Learn 30+ Common Valuation Interview Questions With Answer
Q1- What are the three most common methods for valuing a business?
Suggested Answer: The three most common methods for valuing a business Comparable Companies, Precedent Transactions and Discounted Cash Flow Analysis.
Q2- Could you explain how you use public comps and precedent transactions?
Suggested Answer: Initial selection of companies and transactions is based on industry, size, and geographic location of the companies and transactions (and time for the transactions).
Afterwards, you determine the appropriate metrics and multiples for each set of companies and transactions - such as sales revenue, sales growth, earnings before interest and taxes (EBITDA), EBITDA margins, and revenue and EBITDA multiples - and calculate them for all of the companies and transactions in the set.
The next step is to calculate for each valuation multiple in the set the minimum, the 25th percentile, the median, the 75th percentile, and the maximum.
You then apply these figures to the financial metrics of the company under consideration in order to derive an estimate of the company's Implied Value.
When a company has $100 million in LTM EBITDA and the median LTM EV/EBITDA multiple in a set of comparable companies is 7x, the implied Enterprise Value is $700 million for the company in question.
In order to obtain a range of possible values, you must first calculate its Implied Value for all the other multiples.
Q3- When you analyze a company how do you select comparable companies or precedent transactions when you analyzing a company?
Suggested Answer: The 3 main criteria for selecting companies and transactions:
Financial criteria (Revenue, EBITDA, EV, 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.
Q4- Tell me about the most frequently used valuation multiples. And what exactly do they mean?
Enterprise Value / Revenue: When measured in terms of total sales, a company's worth is determined.
Enterprise Value / EBITDA: How valuable a company is in relation to its estimated cash flow is determined.
Enterprise Value / EBIT: a measure of how valuable a company is in relation to the pre-tax profit it generates from its primary business operations
Price Per Share / Earnings Per Share (P / E): a measure of a company's worth in relation to its after-tax profits, which include interest income and expense as well as non-core business activities
Q5- Why can't you use Equity Value/EBITDA instead of Enterprise Value/EBITDA as a multiple?
Suggested Answer: The Equity Value metric is used when the metric includes interest income and expense; the Enterprise Value metric is used when the metric excludes them (or is "before" them).
It is not only common shareholders who have access to EBITDA; all investors in the company have access to it as well. Additionally, Enterprise Value is available to all investors because it includes both equity and debt, and you can pair them together to create a total return.
The ratio of equity value to earnings before interest and taxes (EBITDA) is misleading, however, because equity value does not represent the company's entire capital structure - only that which is available to common shareholders.
Q6- Please describe what are the some issues with the EBITDA multiple.
It hides the amount of debt principal and interest owed.
It does not comply with the working cap requirements.
A large number of charges are refunded by businesses.
EBITDA is frequently not indicative of true cash flow.
Q7- P/E, EV/EBITDA, and EV/EBIT multiples all measure a company profitability. What's the difference between the two, and when should you use each? Why
Suggested Answer: P / E is affected by the company's capital structure, whereas EV / EBIT and EV / EBITDA are not affected by the company's capital structure. Consequently, P / E is used for banks, insurance companies, and other businesses where interest is critical and capital structures are typically similar.
You're more likely to use EV / EBIT in industries where Depreciation and Amortization (D&A) is significant and where capital expenditures and fixed assets are significant (e.g. manufacturing), whereas EV / EBITDA is more likely to be used in industries where fixed assets are less significant and where D&A is comparatively smaller (e.g. service industries) (e.g. Internet companies).
Please keep in mind that many bankers have this logic backwards and believe that EV / EBITDA is better when both CapEx and Depreciation are high... which is not correct, if you stop and think about it. Just give in and agree with what they have to say if they start arguing about it during an interview.
Q8- Why Depreciation & Amortization is included in EV/EBIT, but not in EV/EBITDA.
Suggested Answer: In contrast to EV / EBITDA, which excludes Depreciation and Amortization, EV / EBIT includes both. You're more likely to use EV / EBIT in industries where D&A is significant and where Capital Expenditures and fixed assets are important (e.g. manufacturing), and EV / EBITDA in industries where fixed assets are less important and where D&A and capital expenditures are relatively small (e.g. Internet companies).
Q9- In a valuation, how do you account for a company's competitive advantage?
Suggested Answer: Instead of looking at the medians, consider the 75th percentile multiples. Make more aggressive assumptions in your writing. Increase the value by including premiums.
Q10- Do you always utilize the median multiple of a group of comparable public companies or precedent transactions?
Suggested Answer: If the company is outperforming or underperforming for some reason, you may choose to make the median the Centre of that range, but you are not required to do so. You could instead choose to focus on the 75th percentile, 25th percentile, or anything else.
Q11- What would you put a value on a company that makes no money and generates no revenue?
Suggested Answer: You could still use a relative valuation approach based on comparable and precedent transactions - but because you don't have any revenue or profits, you won't be able to use common multiples such as EV to Revenue, EV to EBITDA, or P/E because you don't have any revenue or profits.
Using a pre-revenue internet company, you could look at metrics such as the number of users, or the number of unique website visitors, the number of page views, and other out-of-box multiples. You go one level above revenue and compare companies based on the metrics you've gathered so far.
