A couple tech questions I got
Hey guys, would appreciate some help clarifying the answers to a couple tech questions I got.
1.) What's the difference between unlevered FCF and levered FCF? How is the levered FCF calculated?
2.) In terms of a DCF, assume a company levers up. Discount rate aside, is the FCF affected?
3.) Why does Warren Buffet believe in using the EBIT multiple over the EBITDA multiple?
4.) What are the main points to touch on when you're deciding whether to buy a stock? (i.e. competitors, PE ratio etc...)
5.) If you are a CFO that's stranded on an island and you're given the opportunity to have ONE financial statement of your company, which one would it be? (apparently the interviewer told me the correct answer should have been the CFS. why?)
6.) What would affect the DCF more, a 10% change in FCF or a 1% change in the discount rate?
Thanks!
Alright - here's what I think:
1.) What's the difference between unlevered FCF and levered FCF? How is the levered FCF calculated?
Unlevered = no debt. Levered = with debt. Under Merton & Miller's ideal world without taxes, leverage makes no difference to FCF or firm value. However in the real world with taxes, leverage (up to a certain point) increases FCF because of the tax shield associated with interested payments.
2.) In terms of a DCF, assume a company levers up. Discount rate aside, is the FCF affected?
No. it affects FCF only via the discount rate.
3.) Why does Warren Buffet believe in using the EBIT multiple over the EBITDA multiple?
Here's my guess: for a firm that's experiencing low/no growth, EBIT is a closer approximation to FCF. FCF = EBIT(1-tax rate) - change in working capital + depreciation/amortization - CAPEX. if firm is not growing, there's no change in working capital, and depreciation/amortization should just net off CAPEX. hence FCF = EBIT (1 - tax rate).
4.) What are the main points to touch on when you're deciding whether to buy a stock? (i.e. competitors, PE ratio etc...)
You should talk about both valuation and strategic considerations. Valuation involves either DCF or COMPS generally. DCF method is probably more sophisticated than comps. You need to explain why you think the firm is now trading at a discount to its "true" value.
5.) If you are a CFO that's stranded on an island and you're given the opportunity to have ONE financial statement of your company, which one would it be? (apparently the interviewer told me the correct answer should have been the CFS. why?)
Obviously statement of cash flow, since it's cash flow that determines firm value. See question 1.
6.) What would affect the DCF more, a 10% change in FCF or a 1% change in the discount rate?
1% change in discount rate. take a simple example of a firm with $10 FCF every year, and 10% discount rate. assume no growth. what's firm value? $10/10% = $100. If you increase FCF by 10%, value becomes 11/10% = $110. if you decrease discount rate by 1%, firm value becomes 10/9% = $111.1. So there you go!
Thanks!
i was going to answer but realized it was probably the kid's hw....
i agree with above except for the following:
3) he believes in using Ebit multiple over Ebitda b/c ebitda can be misleading...it could overstate cash flow... think of ebitda as a chick u met at the club with massive makeup.
Isn't that what I was saying except that you paraphrased it?
There is no right or wrong answer to #6 given the spectrum of possible discount rates.
As for #5, I like that the interviewer felt a need to provide context that the CFO was "stranded on an island". You should have just replied "What does it matter? He's still going to be stuck on that fucking island".
To SMU guy: disagree. work out the algebra for #6 and you will realize that my answer is correct no matter what the discount rate is. I'll post the solution in a while ;)
Actually, smuguy is correct. This question has appeared on the forums before and I had previously worked out the algebra. I can guarantee you that there are cases in which a 10% change in FCF will outweigh a 1% change in WACC. I think that this is a dumb interview question.
For #1, wouldn't the FCF be negatively affected by increases leverage? I would assume the interest payments could possible and most likely outweigh the debt tax shield.
For #3, looking at it again, could you give the example that company A and B might have equal EBITDA's but company A could have a piece of equipment that depreciates 500 a year but company B has a piece that depreciates 1000 a year? That means, EBITDA could potentially overstate the cash flow for the company?
For #4, it's great to think about using DCF/Comps as a comparison -- I never thought of that. Would it be smart to also talk about looking at the value of the company, the industry outlook and the future growth opportunities?
Finally, for #5, would it be acceptable to say that from the CFS, you can derive many of the key points on the BS and the IS? Such as, the net income, depreciation, non-cash current assets from change in WC, change in longterm assets and differences to the retained earnings not affected by net income?
2 and #6 make a long more sense now. I've asked a few people and #6 CAN vary depending on the numbers. I still can't think of a coherent way to answer the question and sound smart though...
just out of curiosity, what bank was this for?
Mmm numerous actually...
1, 2 & 4.) MS superday
3.) Moelis superday
5.) Jefferies 1st Round
6.) Someone got it somewhere.
I think the names you were looking for modigliani and miller, not merton and miller (merton is miller's first name)
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