Technical Notes Valuation 1) How would you value a company a. DCF i. Best intrinsic value of a company ii.

Done whenever you are valuing a company iii. Forecast future fcf of a company till the terminal year, then discount back to net present value using an appropriate rate and the present value of the terminal value of the company b. Market Comparables i. Used when you want to determine if a company is undervalued or overvalued compared to its peer group based on various multiples ii. How a private company might trade in the public markets, or as a benchmark for the private company in a merger iii. Can be used to establish a breakup value for a conglomerate by analyzing each segments individual value c. Past Precedent Transactions i. Used to see how much acquirers recently paid for a similar business d. LBO i. Looks at what a financial sponsor could pay considering a target IRR and the debt capacity of the firm ii. Usually 70% debt iii. 20-25 rate of return hurdle iv. What kind of return can you get v. What is the debt capacity vi. Ability to pay-how much equity 2) Additional Valuations a. Trading Range i. Range the stock has been trading in during the past 52 weeks b. Asset Value i. Examines what you can sell the companys assets for c. Merger Consequences Analysis i. A form of affordability analysis (what can an acquirer pay) rather than an analysis of the value of a target 3) Which of the valuations methods tend to lead to the highest valuation? a. Past Precedent Transaction i. Because it includes not only the stand alone value of the corporation, but the synergies that are expected from the transaction as well as a control premium 4) Which of the valuation methods tend to lead to the lowest valuation? a. Public Comps i. Will tend to lead to the lowest valuation because they involve market expectations. ii. It relies a lot on the current market rather than the fundamentals of a company.

iii. If your company is constantly outperforming its competitive set than your analysis might state the company is overvalued when really it is just better b. DCF i. If you use a very high discount rate ii. Or value lower managerial expectations 5) Plus/Minuses of Each Valuation Method a. DCF i. + 1. The theoretical intrinsic value of the firm, looking at the actual, unlevered cash flows 2. Less influenced by temperamental market conditions or non-economic factors 3. Can value components of business or synergies separately from the business 4. Shows the maximum an acquirer will be willing to pay 5. Objective calculation that is always obtainable ii. 1. Present values obtained are sensitive to assumption and methodology 2. Assumptive imputs (FCF, WACC) 3. Terminal Value represents significant portion of value, and is highly sensitive to valuation assumptions 4. Most DCFs in banking are done with WACC, which doesnt allow for varying debt levels and costs b. Market Comps i. + 1. They focus on companies with similar operations and financial situations allowing for relative, market oriented comparisons ii. 1. Rely on publicly available information 2. Subject to changes in market conditions 3. Often are not pure comparables because of differences in business even in the same industry c. Acq. Comps i. Helps you value a company based on similar transactions ii. Allows you to understand M&A activity in an industry 1. Determine demand 2. I.D. the active buyers and potential targets 3. Understand industry trends iii. 1. Have a lot of the same drawback as market comps 2. Deal could have been done in a bad market, leading to lower value 6) What is Unlevered FCF? a. FCF represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. FCF is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, its hard to develop new products, make acquisitions, pay dividends, and reduce

7) Is unlevered or levered FCF used in a DCF analysis a. Unlevered i. Because you unlevered FCF are the cash flows generated by the firms real assets. When calculating FCF you are not including interest from debt. ii. The financing portion of a company is incorporated in a DCF analysis through the WACC calculation. So if you used levered FCF you would be double counting the refinancing effect. 8) How do you calculate FCF? a. From NI i. NI + D/A - Cap Ex - Increasing in Working Cap + After Tax Interest Exp b. From EBIT (USE THIS IF THEY DONT SPECIFY) i. EBIT * (1-t) + D/A Cap Ex Increase in Working Cap c. From EBITDA i. (EBITDA D/A) * (1-t) + D/A Cap Ex Increase in Working Cap 9) What is Terminal Value? a. Value of the business beyond the growth period b. A lump sum cash flow that represents a perpetual and infinite line of future cash flows c. Usually represents the largest portion of value 10) How do you calculate Terminal Value? a. Two Common Methods i. Perpetuity Growth Model Academically proven approach 1. Assumes FCFs grow at a constant rate in perpetuity 2. [FCFn * (1+g) / (r-g)] 3. FCF of the terminal year multiplied by 1 plus the growth rate divided by the discount rate minus growth rate 4. HIGHLY SENSTIVE TO IMPUT CACULATIONS ii. Exit Multiple 1. [EBITDAn * EBITDA multiple] 2. Used more often because it is extremely difficult to determine the constant growth rate b. Less Common Methods i. P/E multiple of the net income of the terminal year ii. Liquidation Value in the terminal year 11) What % of total DCF value is usually in the Terminal Value? a. The amount of the EV PV in the terminal value depends on the length of the forecast period and the growth rate of the cash flows. b. LONGER FORECAST PERIOD = SMALLER % IN THE TV c. Terminal value is usually the majority of the total value (often 3 quarters). Increase in Terminal value = more sensitivity a DCF valuation is to its assumptions. 12) What is an appropriate discount rate a. WACC = Weighted Average Cost of Capital b. ( Cost of Equity * Weight of Equity) + ( Cost of Debt * Weight of Debt) Tax Savings 13) How do you find Cost of Equity? a. CAPM i. Risk free rate + Beta * (market return risk free rate) 14) What do you use as the Risk Free Rate

