Basic technicals
Hey, I have a few questions that I'm sure many of you will find incredibly easy. Being an econ major with no background in finance and accounting, i'm trying to gain an intuitive understanding of the basic stuff that goes a bit beyond the vault guide.
1. When would one use each of the different valuation methods. Obviously, market comps are for public firms while others can be used to project the value of private companies, but are there some basic guidelines?
2. Beyond the APV and WACC discount rate, can you tell me more about the FTE method for DCFs
3. Beyond the Income statement, would one find depreciation on the cash flow statement? What is the logic behind depreciation as something that adds to cash flow?
Is there anywhere on the internet where i can find this stuff out?
Thanks a ton....
Yeah sure,
1. I'm pretty sure most banks will use both DCF and Comp valuations in the analysis of every transaction they want to be a
part of; and when I say analysis, I should say arithmetic because that's all the analysis is.....arithmetic (+ - / *).
2. What's FTE? Nobody uses that.
3. Depreciation is found on all the financial statements. A good way to think of depreciation is as phantom cash going out.
It's a negative item on the income statement, implying a reduction in value; it's really just a way to limit tax liability. Add
it back to net income when figuring cash flows because depreciation is a negative number that has nothing to do with value
leaving the asset.
I know this is really basic, and I am can't believe I can't wrap my brain around it, but I struggled through this one in an interview, and have another coming up and don't want to screw it up again... So here was the question.
You are working with your accountant and he has decided to depreciate a $1000 item over 5 years, straight line, no salvage value. However, you decide that you want to depreciate it over 4 years rather than 5. The tax rate is 30%. What effect does this adjustment have on each of the three financial statements?
If someone could clear this up for me it would be great, I got all confused with the taxes and figuring out and what the exact numbers would be... Thanks so much.
I think this is it -
net change in amount of depreciation would be $50 for the year.
On the income statement: this would decrease operating income by $50. With the tax rate of 30%, net income will decline by $35.
On the cash flow statement: Net income decreased $35 and depreciation increased $50, so cash flow from operations increases by $15.
On the balance sheet: Cum. depreciation increases $50, so Net PP&E decreases $50. Cash increases by $15, and Retained Earnings decreases by $35 (from the change in NI on the Cash Flow Statement). Overall, assets decrease $35 (net of Cash and PP&E) and Shareholder Equity decreases $35 (Retained Earnings), so it balances.
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