Read below Valuations questions and answers. In this article, We have discussed some of the most useful valuations interview questions and answers.
Q1- Tell me which method would you do value a company?
1. Asset Valuation
The assets of your company include both tangible and intangible items. Calculate the value of your company's assets based on the book or market value of those assets. When calculating the asset valuation for your company, make a list of all of the cash, equipment, inventory, real estate, stocks, options, patents, trademarks, and customer relationships that you have on hand.
2. Historical Earnings Valuation
The current value of a business is determined by the gross income generated, the ability to repay debt, and the capitalization of cash flow or earnings. If your company is having difficulty generating enough revenue to cover its expenses, its value will decline. On the other hand, paying off debt quickly and maintaining a positive cash flow increase the value of your company. Make use of all of these considerations when determining the historical earnings valuation of your company.
3. Relative Valuation
The relative valuation method is used to determine how much a similar business would be worth if it were sold at the same time. It determines a reasonable asking price for your company's assets by comparing the value of your assets to the value of similar assets in the market.
4. Future Maintainable Earnings Valuation
In order to determine the value of your business today, you must first determine how profitable your business will be in the future. When profits are expected to remain stable, you can use the future maintainable earnings valuation method for business valuation. You should evaluate your company's sales, expenses, profits, and gross profits from the previous three years in order to determine its future maintainable earnings valuation.. These figures assist you in forecasting the future and providing a current market value for your company.
5. Discount Cash Flow Valuation
If profits are not expected to remain stable in the future, the discount cash flow method should be used to value the business. Future net cash flows from your company's operations are discounted to present day values using this method. With these figures, you can determine the discounted cash flow valuation of your company as well as the amount of money your business assets are expected to generate in the near future.
Q2-When does a DCF come in useful? When does it become less useful?
Suggested Answer: That's about as far ahead as you can reasonably predict for the vast majority of businesses. For most businesses, less than 5 years would be too short to be useful, and more than 10 years would be too difficult to project.
Q3-What methods of valuation are there?
When it comes to determining the value of a company as a going concern, there are three main valuation methods that industry practitioners employ:
(1) DCF analysis, (2) comparable company analysis, and (3) precedent transactions
When determining the worth of a business or asset, there are three broad categories to consider, each with its own set of methods.
Cost Approach, Market Approach, and discounted cash flow (DCF) approach
Q4-When does a Liquidation Valuation come in handy?
Suggested Answer: In bankruptcy situations, it is most commonly used to determine whether or not shareholders will receive anything after the company's liabilities have been paid off with the proceeds from the sale of all of its assets, which is the most common application. It is frequently used to advise struggling businesses on whether it is better to sell assets separately or whether it is better to sell the entire company outright.
Q5-Tell me it is possible EV/EBITDA ever be higher than EV/EBIT?
Suggested Answer: No. EBITDA, by definition, must be greater than or equal to EBIT because it is calculated by taking EBIT and adding Depreciation & Amortization, neither of which can be negative (they could, however, be zero, at the very least theoretically). The ratio of EV to EBITDA for a single company must always be less than or equal to the ratio of EV to EV for that company because EBITDA is always greater than or equal to EBIT.
Q6-From highest to lowest expected value, rank the three main valuation approaches.
Suggested Answer: Because companies are paying a premium to acquire another company, precedent transactions typically yield the highest value. DCF valuations typically yield the second highest value because those who build the DCF tend to be optimistic on their assumptions. Comparable company analysis yields typically the lowest value because it does not account for premiums or synergies. DISCLAIMER: There is no predetermined order in which transactions should be valued.
Q7-Is it more likely that an LBO or DCF will result in a better valuation?
Technically, it could go either way, but in the vast majority of cases, the LBO will result in a lower valuation for your business.
For the sake of simplicity, consider the following: with an LBO, you do not receive any value from a company's cash flows between the first and final year — you are only valuing it based on its terminal value.
As opposed to this, when using a DCF, you are considering both the company's cash flows in between and its terminal value, which results in a higher overall valuation for the company.
Note that, in contrast to a DCF, an LBO model does not provide a specific valuation on its own. Instead, you set a target internal rate of return (IRR) and use that to determine how much you could pay for the company (its valuation).
Q8-Why are public comps and precedent transactions considered as "more reliable" than a DCF?
Suggested Answer: This is because they are based on actual market data rather than on assumptions that are far in the future. For forward multiples, you must still make future assumptions, even if they are not explicit. When you don't have good or truly comparable data, a DCF may be a better option because it produces more accurate results.
Q9-What are the drawbacks of public comps?
Suggested Answer: Targets with no obvious public comparables are more difficult to achieve, and you must find other companies, even those outside of the sector, that have similar business and financial characteristics to benchmark against them.
Q10-What are some of the disadvantages of precedent transactions?
Suggested Answer: It is possible to have infrequent data (especially for private company acquisitions). It is possible that there are no truly comparable transactions. Include assumptions such as the control premium and synergy assumptions, which are not generally known.
Q11-Why would a firm with comparable growth and profitability be valued higher than its Comparable Companies?
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.