a. A treasury bond for the same projection period 15) How do you find cost of debt? a. The average rate associated with the LT debt of the company adjusted for tax shields created by interest expense 16) What are the tax savings? a. The interest paid on a firms borrowings can be deducted from taxable income and must be accounted for 17) What is Beta? a. A volatility of a companys returns compared to the markets returns b. Stocks with higher betas have higher risks and also tend to have higher returns over time 18) Why would you unlever beta? a. To find the beta of a private company b. Unlever a similar companies beta than relever it back up given the private companies capital structure c. BU = BL / [1 + (1 t) * (D/E)] d. BL = BU (1 + (1 t) * (D/E)] 19) How would you normalize EBIT or EBITDA? a. You would adjust for one-time items i. Items NOT expected to be part of the normal course of business in the future. 20) How do you perform a public comps valuation? a. Indentify peer companies b. Good comps have similar operational and financial aspects. i. Size, Risk, Growth ii. Same or similar business iii. Same size range iv. Similar growth expectations v. Similar cap structures 21) Common ratios to compare equity performance? a. Price/EPS b. MV/NI c. MV/BV d. Price to Earnings / Growth Rate (PEG Ratio 22) What are some common ratios used to compare enterprise performance? a. EV/EBITDA b. EV/EBIT c. EV/Sales 23) ADDITIONS/SUBTRACTIONS to get to FCF a. Adding back D/A i. Because they are non cash expenses b. Subtracting net increase in working cap i. Because you need to account for non cash gains and loses incorporated on the income statement c. Subtract cap ex i. Because you only want to focus on the operating side of the business and cap ex involves investing

d. After tax interest exp i. Because you want to find unlevered FCF when using a DCF because you may change the capital structure (the equity/debt portion of capital that the firm uses) of the firm during the deal 24) What is the problem with applying public comps to private companies? a. There are premiums involved with comps on a public company because of the liquidity and transparency involved in the public company which will lead to a higher valuation for the private company than should be realized. 25) If you were forecasting two business segments within a company, wooden chairs/at home delivery system? Which would have a longer forecast period? a. Wooden Chair- shorter because growth will be stable in a quicker time period (5 Years) b. At Home Delivery System longer because growth will take longer to become stable (10 Years) 26) How do you go from NI, EPS, and SP to equity value of the company? a. You need to first calculate # of shares outstanding i. NI/EPS = # of shares outstanding b. Then take number of shares outstanding, multiplied by share price and you have the equity value of the corporation. 27) How do you calculate Enterprise value a. Equity Value + Net Debt (Total Debt Cash & Equivalents) + Preferred Stock + Minority Interest b. Cash Equivalents i. Are investments so liquid and so safe that they are nearly cash 1. 3 months or less 2. T-Bills, Money Market Funds, Commercial Paper 28) Why do you add net debt a. Enterprise value is the total value of all the claims that people have on the company and since debt holders have a claim they need to be included. 29) How do you calculate equity value a. Per Share Price * Shares Outstanding (CS+PS+Options/Convertible Securities) i. Shares Outstanding need to be fully diluted which include options and convertible securities b. How do you account for options in the equation i. Treasury Stock Method 30) Walk me through the Treasury Stock Method a. You take the proceeds from the in the money options sale to buy back shares on the open market to reduce the earnings dilution. 31) Why are some stock options relevant to valuation? a. Unexercised, in the money options represent implicit equity value not reflected ijn the current market cap, but should be included 32) If a company has cash what should it do with it? a. Share Buyback b. Pay down debt c. Increase dividend d. Make acquisition e. Cap Ex

33) Why do companies merge? a. Impact on credit ratings b. EPS share change c. Synergies d. Strategic Concerns 34) Enterprise Value to EPS (non diluted) a. (EV - Net Debt Preferred Stock Minority Interest) / # of Common Shares Outstanding 35) Enterprise Value to Fully Diluted EPS a. (EV Net Debt Minority Interest) / # of fully diluted shares b. # of fully diluted shares include CS, Preferred Stock, In the Money Stock Options 36) FLOOR PRICE in an LBO a. The maximum amount a private equity firm will pay for a company and still meet its debt covenants i. You would need to know cost of debt and net income 37) What is a Greenshoe? a. Additional offering 15% of the original offering 38) When would BV of equity be negative and would that be a problem? a. When NI has been consistently negative over the years to bring R.E. down to negative b. It means you have an extremely high amount of liabilities compared to your assets c. You could have taken huge write downs on your assets 39) If company A has revenue increase by 10% and company B has WACC (discount rate) decrease by 1% than which would have a higher NPV? a. Company B. The discount rate is arguably the biggest determinant in NPV. A typical discount rate is 3-4% and a decline of 1% that will be incorporated over a number of years is going to have a much larger effect than a one year 10% increase in revenue 40) Cost of Capital vs. Leverage Question a. Cost of capital = the rate changed to the company by debt/equity holders in order for that company to use its money

b. X axis equals leverage, y axis equals cost of capital c. This shape indicates that as a company takes on more debt their cost of capital is decreasing d. However, when the company begins to take on more debt there is the risk of bankruptcy and a debt holder will want a higher yield on those new debt issuances for that increased risk. 41) P/E ratio is a. Price/EPS

b. Is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share Public Comps Analysis 1) What is it? a. It is when you create a relative valuation of a company based on key multiples gained from a set peer group of similar companies. 2) Why would you use it? a. Gives a relative valuation for your company to the public market and its peers b. How a private company might trade in the public markets, or as a benchmark for a private company in a merger c. See if the company is overvalued/undervalued relative to its peers d. Establish a breakup value for a conglomerate by analyzing each segments individual value 3) How would you locate your defined set of peers? a. Industry, Size, Expected Growth, Capital Structure, Geography 4) Cons for using it? a. How do you assess a company with multiple divisions b. Difficult to assess brand equity and management experience c. Very dependent on current market conditions 5) How would you do? a. You would find multiples of those comparable companies, and the multiples of the company you are trying to value and compare the two. If the company is trading below the median value of a multiple than it is undervalued compared to its peers.