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Question 1

1. What is the most common way a deferred tax asset arises? Explain this concept.
2. Do deferred tax liabilities make an impact on the income statement?

Answer 1

Net Operating Losses

A company can use prior year’s losses as a way to reduce future taxable income to reduce its taxes

2. No. You make an adjustment for cash, but no adjustments to the income statement.

Question 2

1. What are 2 criteria for an item to appear on the income statement?
2. Short term investments, although a current asset, are adjusted for in which portion of the cash flow statement?
3. What is NOPAT?

Answer 2

1. a) it must correspond to the IS’s time period
   b) it must affect taxes
2. Cash flows from investments for available for sale (trading securities are CFO)
3. Net operating profit after taxes (EBIT x (1-T))

Question 3

1. What is the formula for the deferred tax liability as a result of an asset write up?
2. Anytime cash taxes exceed book taxes, you record ____?
3. When book taxes are more than cash taxes, you record ____?

*** Be careful on this one***

Answer 3

1. Amount of write up x tax rate
2. Decrease to deferred tax liability
3. Increase to deferred tax liability

Question 4

In general, how do you value net operating losses and take them into account in a valuation? NOLs should be treated like what in regards to enterprise value or equity value?

Answer 4

Take the sum of the PV of future tax savings.

Treated like cash, thus subtracted from enterprise value or equity value

Question 5

1. Why do you add preferred stock to enterprise value?

Answer 5

1. It is similar to debt due to paying interest as well as having capital appreciation opportunity. The company receives funding via preferred stock.

It’s also a source of capital

Question 6

1. What is important to specify when FCF term is used?
2. How do you take into account a company’s competitve advantages in a valuation?
3. Why does Warren Buffett prefer EBIT instead of EBITDA?

Answer 6

1. Whether these are levered or unlevered FCFs
2. a) Instead of using the median in the range of valuations, tend towards the higher multiples
   b) add a premium
   c) more aggressive projections
3. CapEx is sometimes a significant portion of a companies balance sheet and can significantly impact earnings

Question 7

Will the act of raising equity ever impact the income statement?

Answer 7

No.

Question 8

1. What are 3 examples of line items excluded from changes in working capital portion of the CFO?
2. Why might a company impair Goodwill?

Answer 8

1. a) cash
   b) short term investments (CFI)
   c) short term debt (CFF)
2. The acquired company turns out to be less than expected

Question 9

How does a 100mm PIK note with 10% interest affect the 3 financial statements? Assume 40% tax rate.

Answer 9

income statement

NI (6)

Cash Flow

NI (6)

PIK 10

Cash 4

Balance Sheet

Cash 4

Note payable 10

NI (6)

Question 10

1. How much debt could a company issue to fund an acquisition?
2. What happens if a company way overpays for another company? Give an example.
3. Why do most mergers and acquisitions fail?

Answer 10

1. Up to the acceptable total leverage ratio, typically 2.5x - 3.0x
2. Ebay acquired skype for a large premium in which Ebay had to impair a lot of the Goodwill, thus taking a huge hit to earnings
3. The integration aspect is extremely difficult

Question 11

What is M&A premiums analysis?

Answer 11

Analyzing historical premiums of offer price to unaffected stock price.

Look at precedent transactions’ offer values and premiums to unaffected stock prices

Question 12

1. When would you utilize Sum of the Parts valuation?
2. What would give you a higher valuation, DCF or LBO analysis? Why, and what is important to note about LBO analysis?
3. How would you value Facebook back in 2004 when it had no profit or revenue?

Answer 12

1. When a company has a lot of completely different divisions, like GE for example. You would value each one separately and then take the sum of those values.
2. DCF would have a higher valuation, most likely. LBO anaylsis only values terminal value, not the intermediate cash flows. Also, remember, LBO anaylsis does not craft value, but it seeks an optimal value based on a desired IRR.
3. I would analyze previous acquisitions of similar companies. I would NOT attempt to project revenes unless I was very certain FB would start to turn a profit

Question 13

1. What is an alternate way to calculate unlevered FCFs?
2. A company has a high debt load and is paying off a significant poriton of its principal each year. How do you account for this in a DCF?

Answer 13

1. cash flow from operations - CapEx + after tax interest expense - after tax interest income
2. It depends on whether using levered or unlevered FCFs.

If unlevered FCFs, no adjustments are needed

If levered FCFs, then subtract interest expense and subtract debt repayments