When an industry leader has a larger market share than its competitors, the company is considered to be the market leader.
Q12-How would Excel treat a PMT function
Suggested Answer: PMT, one of the financial functions, calculates the payment for a loan based on constant payments and a constant interest rate, which is one of the financial functions. Calculate a monthly loan payment with the help of the Excel Formula Coach.
Q13-Why is CAPEX a negative number on the cash flow statement?
Suggested Answer: Because they are amounts that are being subtracted from your balance sheet, or because they represent a negative capital expenditure on your cash flow statements, capital expenditures are considered negative. Capital expenditures, also known as capital outlays, are used to purchase assets that will be used by your company for a period of more than a year after they are purchased.
Q14-Why does D&A have a positive impact on the Statement of Cash Flows?
Suggested Answer: Operating cash flow is calculated by beginning with net income and then adding depreciation or amortization, net change in operating working capital, and other operating cash flow adjustments to arrive at the final figure. As a result, the amount of cash on the cash flow statement increases because depreciation is re-adjusted to reflect the increase in operating cash flow.
Q15-What are the types of inventory method and explain me in detail?
Specific Identification: Inventories are tracked using the inventory cost flow method, in which a company physically tracks both its remaining inventory and the inventory that has been sold to customers. Although it is technically not an assumption because the companies that chose this method are aware of the products that are being sold. Automobiles, for example, have unique identification tags attached to them. This method is used for expensive and one-of-a-kind items, rather than for identical items, as the name implies. Maintaining meticulous records.
First-In, First-Out (FIFO): According to Inventory Cost Flow, the oldest costs are transferred first from inventory to cost of goods sold, with the most recent costs remaining in ending inventory until the oldest costs are transferred to cost of goods sold. The assumption that selling the oldest items first will more closely reflect reality (because you don't want inventory to lose its freshness) Rarely is the identity of the actual item sold revealed. It is not always the oldest item that is sold, but rather the oldest cost that is reclassified as COGS that is the first to sell. A thorough investigation is not conducted to determine which specific item was purchased. Income that has been reported to be higher
Last-In, First-Out (LIFO): According to the inventory cost flow assumption, costs are transferred from ending inventory to cost of goods sold in the order in which they were incurred, with the oldest costs remaining in the ending inventory. Because a cost that is relatively current is shown as COGS rather than a figure that is out-of-date, it is more consistent with the matching principle. By matching current costs to current sales, it is possible to obtain a more accurate picture of income. It is popular in the United States because it helps to reduce the amount of income taxes that many businesses must pay. The International Financial Reporting Standards (IFRS) do not permit the use of this method.
Average Method: In this scenario, the average cost is transferred from ending inventory to cost of goods sold while the same average cost remains in beginning inventory, as described above. Out of all the methods, this one is the most logical. Although it is less appealing than other methods due to the lack of breaks, it is still an option.
Q16-What exactly does the exit multiple method measure means?
Suggested Answer: The calculation of the terminal value in a discounted cash flow formula, which is used to determine the value of a business, is accomplished through the use of an exit multiple. The method is predicated on the assumption that the value of a business can be determined at the end of a projected period based on the current public market valuations of similar companies.
Q17-What is meaning of negative FCF?
Suggested Answer: It is possible for a company to have a negative free cash flow if it does not have enough internal funds to finance its investments in fixed assets or working capital, and it will have to raise new money from investors in the capital markets to pay for these investments.
Q18-Distinguish between the Excel functions PMT, IPMT, and PPMT. What kind of cash-flow stream is behind each of these? When should you utilise each of these? Which of your amortization schedule's variables change over time? Why?
Suggested Answer: Each of these is intended to be used in conjunction with an annuity or annuity-type cash flow (constant cash flows over a set period of time at regular intervals). In each period, PMT calculates the total payment, which is the same as the previous period. IMPT calculates the interest payment for each period, which will vary depending on how much of the loan balance is still owed at the end of each period. PPMT calculates the principal payment for each period, which will change over time as the amount of money borrowed increases. These change over time because the interest rate decreases as the balance of the loan decreases, resulting in a greater proportion of the total payment going to principal and a smaller proportion going to interest. PMT should be used to calculate the total payment for each period, whereas IPMT and PPMT should be used to calculate the payment for each period separately (because they change each period).
Q19-what are diluted shares outstanding?
Suggested Answer: If a security has the potential to create more shares, it is considered dilutive. The best example is a call option, which gives someone the ability to pay the company money in exchange for receiving a newly issued share in the company in exchange.
Q20-How you will get equity value from enterprise value?
Enterprise value + cash & cash equivalents, — debt, preferred stock, non-controlling interests
WHY? In order to determine the value available to equity investors, we subtract the value of debt and debt equivalents, non-controlling interest, and preferred stock. These items are subtracted because they represent the share of other shareholders; we are only interested in the value available to equity investors.
Q21-What are the benefits and disadvantages of using EV/EBITDA vs. EV/EBIT vs. P/E as a valuation multiple?
