up allows the buyer to claim higher depreciation and amortization, reducing taxable income, which provides a tax benefit over time.

Answer 243

A seller almost always prefers a stock purchase to avoid double taxation and to get rid of all its liabilities. The buyer almost always prefers an asset deal so it can be more careful about what it acquires and to get the tax benefit from being able to deduct depreciation and amortization of asset write-ups for tax purposes.

Answer 244

A contribution analysis compares how much revenue, EBITDA, Pre-Tax Income, cash, and possibly other items the buyer and seller are “contributing” to estimate what the ownership of the combined company should be. For example, let’s say that the buyer is set to own 50% of the new company and the seller is set to own 50%. But the buyer has $100 million of revenue and the seller has $50 million of revenue – a contribution analysis would tell us that the buyer “should” own 66% instead because it’s contributing 2/3 of the combined revenue. It’s most common to look at this with merger of equals scenarios, and less common when the buyer is significantly larger than the seller.

Answer 245

expense transaction and miscellaneous fees upfront, but capitalize the financing fees and amortize them over the life of the debt. Expensed transaction fees come out of Retained Earnings when you adjust the Balance Sheet, while capitalized financing fees appear as a new Asset on the Balance Sheet and are amortized each year according to the tenor of the debt.