Enterprise / Equity Value Questions & Answers -
Advanced, Valuation Questions & Answers -
Advanced, Merger Model Questions & Answers -
Advanced, Merger Model - Basic, Accounting - Basic,
Accounting - Advanced, Enterprise / Equity Value
Questions & And Answers
Are there any problems with the Enterprise Value formula you just gave me?
Yes - it's too simple. There are lots of other things you need to add into the formula with
real companies:
• Net Operating Losses - Should be valued and arguably added in, similar to cash.
• Long-Term Investments - These should be counted, similar to cash.
• Equity Investments - Any investments in other companies should also be added in,
similar to cash (though they might be discounted).
• Capital Leases - Like debt, these have interest payments - so they should be added in
like debt.
• (Some) Operating Leases - Sometimes you need to convert operating leases to capital
leases and add them as well.
• Unfunded Pension Obligations - Sometimes these are counted as debt as well.
So a more "correct" formula would be Enterprise Value = Equity Value - Cash + Debt +
Preferred Stock + Noncontrolling Interest - NOLs - LT and Equity Investments + Capital
Leases + Unfunded Pension Obligations...
In interviews, usually you can get away with saying "Enterprise Value = Equity Value -
Cash + Debt + Preferred Stock + Noncontrolling Interest"
I mention this here because in more advanced interviews you might get questions on
this topic.
Should you use the book value or market value of each item when calculating
Enterprise Value?
Technically, you should use market value for everything. In practice, however, you
usually 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 - so you
just take the numbers from the company's Balance Sheet.
What percentage dilution in Equity Value is "too high?"
There's no strict "rule" here but most bankers would say that 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.
,. How do you value banks and financial institutions differently from other
companies?
For relative valuation, the methodologies (public comps and precedent transactions) are
the same but the metrics and multiples are different:
• You screen based on assets or deposits in addition to the normal criteria.
• You look at metrics like ROE (Return on Equity, Net Income / Shareholders' Equity),
ROA (Return on Assets, Net Income / Total Assets), and Book Value and Tangible
Book Value rather than Revenue, EBITDA, and so on.
• You use multiples such as P / E, P / BV, and P / TBV rather than EV / EBITDA
Rather than a traditional DCF, you use 2 different methodologies for intrinsic valuation:
• In a Dividend Discount Model (DDM) you sum up the present value of a bank's
dividends in future years and then add it to the present value of the bank's terminal
value, usually basing that on a P / BV or P / TBV multiple.
• In a Residual Income Model (also known as an Excess Returns Model), you take the
bank's current Book Value and simply add the present value of the excess returns to
that Book Value to value it. The "excess return" each year is (ROE Book Value) - (Cost
of Equity Book Value) - basically how much the returns exceed your expectations.
You need to use these methodologies and multiples because interest is a critical
component of a bank's revenue and because debt is a "raw material" rather than just a
financing source; also, banks' book values are usually very close to their market caps.
Walk me through an IPO valuation for a company that's about to go public.
1. Unlike normal valuations, in an IPO valuation we only care about public company
comparables
2. After picking the public company comparables we decide on the most relevant
multiple to use and then estimate our company's Enterprise Value based on that.
3. Once we have the Enterprise Value, we work backward to get to Equity Value and
also subtract the IPO proceeds because this is "new" cash.
4. Then we divide by the total number of shares (old and newly created) to get its per-
share price. When people say "An IPO priced at..." this is what they're referring to.
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.
I'm looking at financial data for a public company comparable, and it's April (Q2)
right now. Walk me through how you would "calendarize" this company's
financial statements to show the Trailing Twelve Months as opposed to just the
last Fiscal Year.
The "formula" to calendarize financial statements is as follows:
TTM = Most Recent Fiscal Year + New Partial Period - Old Partial Period
,So in the example above, we would take the company's Q1 numbers, add the most
recent fiscal year's numbers, and then subtract the Q1 numbers from that most recent
fiscal year.
For US companies you can find these quarterly numbers in the 10-Q; for international
companies they're in the interim reports.
Walk me through an M&A premiums analysis.
The purpose of this analysis is to look at similar transactions and see the premiums that
buyers have paid to sellers' share prices when acquiring them. For example, if a
company is trading at $10.00/share and the buyer acquires it for $15.00/share, that's a
50% premium.
1. First, select the precedent transactions based on industry, date (past 2-3 years for
example), and size (example: over $1 billion market cap).
2. For each transaction, get the seller's share price 1 day, 20 days, and 60 days before
the transaction was announced (you can also look at even longer intervals, or 30 days,
45 days, etc.). http://breakingintowallstreet.com http://www.mergersandinquisitions.com
45
3. Then, calculate the 1-day premium, 20-day premium, etc. by dividing the pershare
purchase price by the appropriate share prices on each day.
4. Get the medians for each set, and then apply them to your company's current share
price, share price 20 days ago, etc. to estimate how much of a premium a buyer might
pay for it.