Suggested Answer: First and foremost, it is important to note that when valuing companies, you never look at just one multiple. You should consider the big picture when valuing a company, and you should evaluate the company using a variety of multiples and methodologies. However, because the interviewer is likely to be irritated and press you on this point, you can say that when comparing EV / EBITDA to EV / EBIT, EV / EBITDA is preferable in cases where you want to completely exclude the company's capital expenditures, depreciation, and capital structure from consideration.
When you want to exclude capital structure but partially factor in CapEx and Depreciation, EV / EBIT is a better measure to use. Industry sectors such as manufacturing, where those items are critical value drivers for businesses, are accustomed to this practise.
Because it is affected by various factors such as tax rates, capital structures, non-core business activities, and other factors, the P / E multiple is not particularly useful in most cases. Instead, it is used primarily to be "complete" and ensure that you have covered all of the commonly used multiples. Furthermore, it is sometimes more relevant and important in certain industries, such as commercial banks and insurance companies, where it is necessary to take into account interest income and expense when determining profitability.
Q22-How would you go about choosing a set of comparable public companies to use in a valuation?
The 3 main criteria for selecting companies and transactions:
Financial criteria (Revenue, EBITDA, etc.)
In the case of Precedent Transactions, you can also limit the set based on the date, with the majority of transactions occurring within the last 1-2 years being the most common. Companies and transactions are screened for based on the most important factor, which is industry. The remaining factors are optional and are used only if you want to be extremely specific about your search.
Q23-Is the cost of debt or the cost of equity usually higher?
Equity has a higher cost of capital than debt because owners bear a greater risk than creditors in their investments.
Q24-What is the formula for calculating the cost of equity?
Suggested Answer: iE = Rf + B(Rm - Rf)
Q25-How would you calculate a company's beta?
The beta of a security can be calculated by first dividing the standard deviation of returns of the security by the standard deviation of returns of the benchmark. The value obtained as a result is multiplied by the correlation between the returns of the security and the returns of the benchmark.
Q26-How you will forecast revenue in financial modelling?
When it comes to model building, there are two approaches to take: making your model realistic or keeping it simple and robust. After identifying various methods to model revenues with high levels of detail and precision, the first principles approach can be applied to the problem. There are also considerations that are specific to the industry that must be taken into account. For example, when forecasting revenue in the retail industry, you will forecast the rate of expansion and calculate the income per square metre. The size of the market will be predicted, and current market share and competitor analysis will be used to forecast revenue in the telecommunications industry. Whenever you forecast revenue in the service industry, you will estimate the headcount and use the income to determine employee trends. The quick and dirty approach to robust models, on the other hand, outlines how you can model revenues in a much more straightforward manner, with the added benefit that the model will be simpler and easier to use as well. In this approach, you will make predictions about the future growth rate based on historical data and trends.
Q27-What exactly is the purpose of financial modelling?
A financial model is simply a tool that is typically created in Excel and used to forecast the financial performance of a company in the foreseeable future. An income statement, balance sheet, cash flow statement, and supporting schedules are typically required to prepare a forecast based on a company's historical performance and are required to be prepared in conjunction with the other financial statements (known as a 3-statement model). More advanced types of models, such as discounted cash flow analysis (DCF model), leveraged buyout, mergers and acquisitions, and sensitivity analysis, can be developed from there. • Raising capital (debt and/or equity) for a variety of purposes. In the process of acquiring new businesses and/or assets • Organically expanding the company's operations (i.e. opening new stores, entering new markets, etc.) • Assets and business units are being sold or disposed of. Budgeting and forecasting (planning for the years ahead) • Allocation of resources to capital projects (priority of which projects to invest in) Putting a monetary value on a company
Q28-What is Calendarization and how you will use in valuation
Calendarization refers to the fact that different companies have different fiscal years. For example, some businesses' fiscal years may run from January 1 to December 31; however, others may have fiscal years that run from April 1 to March 31, or from July 1 to June 30, depending on their industry.
It becomes difficult to compare all of these periods because you always have to look at the same calendar period when creating a set of Public Comps, which makes it difficult to compare all of them at the same time.
As a result, you must adjust all fiscal years by adding and subtracting "partial" periods from the total.
You almost always adjust the fiscal years of other companies to match the fiscal year of the company you're valuing.
Consider the scenario in which you need to change a fiscal year that runs from July 1 to June 30 to one that ends on December 31.
The financials from the July 1 - June 30 period would be added to those from the June 30 - December 31 period this year, and the financials from the June 30 - December 31 period the previous year would be subtracted from those of the July 1 - June 30 period.
Q29-What is the difference between calendarization and LTM?
Suggested Answer: The difference between LTM and calendarization is that LTM uses data from the preceding 12 months when calculating financial metrics such as earnings, EBITDA, or revenue while calendarization uses data from the current fiscal year.
Q30-How do you calculate diluted earnings per share (DEPS)?
Suggested Answer: To calculate diluted earnings per share, start with a company's net income and subtract any preferred dividends. Then divide the result by the sum of the weighted average number of shares outstanding and dilutive shares, which is the weighted average number of shares outstanding plus the number of dilutive shares (convertible preferred shares, options, warrants, and other dilutive securities).