M&A-DCF 1 - Summary of M&A and DCF in-depth review for Investment Banking II. Part 1 of Review. PDF

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Summary of M&A and DCF in-depth review for Investment Banking II. Part 1 of Review....

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I nve s t me ntBa nki ngI I

Ove r vi e wa ndKe yRul e sofThumb I twoul dbes hoc ki ngi fyouwe ntt hr oughan i nt er vi ew andyoudi dno tge tque s t i onsont heDCF anal ys i sandr e l a t edc onc ept sl i kedi s c ountr a t e sand WACC. Val uat i oni soneoft hec or es ki l ls et syouus ei n i nves t me ntbanki ng,pr i vat eequi t y , athe dgef unds ,i n e qui t yr es ear c h, andanyt hi nge l s ei n financ e , andt heDi s c ount edCas hFl ow anal ys i si soneoft heke yme t hodsyouus e t oval ueac ompany . Ye s ,t her ear epl ent yofdowns i de s … andi ns omei ndus t r i esandf ors ome c ompani e si ti snott ake ns e r i ous l y . Buti ti ss t i l la ne xt r e me l yc ommont opi ci ni nt e r vi e ws , s oyoune e dt oknow i tl i ke t hebac kofyourhand–e ve ni fyou’ r ei nt e r vi e wi ngf oragr oupl i keFI Gwhe r ei t ’ s nota sa ppl i c abl e . He r ear et he5ma i nt opi c syoune e dt ounde r s t andwi t haDCF: 1 .Wha ti ti s , how youus ei t , andhow t owal kt hr oughaDCFanal ys i s . 2 .How t oc a l c ul a t ea ndpr oj e c tFr eeCas hFl ow ( FCF)andhow Le ve r e dFr e eCas h Fl ow ( Fr e eCas hFl ow t oEqui t y)di ffe r sf r om Unl e ve r e dFr e eCas hFl ow ( Fr e e Ca s hFl ow t oFi r m) . 3 .How t oc a l c ul a t et hedi s c ountr a t ei naDCFa ndhow t oa ppl yc onc e pt sl i ke WACCa ndt heCos tofEqui t y . 4 .How t oc a l c ul a t et heTe r mi na lVa l ue, wha ti tme ans ,a ndhow i t c ont r i but e st oaDCF. 5 .How di ffe r e ntf ac t or si mpac tt heout putofaDCFa ndwha tc ha nge sha vet he bi gge s te ffe c t . We ’ r egoi ngt ot ac kl et hos e5t opi c si ne ac hoft hes e c t i onsbe l ow,br i ngi ngi nt heEx c e l DCFmode li nc l ude dwi t ht hi sgui dea sne c e s s a r y .

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I nve s t me ntBanki ngI I

The n,we ’ l lgot hr oughac ompr e hens i ves e tofBa s i candAdvanc e di nt e r vi e w que s t i onsont heDCFt ha tc ove r sa l lt opi c s–i nc l udi ngaf e w que s t i onst ha tmos t wor ki ngbanke r swoul dnote ve nbea bl et oe xpl ai n( e . g. how t ode r i vet he Gor donGr owt hf or mul af orTe r mi nalVal ue ) .

Key Rule #1: DCF Concept and Walking Through It Theba s i cc onc e ptbe hi ndaDi s c ount e dCas hFl ow ana l ys i si st ha tac ompa nyi s wor t ht hepr es entval ueofi t sf ut ur ec as hflows . Wha tt he“ ma r ke t ”t hi nkst hec ompanyi swor t hi si r r e l e va nt–a l lt ha tma t t e r si s how muc hi nr e alc as hflow i tge ne r a t e si nt hef ut ur e . Mone yt oda yi swor t hmor et hanmone yt omor r ow,be c aus eyouc oul dal wa ys i nve s tmone yt oda y ,e ar ni nt e r e s toni t ,a nde ndupwi t hmor ei nt hef ut ur e . Soyouha vet odi s c ounta l lt he s ef ut ur ec as hflowsbac kt ot he i rpr e s e ntval uet o a c c ountf ort ha t“ c os t ”–t het i meval ueofmoney. Ex ampl e:Le t ’ ss a yyoue s t i ma t et ha tac ompa ny’ sf ut ur ec as hflowsar e$100i n Ye ar1, $120i nYe ar2, and$ 140i nYe ar3. You’ r egoi ngt odi s c ountt hec as h flowsa t1 0% pe rye arbe c aus eyoube l i e veyouc oul de ar n10% pe rye arby i nve s t i ngyourmone ye l s e whe r e . Sot hedi s c ount e dval uei nYe ari s$100/( 1 +10%) ,ora bout$ 91,i nYe ar2i t ’ s$ 120/( ( 1 +10%) ^2) ,orabout$99,a ndi nYe ar3i t ’ s $ 140 /( ( 1 +1 0%) ^3) ,ora bout$ 105. Addi ng t he s eup,t hene tpr e s e ntval uei s$295. Thi si st hebas i cc onc e pt ,buti tge t smor ec ompl i c a t e df oras i mpl er e as on: c ompani esdon’ tj us t“ s t op”ope r a t i ngaf t e raf ew ye ar s .

I nve s t me ntBanki ngI I

The yc ont i nuet oge ne r a t ec as hflow f ari nt ot hef ut ur e ,pe r hapsf orde c ade sor hundr e dsofye ar s–a ndwene e dawa yt oe s t i ma t ea l lt hos ec as hflowsand di s c ountt he ma ppr opr i a t e l y . Younor mal l yt ac kl et hi spr obl e m bydi vi di ngaDCFi nt o2pa r t s : t hepr oj ec t i on pe r i od( t hene arf ut ur e )a ndt heTer mi nalVal ue( t hedi s t antf ut ur e ) . Wea s s umet ha twec anpr oj e c tac ompany’ sc as hflowsmor epr e c i s e l yove rt he ne xt5 10ye ar s , s owepr oj e c tt he m, di s c ountt he m, anda ddupe ve r yt hi ngf or t ha tpe r i od. Be yondt ha twes a y ,“ Wec a n’ te s t i ma t ec as hflowsaspr e c i s e l y , s ol e t ’ snote ve n bot he r … butwec a nc omeupwi t hana ppr oxi ma t i on( t heTe r mi nalVal ue )of how muc ht hec ompanymi ghtbewor t hi nt ot hedi s t antf ut ur e . ”

Sot ha ti st hebas i cc onc e pt :di vi deac ompany’ sc as hflowsi nt oa“ ne arf ut ur e ” pe r i oda ndt he na“ di s t a ntf ut ur e ”pe r i od, de t e r mi net heval ue sf ore ac hpe r i od, a ndt he ndi s c ountt he m bac kt ot he i rpr e s e ntval ue ss i nc emoneyt oda yi swor t h mor et hanmoneyt omor r ow. Thi sc onc e pti snotr oc ke ts c i e nc e ,butt heex ec ut i onge t st r i c ky: 1 .How doyoupr oj e c tc as hflowsf orac ompany?...