Note that you only use this analysis when valuing public companies because private
companies don't have share prices. Sometimes the set of companies here is exactly the
same as your set of precedent transactions but typically it is broader.
Walk me through a future share price analysis
The purpose of this analysis is to project what a company's share price might be 1 or 2
years from now and then discount it back to its present value.
1. Get the median historical (usually TTM) P / E of your public company comparables.
2. Apply this P / E multiple to your company's 1-year forward or 2-year forward projected
EPS to get its implied future share price.
3. Then, discount this back to its present value by using a discount rate in-line with the
company's Cost of Equity figures.
You normally look at a range of P / E multiples as well as a range of discount rates for
this type of analysis, and make a sensitivity table with these as inputs.
, Both M&A premiums analysis and precedent transactions involve looking at
previous M&A transactions. What's the difference in how we select them?
• All the sellers in the M&A premiums analysis must be public.
• Usually we use a broader set of transactions for M&A premiums - we might use fewer
than 10 precedent transactions but we might have dozens of M&A premiums. The
industry and financial screens are usually less stringent.
• Aside from those, the screening criteria is similar - financial, industry, geography, and
date.
Walk me through a Sum-of-the-Parts analysis.
In a Sum-of-the-Parts analysis, you value each division of a company using separate
comparables and transactions, get to separate multiples, and then add up each
division's value to get the total for the company. Example:
We have a manufacturing division with $100 million EBITDA, an entertainment division
with $50 million EBITDA and a consumer goods division with $75 million EBITDA.
We've selected comparable companies and transactions for each division, and the
median multiples come out to 5x EBITDA for manufacturing, 8x EBITDA for
entertainment, and 4x EBITDA for consumer goods.
Our calculation would be $100 5x + $50 8x + $75 * 4x = $1.2 billion for the company's
total value.
How do you value Net Operating Losses and take them into account in a
valuation?
You value NOLs based on how much they'll save the company in taxes in future years,
and then take the present value of the sum of tax savings in future years. Two ways to
assess the tax savings in future years:
1. Assume that a company can use its NOLs to completely offset its taxable income
until the NOLs run out.
2. In an acquisition scenario, use Section 382 and multiply the adjusted long-term rate
(http://pmstax.com/afr/exemptAFR.shtml) by the equity purchase price of the seller to
determine the maximum allowed NOL usage in each year - and then use that to figure
out the offset to taxable income.
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.
I have a set of public company comparables and need to get the projections from
equity research. How do I select which report to use?
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.
Advanced, Valuation Questions & Answers -
Advanced, Merger Model Questions & Answers -
Advanced, Merger Model - Basic, Accounting - Basic,
Accounting - Advanced, Enterprise / Equity Value
Questions & And Answers
Are there any problems with the Enterprise Value formula you just gave me?
Yes - it's too simple. There are lots of other things you need to add into the formula with
real companies:
• Net Operating Losses - Should be valued and arguably added in, similar to cash.
• Long-Term Investments - These should be counted, similar to cash.
• Equity Investments - Any investments in other companies should also be added in,
similar to cash (though they might be discounted).
• Capital Leases - Like debt, these have interest payments - so they should be added in
like debt.
• (Some) Operating Leases - Sometimes you need to convert operating leases to capital
leases and add them as well.
• Unfunded Pension Obligations - Sometimes these are counted as debt as well.
So a more "correct" formula would be Enterprise Value = Equity Value - Cash + Debt +
Preferred Stock + Noncontrolling Interest - NOLs - LT and Equity Investments + Capital
Leases + Unfunded Pension Obligations...
In interviews, usually you can get away with saying "Enterprise Value = Equity Value -
Cash + Debt + Preferred Stock + Noncontrolling Interest"
I mention this here because in more advanced interviews you might get questions on
this topic.
Should you use the book value or market value of each item when calculating
Enterprise Value?
Technically, you should use market value for everything. In practice, however, you
usually 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 - so you
just take the numbers from the company's Balance Sheet.
What percentage dilution in Equity Value is "too high?"
There's no strict "rule" here but most bankers would say that 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.
,. How do you value banks and financial institutions differently from other
companies?
For relative valuation, the methodologies (public comps and precedent transactions) are
the same but the metrics and multiples are different:
• You screen based on assets or deposits in addition to the normal criteria.
• You look at metrics like ROE (Return on Equity, Net Income / Shareholders' Equity),
ROA (Return on Assets, Net Income / Total Assets), and Book Value and Tangible
Book Value rather than Revenue, EBITDA, and so on.
• You use multiples such as P / E, P / BV, and P / TBV rather than EV / EBITDA
Rather than a traditional DCF, you use 2 different methodologies for intrinsic valuation:
• In a Dividend Discount Model (DDM) you sum up the present value of a bank's
dividends in future years and then add it to the present value of the bank's terminal
value, usually basing that on a P / BV or P / TBV multiple.
