Comps Test Questions
Hey folks, I've been working through materials for recruiting prep and had a couple questions. Would love some help if anyone knows how to answer these:
1) Which of the following statements is most correct about building a comparable company analysis?
A) Using the peer group's average multiple is preferable to using the peer group's median multiple when you suspect significant outliers.
B) When EBITDA forecasts are available, share price valuation using EV/next year EBITDA is always preferable to valuation using EV/LTM EBITDA.
C) Valuing the share price of a company based on the P/E of its peers is not as useful as valuing based on the EV/EBITDA of its peers when the target and peer group have widely differing leverage.
2) Two businesses both have the same Enterprise value, EBITDA, and the same EBITDA growth expectations. Company A is more capital intensive than Company B, requiring more reinvestment to achieve the forecast growth rate. They are otherwise identical. Based on this information, which of the following statements is correct:
A) Company A is undervalued relative to Company B
B) Company B is undervalued relative to Company A
C) Company A will have a lower EBIT multiple than Company B
D) Company A & B are properly valued relative to one another on an EV/EBITDA basis
3) LongCo and ShortCo are two companies that are identical in every way, except that LongCo's management ascribes longer useful life estimates for its assets than ShortCo's. Assume this decision has no effect on the taxes either company pays (i.e. they pay the same tax), and assume the market is valuing LongCo and ShortCo correctly. Which of the following statements is correct?
A) EV/EBIT is a preferable multiple to P/E for comparing these two companies.
B) Both companies will have identical P/E multiples.
C) LongCo will show a higher EV/BIT multiple than ShortCo.
D) Both companies will have identical EV/EBIT multiples.
E) EV/EBITDA is a preferable multiple to EV/BIT for comparing these two companies.
Question 1
a) Incorrect; median multiples are preferred in most instances. We tend to look at different quartiles.
b) Incorrect; yes and no, the market usually trades on forward multiples, but this generally depends on the peer set (e.g., if some of peers have a in-process development projects or growth levers reflected in next year’s estimates, which can throw off your forecast). We tend to look at all multiples available and go from there
c) Correct; P/E multiple is impacted by capital structure / financing decisions. EV/EBITDA is not (see my response to your previous post)
Question 2
a) Incorrect; can’t say for sure without detail on cap structure, financial / business risk. All we know is that EV and EBITDA are the same, but they could have completely different risk profiles for all I know
b) Incorrect; same as “a)”
c) Incorrect; multiple will be higher as EBIT will be lower due to higher D&A
d) Correct
Question 3
a) Incorrect; they are both equally useless due to the impact of D&A, in fact, if we assume that taxes are the same both multiples will be exactly the same in a relative basis (e.g. % change between each company’s P/E and EV/EBIT multiple will be exactly the same)
b) Incorrect; ShortCo will have a lower NI and a higher P/E
c) Incorrect; ShortCo will have a lower EBIT and a higher EV/EBIT multiple
d) Incorrect; see “c)”
e) Correct; ideal multiple would strip D&A and EV/EBITDA does just that
Think you are wrong on question 2.The question says "based on this information…" so, considering only the information provided in the question: if you have 2 companies with same EV, EBITDA, multiple and growth profile but one has significantly higher capex, then the the less capital intensive one is clearly undervalued relative to the other.
Also, thinking about your reasoning, EV/EBITDA should be capital structure neutral and financial / business risk would be reflected in the companies’ growth expectations (obviously assuming we believe them, but that’s the point of the question).
Agreed. However, we are told they have the same financial metrics, not that they are operationally identical. Reason I brought up the idea of cap structure and risk is b/c of WACC. Perhaps, the more capital intensive company has a lower WACC due to its operating environment. Reinvestment rate doesn’t tell me anything in terms of relative valuation unless we assume both companies are identical, which I am inclined to assume, though not explicitly told in the question. This seems more like a tricky business finance exam question than anything else.
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