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What are the most common valuations interview questions? Let's take a look at the most common Valuation questions and answers In Detail!
Q1- What is the meaning of operating leverage?
Suggested Answer: A measure of how sensitive net operating income is to a percentage change in dollar sales over a specified period of time.
Q2 - For Public Company, you calculate Equity Value and Enterprise Value for use in multiples based on companies' share prices and share counts. Tel me what about Precedent Transactions? How would you calculate multiples there?
Suggested Answer: They should be calculated in accordance with the purchase price of the company at the time of the announcement of the transaction.
For example, the current share price of a seller is $40.00, and the company has 10 million shares in circulation. For the seller's shares, the buyer has announced that it will pay $50.00 per share to the buyer.
In this particular case, the seller's equity value would be $50 multiplied by 10 million shares, or $500 million, in the context of the transaction. After that, you would calculate its Enterprise Value in the conventional manner: subtract cash, add debt, and so on.
Q3- How would you present these DCF valuation methodologies to a company or its investors? and what do you use this for?
Suggested Answer: Typically, you'll use a "football field" chart to illustrate the valuation range implied by each method of estimation. You always use a range of numbers rather than a single specific number.
In the following situations, you could use a valuation: Pitch Books and Client Presentations - when you provide updates to clients and tell them what you believe they are worth Several other models, including defence analyses, merger models, LBO models, DCFs, and almost everything else in finance, will include elements of the asymmetric information model (AIM). In some way, there is a monetary value to something. Opinions of fairness- just before a deal with a public seller is completed, the financial advisor of the public seller prepares an opinion of fairness that justifies the acquisition price and provides a direct estimate of the company's value.
Q4 - Why would a firm with comparable growth and profitability be valued higher than its Similar Firms?
Suggested Answer: This could occur for a variety of reasons, including:
The company has recently reported earnings that were significantly higher than expectations, and its stock price has recently increased.
It possesses some type of competitive advantage that is not reflected in its financial statements, such as a key patent or other intellectual property rights.
It has recently received a favourable ruling in a significant lawsuit.
It is the market leader in a particular industry and commands a larger share of the market than its competitors.
Q5 - How do you account for a company's competitive advantage when valuing it?
Suggested Answer:
Obtaining competitive advantage requires the ability to 1) accurately assess firm performance and 2) compare and benchmark the firm's performance to that of other competitors in the same industry or to the overall industry average.
For example, a cost advantage over competitors
Q6 - Suppose there is companies and both companies have equal growth rates and profit margins. Which multiple will be higher?
Suggested Answer: Since a company's value is determined by its cash flow, cash flow growth rate, and discount rate, it is most likely that EV/EBITDA multiples will be correlated with EBITDA growth rates. Some correlation between revenue growth rate and EV/EBITDA multiples may exist, but the correlation between revenue growth rate and EV/Revenue multiples will be stronger.
Q7 - When you're using Levered FCF to value a company, is the company better off paying off Debt quickly or repaying the bare minimum required?
Suggested Answer: It is always preferable to pay the bare minimum amount.
Q8 - Why do we consider both the Enterprise and Equity Values?
Suggested Answer: In contrast to Equity Value, which only represents the portion of the company's value that is available to shareholders, Enterprise Value represents all of the company's value that is attributable to all investors (equity investors). You consider both because Equity Value is the number that the general public sees while Enterprise Value represents its true value, i.e. how much it would really cost to acquire the company.
Q9 - What are the differences between Equity Value and Enterprise Value?
Suggested Answer:
The value of a company's operations that can be attributed to all sources of capital is represented by the term Enterprise Value.
Equity Value is one of the components of Enterprise Value, and it only represents the portion of value that can be attributed to the shareholders' investments.
Q10 - What is the Enterprise Value formula?
Suggested Answer: Enterprise value = Market cap + Debt + Minority interest + Preferred shares - Total cash and cash equivalents.
Q11 - Why do two companies with the same growth and capital costs sell at different P/E multiples?
