Key Rule #4 to #6

Question 1

What do dilutive securities do?

Answer 1

create more shares

Question 2

Why do companies issue dilutive securities?

Answer 2

decrease cash operating expenses b/c can pay less salaries
increase retention

Question 3

What is diluted equity value?

Answer 3

Decrease in equity ownershp that occurs when a company issues new shares

Question 4

How to calculate dilution for everything except convertible bonds?

Answer 4

Treasury Stock Method

Question 5

How do you use the treasury stock method?

Answer 5

• if current share price > exercise price
• ees pay co price x options to exercise, get 1 share/ option
• co uses proceeds to repurcahse newly created shares at the current share price
• shares that don’t get bought are the net dilution

Question 6

What are the cons of the treasury stock method?

Answer 6

• cos/ ees don’t necessarily act like this
• still use b/c standardizes things, better comparison

Question 7

For a public co what do you calculate first?

Answer 7

EqV, before moving to TEV

Question 8

For TEV what values do you use?

Answer 8

use market value
if not available, book value (except for eqv)

Question 9

What is restricted stock?

Answer 9

incentive compensation for ees

Question 10

What are RSUs?

Answer 10

Restricted stock units- bound by time

Question 11

What are performance shares?

Answer 11

Performance goal restriction

Question 12

Which securities use the treasury stock method to calculate dilution?

Answer 12

Restricted Stock, RSUs, Performance Shares

Question 13

Do you add restricted stock to common stock count?

Answer 13

Y

Question 14

Do you add restricted stock to diluted share count?

Answer 14

N

Question 15

What is a convertible bond?

Answer 15

• alternative form of debt
• co pays lower interest rates in exchange for giving holders option to convert into new shares if share price reaches a level

Question 16

What are the pathways by which a convertible bond could reach diluted shares?

Answer 16

• if current share price > converstion price= all convert
  principal / conversion price
• capped call

Question 17

What happens in a capped call?

Answer 17

• if share price reaches conversion price, co buys back all the newly released shares
• dilution cancelled
• share price climbs and reaches warrant exercise price
• warrants are sold, creating new stock as they are exercised
• some dilution but less than initial
• use TSM to calculate dilution on warrants

Question 18

Why do we need to find diluted share count?

Answer 18

Find implied EqV and TeV to find implied share price

Question 19

Why is implied share price so important?

Answer 19

compare to current stock price to see if undervalued.

Question 20

How do you calculate implied share price?

Answer 20

EqV/share count

Question 21

Is it accurate to minus 100% of cash balance when EqV -> TEV?

Answer 21

• no b/c some cash is an operating asset b/c need minimum cash to run biz

Question 22

Why do we minus all cash?

Answer 22

b/c the amt of cash as OA is seldom disclosed and varies, so subtract

Question 23

Why do you not subtract goodwill when moving from EqV to TEV?

Answer 23

• if subtract, saying “this acq is not part of core biz anymore”

Question 24

When do u subtract goodwill when moving from EqV to TEV?

Answer 24

if acq has been sold/ shut down

Question 25

How do you factor in working capital when going to EqV to TEV?

Answer 25

don't adjust anything each WC item counts in both net assets and net operating assets -> EqV and TEV include full value of WC

Question 26

Why subtract equity investments when EqV to TEV?

Answer 26

- they're non-operating assets since parent company has minority status and can't control them - compatability- EqV implicitly includes value of the stake. But TEV-based multiples w numerators eg. EBITDA don't include so subtract away to let TEV mults match it

Question 27

What is a valuation allowance?

Answer 27

an account that offsets a DTA when it is more likely than not that some/ all of DTA will not be realized

Question 28

Why subtract only part of co's DTA when calc TEV?

Answer 28

- only subtract NOL b/c they're non-operating assets- less related to operations than DTA's other items - also decrease NOL in proportion to Valuation Allowance/ DTA as VA indicates that co doesn't expect to realize full DTA benefit

Question 29

What is basic equity value vs diluted equity value?

Answer 29

diltued shares outstanding x common share price vs just common shares outstanding more accurate measure of co's net assets are worth to common shareholders

Question 30

Why do you add noncontrolling interests when EqV to TEV?

Answer 30

- NCI presents another investor group- minority share holders of the other co which co owns a majority of - they are investors b/c co controls other co b/c of majority stake - comparability- financial statements are 100% consolidated when co owns majority stake in other co -> rev, EBIT, EBITDA include 100% of financials - But EqV only has the % of the ownership - remaining %tage is added when creating TEV to bring it to par with numerators of TEV mults whihch reflect 100%