• In a Residual Income Model (also known as an Excess Returns Model), you take the
bank's current Book Value and simply add the present value of the excess returns to
that Book Value to value it. The "excess return" each year is (ROE Book Value) - (Cost
of Equity Book Value) - basically how much the returns exceed your expectations.
You need to use these methodologies and multiples because interest is a critical
component of a bank's revenue and because debt is a "raw material" rather than just a
financing source; also, banks' book values are usually very close to their market caps.
Walk me through an IPO valuation for a company that's about to go public.
1. Unlike normal valuations, in an IPO valuation we only care about public company
comparables
2. After picking the public company comparables we decide on the most relevant
multiple to use and then estimate our company's Enterprise Value based on that.
3. Once we have the Enterprise Value, we work backward to get to Equity Value and
also subtract the IPO proceeds because this is "new" cash.
4. Then we divide by the total number of shares (old and newly created) to get its per-
share price. When people say "An IPO priced at..." this is what they're referring to.
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.
I'm looking at financial data for a public company comparable, and it's April (Q2)
right now. Walk me through how you would "calendarize" this company's
financial statements to show the Trailing Twelve Months as opposed to just the
last Fiscal Year.
The "formula" to calendarize financial statements is as follows:
TTM = Most Recent Fiscal Year + New Partial Period - Old Partial Period
,So in the example above, we would take the company's Q1 numbers, add the most
recent fiscal year's numbers, and then subtract the Q1 numbers from that most recent
fiscal year.
For US companies you can find these quarterly numbers in the 10-Q; for international
companies they're in the interim reports.
Walk me through an M&A premiums analysis.
The purpose of this analysis is to look at similar transactions and see the premiums that
buyers have paid to sellers' share prices when acquiring them. For example, if a
company is trading at $10.00/share and the buyer acquires it for $15.00/share, that's a
50% premium.
1. First, select the precedent transactions based on industry, date (past 2-3 years for
example), and size (example: over $1 billion market cap).
2. For each transaction, get the seller's share price 1 day, 20 days, and 60 days before
the transaction was announced (you can also look at even longer intervals, or 30 days,
45 days, etc.). http://breakingintowallstreet.com http://www.mergersandinquisitions.com
45
3. Then, calculate the 1-day premium, 20-day premium, etc. by dividing the pershare
purchase price by the appropriate share prices on each day.
4. Get the medians for each set, and then apply them to your company's current share
price, share price 20 days ago, etc. to estimate how much of a premium a buyer might
pay for it.
Note that you only use this analysis when valuing public companies because private
companies don't have share prices. Sometimes the set of companies here is exactly the
same as your set of precedent transactions but typically it is broader.
Walk me through a future share price analysis
The purpose of this analysis is to project what a company's share price might be 1 or 2
years from now and then discount it back to its present value.
1. Get the median historical (usually TTM) P / E of your public company comparables.
2. Apply this P / E multiple to your company's 1-year forward or 2-year forward projected
EPS to get its implied future share price.
3. Then, discount this back to its present value by using a discount rate in-line with the
company's Cost of Equity figures.
You normally look at a range of P / E multiples as well as a range of discount rates for
this type of analysis, and make a sensitivity table with these as inputs.
, Both M&A premiums analysis and precedent transactions involve looking at
previous M&A transactions. What's the difference in how we select them?
• All the sellers in the M&A premiums analysis must be public.
• Usually we use a broader set of transactions for M&A premiums - we might use fewer
than 10 precedent transactions but we might have dozens of M&A premiums. The
industry and financial screens are usually less stringent.
• Aside from those, the screening criteria is similar - financial, industry, geography, and
date.
Walk me through a Sum-of-the-Parts analysis.
In a Sum-of-the-Parts analysis, you value each division of a company using separate
comparables and transactions, get to separate multiples, and then add up each
division's value to get the total for the company. Example:
We have a manufacturing division with $100 million EBITDA, an entertainment division
with $50 million EBITDA and a consumer goods division with $75 million EBITDA.
We've selected comparable companies and transactions for each division, and the
median multiples come out to 5x EBITDA for manufacturing, 8x EBITDA for
entertainment, and 4x EBITDA for consumer goods.
Our calculation would be $100 5x + $50 8x + $75 * 4x = $1.2 billion for the company's
total value.
How do you value Net Operating Losses and take them into account in a
valuation?
You value NOLs based on how much they'll save the company in taxes in future years,
and then take the present value of the sum of tax savings in future years. Two ways to
assess the tax savings in future years:
1. Assume that a company can use its NOLs to completely offset its taxable income
until the NOLs run out.
2. In an acquisition scenario, use Section 382 and multiply the adjusted long-term rate
(http://pmstax.com/afr/exemptAFR.shtml) by the equity purchase price of the seller to
determine the maximum allowed NOL usage in each year - and then use that to figure
out the offset to taxable income.
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.
I have a set of public company comparables and need to get the projections from
equity research. How do I select which report to use?
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.