Suggested Answer: Growth and the cost of capital are not the only factors that influence the value of a company. Another important factor to consider is the return on invested capital. Assuming everything else is equal, if one of the companies has a higher return on equity, you would anticipate its PE ratio to be higher as well. Other possible reasons include relative mispricing or inconsistent earnings per share calculations as a result of nonrecurring items and different accounting assumptions, among other things.
Q12 - Should two companies that are equal but have different leverage rates trade at different EV/EBITDA multiples?
Suggested Answer: Enterprise value and earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) multiples should be similar because they measure a company's value and profits INDEPENDENT of its capital structure.
They will not be exactly equal because EV is dependent on the cost of capital, so there will be a slight difference in the two figures.
Q13 - Should two companies that are equal but have different leverage rates trade at different P/E multiples?
Suggested Answer:
PE multiples for otherwise identical companies can differ significantly due to the difference in leverage levels.
assuming everything else is equal, as a company borrows money, its earnings per share (EPS) will decline due to the increased interest expense.
As a result of debt remaining unused and generating no return, the stock price will either decline (+PE ratio) or grow. If debt is used to efficiently invest and grow the business, the stock price will increase (+PE ratio).
Q14 - Explain me about difference between the unlevered DCF and levered DCF
Suggested Answer: Enterprise value is calculated by discounting unlevered DCF by unlevered Free Cash Flows in order to arrive at a direct estimate of enterprise value. In order to arrive at a present value, first add any non-operating assets such as cash and subtract any financing-related liabilities such as debt until you arrive at a net present value. This will increase the value of your equity. The weighted average cost of capital is the appropriate discount rate for the unlevered DCF because the rate should REFLECT THE RISK TO BOTH DEBT AND EQUITY Capital provider.
Leveraged DCF results in an immediate increase in equity value. It is through forecasting and discounting the leveraged FCFs that you arrive at the equity value. Then you can subtract net debt from total enterprise value to arrive at total enterprise value. The cost of equity should be used to determine the appropriate discount rate for levered free cash flow's because these cash flows belong solely to equity owners and should therefore reflect the cost of equity capital.
As a result, both leveraged and unlevered DCF methods should theoretically result in the same final enterprise and equity values (hard to though). The most frequently encountered is unlevered.
Q15 - What are financial statement non-operating items?
Suggested Answer: Non-operating income is income earned from activities other than the company's core operating activities, which is defined as activities that are not the company's core operating activities.
Q16 - What are the difference between WACC and IRR?
Suggested Answer:
The internal rate of return (IRR) is the discount rate applied to a stream of cash flows that results in a net present value of zero. The weighted average cost of capital (WACC) is the minimum required internal rate of return for both debt and equity capital providers.
So an IRR that exceeds the WACC is frequently used as a criterion to determine WHETHER or NOT to proceed with a project in question.
Q17 - What are the meaning of restructuring costs?
Suggested Answer: Management's plans to materially alter the scope or manner in which its company's operations are conducted will incur costs as a result of this. costs associated with the closure or relocation of facilities, as well as the downsizing of operational operations
Q18 - Despite this, why are valuation multiples and growth rates so frequently used? NOT display as much correlation as you would expect?
Suggested Answer: First and foremost, EBITDA growth and free cash flow growth are diametrically opposed, because free cash flow includes taxes, changes in working capital, and the full amount of capital expenditures, whereas EBITDA does not.
Because a company's value is ultimately determined by its cash flow growth, growth rates in revenue, EBITDA, EBIT, and Net Income are only approximate representations of cash flow growth at best.
Furthermore, not every comparable company will necessarily have the same Discount Rate; for example, the company you're analysing may be significantly riskier than the others, or significantly less risky than the others.
Nonfinancial factors, on the other hand, could have a significant impact on multiples. For example, if a company has recently experienced legal difficulties, has announced the development of a new product, or has hired a key executive, all of these developments could have an impact on its stock price and, consequently, on its multiples.
Q19 - The EV/EBITDA multiple for this company is 15x, whereas the median EV/EBITDA for comparable companies is 10x. What is the MOST LIKELY reason?
