Breaking into walls street - Mergers & Inquisitions Flashcards
- Could you ever end up with negative shareholders’ equity? What does it mean?
Yes. It is common to see this in 2 scenarios:
Leveraged Buyouts with dividend recapitalizations – it means that the owner of the company has taken out a large portion of its equity (usually in the form of cash), which can sometimes turn the number negative.
It can also happen if the company has been losing money consistently and therefore has a declining Retained Earnings balance, which is a portion of Shareholders’ Equity. It doesn’t “mean” anything in particular, but it can be a cause for concern and possibly demonstrate that the company is struggling (in the second scenario).
Note: Shareholders’ equity never turns negative immediately after an LBO – it would only happen following a dividend recap or continued net losses
- What does negative Working Capital mean? Is that a bad sign?
Not necessarily. It depends on the type of company and the specific situation – here are a few different things it could mean:
Some companies with subscriptions or longer-term contracts often have negative Working Capital because of high Deferred Revenue balances.
Retail and restaurant companies like Amazon, Wal-Mart, and McDonald’s often have negative Working Capital because customers pay upfront – so they can use the cash generated to pay off their Accounts Payable rather than keeping a large cash balance on-hand. This can be a sign of business efficiency.
In other cases, negative Working Capital could point to financial trouble or possible bankruptcy (for example, when customers don’t pay quickly and upfront and the company is carrying a high debt balance).
- What are examples of non-recurring charges we need to add back to a company’s EBIT / EBITDA when looking at its financial statements?
- Restructuring Charges
- Goodwill Impairment
- Asset Write-Downs
- Bad Debt Expenses
- Legal Expenses
- Disaster Expenses
- Change in Accounting Procedures
Note that to be an “add-back” or “non-recurring” charge for EBITDA / EBIT purposes, it needs to affect Operating Income on the Income Statement. So if you have one of these charges “below the line” then you do not add it back for the EBITDA / EBIT calculation. 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.
- How do Net Operating Losses (NOLs) affect a company’s 3 statements?
The “quick and dirty” way to do this: reduce the Taxable Income by the portion of the NOLs that you can use each year, apply the same tax rate, and then subtract that new Tax number from your old Pretax Income number (which should stay the same).
The way you should do this: create a book vs. cash tax schedule where you calculate the Taxable Income based on NOLs, and then look at what you would pay in taxes without the NOLs. Then you book the difference as an increase to the Deferred Tax Liability on
the Balance Sheet. This method reflects the fact that you’re saving on cash flow – since the DTL, a liability, is rising – but correctly separates the NOL impact into book vs. cash taxes
- What’s the difference between capital leases and operating leases?
Operating leases are used for short-term leasing of equipment and property, and do not involve ownership of anything. Operating lease expenses show up as operating expenses on the Income Statement.
Capital leases are used for longer-term items and give the lessee ownership rights; they depreciate and incur interest payments, and are counted as debt.
A lease is a capital lease if any one of the following 4 conditions is true:
1. If there’s a transfer of ownership at the end of the term.
2. If there’s an option to purchase the asset at a bargain price at the end of the term.
3. If the term of the lease is greater than 75% of the useful life of the asset.
If the present value of the lease payments is greater than 90% of the asset’s fair
market value.
- Why would the Depreciation & Amortization number on the Income Statement be different from what’s on the Cash Flow Statement?
This happens if D&A is embedded in other Income Statement line items. When this happens, you need to use the Cash Flow Statement number to arrive at EBITDA because otherwise you’re undercounting D&A.
- What’s the formula for Enterprise Value?
EV = Equity Value + Debt + Preferred Stock + Noncontrolling Interest – Cash
This formula does not tell the whole story and can get more complex – see the Advanced Questions. Most of the time you can get away with stating this formula in an interview, though. “Noncontrolling Interest” was formerly known as Minority Interest and some bankers still call it that.
- Why do you need to add the Noncontrolling Interest to Enterprise Value?
Whenever a company owns over 50% of another company, it is required to report the financial performance of the other company as part of its own performance. So even though it doesn’t own 100%, it reports 100% of the majority-owned subsidiary’s financial performance.
- Could a company have a negative Equity Value? What would that mean?
No. This is not possible because you cannot have a negative share count and you cannot have a negative share price.
- What’s the difference between Equity Value and Shareholders’ Equity?
Equity Value is the market value and Shareholders’ Equity is the 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.
Enterprise value and equity value - A company’s future cash flow in the future can be negative, so yes it can be negative!
But market cap equity can never be negative!!
If its negative it means you will have to pay more into the company than what you earn from it!
Tell me about all the different kinds of debt you could use in an LBO and the differences between everything!
See icloud - Capital Structure of an LBO