Instead of a DCF, you could project out further (perhaps 15-20 years) and until a point in the future when the company does generate revenue and profit, after which you would discount the cash flows back to the present. But the problem with doing so is that the further out you go with your projections, the more uncertainty there is, making it impractical in many situations.
Q12- What exactly is DCF and why do we use it?
Suggested Answer: The discounted cash flow (DCF) method of valuing an investment is based on the expectation of future cash flows and is used to estimate the value of the investment. When performing a DCF analysis, the goal is to determine the current value of an investment based on projections of how much money it will generate in the future. This applies to decisions made by investors in companies or securities, such as the acquisition of a company or the purchase of a stock, as well as decisions made by business owners and managers in the context of capital budgeting or operating expenditure decisions.
Q13- What is the definition of Net Working Capital (NWC)?
Suggested Answer: Net working capital (NWC), working capital is the difference between a company's current assets (such as cash, accounts receivable/unpaid bills from customers, and inventories of raw materials and finished goods) and its current liabilities (such as accounts payable and debt). Working capital is a term used to describe the difference between a company's current assets and its current liabilities.
Q14- What is goodwill, and what impact does it have on net income?
Suggested Answer: An intangible asset that appears on a company's balance sheet is known as goodwill. Intangible assets such as intellectual property rights, brand recognition, and customer relationships are examples of goodwill. When a company is purchased, goodwill is acquired if the acquirer pays more than the book value of the company's assets. When something occurs that causes the value of intangible assets to be diminished, goodwill must be "written down" in a manner similar to that used for depreciation in order to be recognized. Goodwill is deducted from net income as a non-cash expense, reducing net income as a result.
Q15- What are some reasons that two companies would desire to merge?
Suggested Answer: The primary reason for a merger between two companies would be the synergies that would be created as a result of combining their respective operations. Aside from that, there are several other reasons for outsourcing, such as establishing a new market presence, consolidating operations, gaining brand recognition and expanding in size, or acquiring rights to some property (physical or intellectual) that they could not obtain as quickly if they built or created it themselves.
Q16- What is meaning of synergies?
Suggested Answer: The concept of synergies states that the combination of two companies results in a company that is more valuable than the sum of the values of the two individual companies that have joined forces. The reasons for synergies can be either cost-saving synergies, such as reducing the number of employees or the size of the office, or revenue-generating synergies, such as higher prices and economies of scale, among other factors.
Q17- What will the balance sheet of the merged company look like if Company A buys Company B?
Suggested Answer: If this is a true consolidation merger (two companies combining to form a new third entity), then all of the assets and liabilities of the two companies will be carried over, with the exception of any intercompany items, which should be eliminated in the consolidated financial statements.
Q18- What does leveraged buyout mean?
Suggested Answer: A leveraged buyout (also known as an LBO) is the process of purchasing another company using money from outside sources, such as loans and/or bonds, rather than money generated by the company itself. Sometimes the assets of the company that is being acquired are used as collateral for the loans that are made (rather than, or in addition to, assets of the company doing the acquiring).
Q19- What is the Asset Approach, and why are we using it?
Suggested Answer: A business is viewed as a collection of assets and liabilities that are used as building blocks to construct a picture of the business's value according to the asset approach. The asset approach is based on the so-called economic principle of substitution, which is intended to answer the following question:
What will it take to start a new business similar to this one that will provide the same economic benefits to its founders and investors?
With assets and liabilities being a part of every operating business, determining the value of these assets and liabilities seems like a logical first step in answering this question. The difference is measured in terms of business value.
While this may appear to be straightforward, the difficulty lies in the specifics: determining which assets and liabilities should be included in the valuation, selecting a standard by which to measure their value, and then actually determining how much each asset and liability is worth.
Q20- What exactly is the Market Approach approach, and why are we using it?
Suggested Answer: The market approach, as the name implies, is based on signs found in the real world market place to determine the value of a company's assets. In this case, the so-called economic principle of competition comes into play:
What are the values of other businesses that are similar to my own business?
There is no such thing as a business that operates in isolation. If what you do is truly exceptional, there is a good chance that others are engaged in the same or similar activities. If you are considering purchasing a business, you must first determine the type of business you are interested in purchasing and then research the "going rate" for businesses of that type in the local area.
Whenever you are planning to sell your business, you will research the market to see what other businesses in your industry are selling for.
On the surface, it seems logical to assume that the "market" will eventually settle on some notion of business price equilibrium - something that both buyers and sellers will be willing to pay and accept. That is what is referred to as the "fair market value" of the asset:
The amount of money that a willing buyer is willing to pay and a willing seller is willing to accept in exchange for the business. Both parties are presumed to be acting in good faith and with full knowledge of all relevant facts, with neither party being under any obligation to complete the transaction.
In this case, the market approach to business valuation is an excellent way to determine the fair market value of the company - the amount of money that would be exchanged in an arms-length transaction where both the buyer and the seller act in their own best interests.
Q21- What is the Income Approach, and why do we use it?
Suggested Answer: With the income approach, you're looking at the most important reason for owning a business: making money. In this case, the so-called economic principle of expectation comes into play:
What economic benefits will I receive if I invest my time, money, and effort into business ownership, and when will these benefits be realized?