Suggested Answer: The most likely explanation is that the market anticipates the company's cash flows to grow at a faster rate than those of its competitors. For example, while other companies might be expected to grow at a rate of 5 percent, this company might be expected to grow at a rate of 10 percent.
Because these companies are all roughly the same size and operate in the same industry, the Discount Rate is unlikely to differ by a significant amount. As a result, the risk should be similar for all of them.
It is possible that non-financial factors have an impact on the multiple; for example, recent positive news about the company's strategy, product, executives, intellectual property, or competitive performance may explain why this company trades at a higher multiple than the others.
Q20 - Why do you use EBIT and EBITDA in valuation multiples instead of CFO or FCF if cash flow is the most important metric?
Suggested Answer: The majority of the time, it's for convenience and comparability. CFO and FCF are more accurate ways of measuring a company's cash flows, but they also require more time to calculate because they require a full or partial Cash Flow Statement to be completed.
Aside from that, the individual items within CFO and FCF differ significantly between companies, and the vastly different figures for Deferred Taxes, Stock-Based Compensation, and the Change in Working Capital make it difficult to make meaningful comparisons.
Q21 - How should Enterprise Value be adjusted when using EBITDAR in the EV / EBITDAR multiple?
Suggested Answer: If an expense is excluded from the denominator of a valuation multiple, the numerator of the valuation multiple should include the Balance Sheet item that corresponds to the expense (and vice versa).
Due to the fact that EBITDAR is equal to EBITDA + Rental Expense, it excludes this annual Rental Expense by re-adding it.
As a result, in order to calculate EBITDAR and EV / EBITDAR, you must first capitalise the company's operating leases, which is typically done by multiplying the annual lease expense by 7x or 8x, and then add the capitalised leases to Enterprise Value.
Because operating leases are not included on the Balance Sheet, you must create a new Balance Sheet item by capitalising these leases. Because operating leases are not included on the Balance Sheet, you must capitalise these leases.
Q22 - Is it possible that a company's EV/EBITDA multiple will ever equal its P/E multiple?
Suggested Answer: The answer is yes because the values of Enterprise Value, EBITDA, equity value, and net income are all potentially arbitrary numbers that can be calculated.
Q23 - The P/E multiples of two companies are the same, but the EV/EBITDA multiples are not. How can you know who has the most debt?
Suggested Answer: Suppose two companies have P / E multiples of 15x, but one has Net Income of $10 and the other has Net Income of $100. The company with Net Income of $100 is more likely to have debt than the company with Net Income of $10, even though the latter's enterprise value to earnings (EV / EBITDA) multiple is lower.
It is possible to "sort of" answer this question if you assume that both companies have the same Net Income and the same EBITDA for the year. The Equity Values of the two companies are equal in this case, and as a result, the company with the higher EV/EBITDA multiple must also have a greater Enterprise Value. The majority of the time, this indicates that it has accumulated more debt.
HOWEVER, it's important to keep in mind that there are other factors to consider. Possibly, both companies have the same amount of debt, but the company with the higher enterprise value to earnings ratio has less cash on hand. If a company's Unfunded Pension or Preferred Stock balance is higher than the market average, the company with the higher multiple wins.
Q24 - When creating valuation multiples, how do you select whether to use Equity Value or Enterprise Value?
Suggested Answer: You need to consider which types of investors have access to this operational metric, which is as follows: Or just common equity investors, or all of the company's investors (including equity and debt, preferred stock, and others)? Enterprise Value should be used if there are all investors, and Equity Value should be used if there are only equity investors.
One simple rule of thumb is to see if the metric includes Net Interest Expense before making a decision. In the first case, it is paired with Equity Value, and in the second case, it is paired with the Enterprise Value. You almost always use Enterprise Value when creating a valuation multiple that is based on a non-financial metric, such as Unique Users or Subscribers, because those metrics are available to and benefit all of the investors in a company.
Q25 - Explain me how do you calculate the Terminal Value?
Suggested Answer: You need to consider which types of investors have access to this operational metric, which is as follows: Or just common equity investors, or all of the company's investors (including equity and debt, preferred stock, and others)? Enterprise Value should be used if there are all investors, and Equity Value should be used if there are only equity investors.
