deleting mood

1.) I'd invest in Comp A since there must be a (positive) reason why Comp A still trades at 10x P/E despite having much smaller margins than its competitor.

2.) Market Leader, EBITDA Margins, revenue growth rates, scandals, customer fragmentation, etc.

3.) CapEx needs to get depreciated, hence a larger CapEx balance will be reflected by a larger depreciation expense. In this sense, what the interviewer was probably looking for was that you would use EV/EBITDA for companies that are either a.) not capital intensive (ex. Software companies where CapEx is not a big factor) or b.) have relatively similar CapEx (and therefore similar depreciation). However when comparing capital-intensive companies, EBIT would be a more helpful multiple.

4.) Don't fully understand your question here but yes, assuming a ridiculously high terminal growth rate would lead to a ridiculous valuation. The key here is to look at what % the terminal value takes up of the resulting implied enterprise value (as compared to the PV of cash flows). If it is way too high (ex. 90%+) then it may be a red flag that your assumptions are unrealistic.

5.) WSO guides, MI guides.

Hope this helps.

For Q1, because I think you guys whiffed:

Company A.

Assume price of the widget they sell is $100, then goes to $101; while costs stay flat at $95 for A and $90 for B.

The expansion of net income for A will be 20%, while B will have NI expand by only 10%. Therefore Company A will have double the expected return of B.

UBS Valuation Multiples: A Primer

For the Terminal Value growth, assume over the long term the economy grows at an average of 2%, as per central banking targets. Then, if you choose a terminal growth of greater than 2%, your company's growth to perpetuity surpasses that of the economy. This implies at some point in the future, your company will surpass the size of the economy, which is not possible.

Thus, your perpetuity growth should always be less than that of inflation/economic growth.

The most important thing in my opinion is to take a few seconds to think about the question that is asked before you answer. For consulting interviews this point is reiterated over and over again, but for some reason I rarely see it mentioned for IB interviews, but in my opinion it is crucial. Think about it - does your interviewer want an analyst who is thoughtful or someone who will blurt out the first thing on his mind?

When you break the questions down, they really aren't too hard. What you need to do is take a few seconds to think about which assumptions would imply which answer, state the assumptions and then give your answer based on that. You need to think the problem through, since there is a high likelihood that the interviewer will ask you to change your assumptions.

As an example, following on Cries' answer to the first question, assuming that costs and PE multiples are fixed and prices go up from 100 to 101, A's valuation will appreciate by 20% (1/(1005%)) while B's valuation will only appreciate by 10% (1/(10010%)). However, if margins are fixed (i.e. assuming 100% variable costs) both companies' valuation will appreciate by 1%. If you understand this quantitatively, then you have in my opinion already given an okay answer. Qualitatively there are pros and cons for both, again it is about understanding your assumptions.

For the second question, think about what multiples really are - a back of the envelope DCF as Cries' mentioned. So what does that imply? That the two companies either have different expected growth in future cash flows or different cost of capital. The reasons you state could be true, but it does not show that you have an understanding of what multiples really are and why they are used.

For the third question, read the UBS primer mentioned above. Again, your answer does not show that you understand the assumptions to your answer. You need to know under what assumptions EBITDA is a good proxy for free cash flow. Start by looking at how to go from EBITDA to FCF (this should be second nature to you if you have done some preparation). If the companies have similar CAPEX intensity, EBITDA is arguably better because it does not include non-cash expenses and is not affected by accounting differences in how D&A are treated. However, if the companies have different CAPEX intensity, EBIT (or EBITA) will (should) show this through depreciation charges.

Regarding the fourth question, you can say that if a company grows at a higher rate than the overall economy infinitely it would eventually become bigger than the economy. For example, if you assumed Apple to grow infinitely at 5% and the US economy to grow at 2% it would be bigger than the US economy in approx. 115 years (6381.05^115 > 17,5551.02^115). Thus, you should aim to forecast to a period where the long-term growth rate isn't (much) higher than growth for the overall economy(ies) that the company is operating in.

There are no "correct" answers to these questions. Just apply valuation concepts appropriately and discuss what considerations are relevant in the questions.

1. Depends on a lot of factors. What is the capital structure? What is the operating leverage? What are the capex requirements? Net income is not free cash flow. If both companies have substantial capex requirements, the company at 5% net income margins may not generate any free cash flow at all. Is this even a good industry to be in? Even if A or B is cheap relative to the other one, are they trading at a discount to intrinsic value? Even if they are trading at a discount to intrinsic value, are there other investments that generate higher risk adjusted returns?

2. The reason why companies trade at different multiples generally falls into one of these categories or a combination of them - growth, risk, taxes, artificial accounting treatment (can be adjusted for), or misvaluation (could be for a variety of reasons).

3. Multiples are bad because they do not reflect the cash flow generation of companies. If everything below ebitda to FCF is similar for companies - similar taxes, d&a, capex, nwc, etc. - then ebitda can potentially be useful. For companies that have different capex requirements, which will eventually be reflected in D&A, then EBIT can potentially be more useful.

4. Growth rate should reflect sustainable long term growth rate - long term GDP or inflation. If your company grows faster than the economy in perpetuity, eventually it will take over the whole economy.

Could someone explain this (UBS valuation multiples page 13)?

Example: With perfect foresight, what multiple could you have paid for Microsoft in 1990 and still have received a fair return on your investment?

Ex post, we estimate that you could have paid an EV/sales multiple of 42x in 1990.

The calculation is simple: we assume a cost of equity of 14.5% based on the tenyear Treasury note rate at that time of 9.5% plus a 5% equity risk premium, and discount back today’s price (adjusted for cumulative dividends) at that rate to 1990, giving us a ‘fair’ price curve. That is, the ‘fair’ share price at the end of each year equals the previous year’s share price × 1.145. We then divide sales for each period by the ‘fair’ price at the end of that period to get a fair EV/sales multiple. An investor with perfect foresight could have paid 42x sales, more than eight times the price at that time, and received an average 14.5% return through today. (The fortunate investor who bought in 1990 and held received a 44% compound return.)

You basically discount today's share price with the cost of equity (equity risk premium would be calculated separately, depending on the risks involved in the company). Then you get the share price in the beginning (1990). What I don't get is how you come up with the 42x? I know that we don't have the actual numbers but how would you calculate that? "We then divide sales for each period by the ‘fair’ price at the end of that period to get a fair EV/sales multiple." --> Don't get that part You take the share price in 1990 and sales of that period in order to see how much higher sales is compared to the discounted share price?

Not sure if it's been mentioned but Damodaran on valuation covers your questions and is more in depth theory than Rosenbaum

The book is far more in depth than the site and more than you need for interviews. It doesn't have questions as such but I found the examples really helpful. I'd get if you're after theoretical knowledge to answer questions but if you just want to practice questions I wouldn't bother.