One simple rule of thumb is to see if the metric includes Net Interest Expense before making a decision. In the first case, it is paired with Equity Value, and in the second case, it is paired with the Enterprise Value. You almost always use Enterprise Value when creating a valuation multiple that is based on a non-financial metric, such as Unique Users or Subscribers, because those metrics are available to and benefit all of the investors in a company.
Q26 - What factors may cause a company's present value to Increase or Decrease?
Suggested Answer: The Present Value of a company may increase if the following conditions are met:
The company's expected future cash flows are increasing.
Cash flows from operations should increase at a faster rate in the future.
Because we no longer have access to certain investments, our "opportunity cost," also known as the Discount Rate, decreases.
The Present Value of a company may decrease if any of the following conditions are met:
The company's expected future cash flows are decreasing.
Its future cash flows are expected to grow at a slower rate in the foreseeable future.
Our "opportunity cost," also known as the Discount Rate, rises as we gain access to more enticing investment opportunities.
Q27 - Tell me how to link three financial statements? For the Cash Flow Statement, use the Indirect Method.
Suggested Answer: To connect the two statements, make the Net Income line at the bottom of the Income Statement the first line of the Cash Flow Statement to create a link between them.
Then, make any necessary adjustments to this Net Income figure to account for non-cash items such as Depreciation and Amortization.
In the following step, update operational Balance Sheet items such as Accounts Receivable, which may have an impact on the company's cash flow depending on how they have changed.
This brings you to the Cash Flow from Operations section.
Following that, account for investing and financing activities, which may result in an increase or decrease in cash flow, and sum Cash Flow from Operations, Investing, and Financing to obtain the net change in cash at the bottom.
Cash on the Balance Sheet should be linked to its corresponding cash amount at the end of the CFS, and net income should be added to Retained Earnings within Equity on the Balance Sheet.
Link each non-cash adjustment to the appropriate Asset or Liability using SUBTRACT links on the Assets side and ADD links on the Liabilities and Equity side, as appropriate.
In accordance with the same rule as above, link each CFI and CFF item to the corresponding item on the Balance Sheet.
Check that Assets equals Liabilities + Equity at the end of the exercise; if this is not the case, you made a mistake and need to go back and re-check your work.
Q28 - When a company is in financial trouble, it requires fast cash. It sells a factory for $80 that was valued at $100 on its Balance Sheet. What happens on the three statements if the tax rate is 40%?
Suggested Answer: The income statement should show a $20 loss, which reduces the pre-tax income by $20 and the net income by $12 at a 40% tax rate.
In the Cash Flow Statement, the Net Income has decreased by $12, but you have to add back the $20 Loss because it is non-cash. You also include the entire amount of proceeds, $80, in Cash Flow from Investing, resulting in an increase of $88 in cash at the bottom.
Cash has increased by $88, but PP&E has decreased by $100, resulting in a decrease of $12 on the Assets side of the balance sheet. The L&E side is also down by $12 because Retained Earnings decreased by $12 as a result of the decrease in Net Income, bringing both sides into balance.
Q29 - What does it mean if a company's Free Cash Flow is increasing each year, but its Change in Working Capital is reducing?
Suggested Answer: Net income or non-cash charges are increasing by a greater amount than the change in WC OR capital expenditures are becoming less negative.
Q30 - Why do capital expenditures (Property Plant &Equipment) increase assets, yet other cash outflows, such as paying salaries, taxes, and so on, do not produce any assets and instead create a cost on the income statement that diminishes equity via retained earnings?
Suggested Answer: Even though they are all considered cash outflows, Capital Expenditures are considered investments in the company's future: fixing or purchasing new assets that will generate additional value in the future, and not just in the current tax year. In contrast, salaries and taxes are only accounted for in the current fiscal year in which they were required to keep the business running. As a result, they are classified as expenses because they do not inherently result in the creation of future assets for the company (with the exception of Prepaid Income Taxes, which are taxes that have already been paid despite having not yet been incurred). Their value is reflected as an asset on the balance sheet.
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