hey i got these questions for investment banking interviews, what are the answers? thanks.
1) Compare coca-cola and a shipbuilding company, which one has lower EV/ebitda?
2) You have company with the following: 100 EBIT, 20% tax, 40 capex, 15 depreciation, 10 change in WC. Currently the projection model is for 5 years out. Why is that not sufficient?
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not sure about 1 2 - i would say that since capex is so much greater than depreciation the company is in a hypergrowth stage and thus you need to project through the hypergrowth phase into a more stable growth pattern, requiring more than 5 years projections.
Depr expense is based on historical cost and the life of the asset. Could be the company invested in long-lived assets at first (as many start-ups do) and then used capex to buy adv equipment and the like (shorter life span). Could also be the case that major assets have already been fully depreciated. Could also be that the company is using some sort of accelerated depreciation schedule. Comparing capex to depreciation without any other info is an apples/oranges comparison. Ratio of capex to EBIT or EBITDA could be an indication of hyper growth or just being in a capital intensive industry. But I agree with what's been said above...questions like these are just to see how u think about the problem and how well you can speculate on a situation without looking at a B/S.
For 1, I would say the shipbuilding company has the lower ratio, simply because coca-cola, being so well established, considered premium and thus expensively priced would lead to a comparatively high TEV (market cap) and high valuation ratio in general.
ps in college and happy to be corrected
1) that's tough. my best guess is that coke's would be higher because of emerging market growth opportunities vs. stagnant growth in the industrial space. 2)not sufficient for what? what are you trying to get to? if you just want free cash flow then it is sufficient. if you are trying to come up with a stock valuation, you will need a growth rate (1st 5 yrs and perpetual), a discount rate, and the market/book value (depending upon who you ask) of the debt.
edit: but then again, pretty much every industry except prostitution has emerging market growth opps so my answer for number 1 is stupid.
1) A shipbuilding company, by nature, should have a lot of debt on their balance sheet. This is mainly because of the low turnover of their expensive product. For that reason, all other things being equal, I would say that the shipbuilding company would have a higher EV/EBITDA because its EV will be heavily weighted by its debt.
just wondering, why does debt matter in this case? we're looking at EV as a whole, so assuming EV is the same between the two companies, the weight of debt wouldn't matter right?
Or are you assuming that equity is equal between the two companies, and shipbuilding has additional debt (or more debt than coke) added on, resulting in a higher EV? that would make more sense to me.
thanks dude.
assuming EV is the same between the two companies defeats the point of calculating the ratio - debt, as one of the constituents, can influence the EV, although whether debt is part of the right answer I can't say.
^^ makes sense. i guess ships are like real estate developments floating on the water. i doubt they would expect him to have this kind of industry knowledge though. therefore, this might not be the answer they are looking for.
Its just about the thought process. Regardless of what your answer is, it should be based on fundamental facts and you should explain it. Don't ever base your answer on a hunch or anything else unsupported.
1) Coca-Cola has a lot of intangibles and lesser depreciable assets on its B/S as compared to a shipping company therefore shiiping co's EV/EBITDA will b lower?
2) same argument as given by dacarez in his post above.
does it make sense to say for number 1:
Since shipbuilding requires much larger capex than coca cola, thus depreciation will be also be much higher than coca cola. Assuming net income is same, higher depreciation means higher ebitda to arrive at the same net income. therefore EV/ebitda is lower for the shipbuilding company.
I also like murdersnexecutions answer regarding a higher premium for cocacola due to brand...however is that technical enough?
Either way can you guys confirm that EV/ebitda is lower for shipbuilding?
For number 1 I would have to agree with Optimist because the shipping company well have more fixed assets to depreciation than coca cola.
The answer is that Shipbulilding or Shipping in general is a highly capital intensive business.
Hence, EV will be much higher for the shipper.
Yes, more capex means higher depreciation --> BUT this is a tax deductible expense. So you get to writeoff 35% of the depreciation expense. Without more info (marginal tax rates, depreciation schedules) then I would not make any judgement comparing the EBITDA's. What if the shipbuilder's factories are 20 years old? Then the depreciation expense is probably zero. Timing matters for the shipper or shipbuilder, whereas it does not for Coke.
?
I just assumed EBITA was a typo because all the comments were referring to EBITDA. Aceman also mentioned it as EBITDA on one of the comments
1) I would say coke has lower ratio. I am assuming coke has lower depreciation (I think in the consolidated statements, they would include depreciation from the bottling company, so there would still be a good amount, but again I am just assuming it is lower than a ship building company). EBITDA - D = EBITA. For coke, you would be subtracting a lower D,so EBITA would be relatively higher, so a lower ratio for coke.
2) currently, it is clear that the company is still growing aggressively, since CapEx is almost 3x depreciation (implying that they are not simply buying new PPE to replace the depreciation PPE). Assuming this trend is projected through the 5th year, the company would not be in a steady state of growth, which is an underlying assumption when you hit terminal value
EDIT: well if EBITA is a typo, then scratch my response for #1.
Thank folks. edited first post to say EBITDA.
for question one, is there really no right answer? based on the way the question is phrased I would think there's a right answer, i mean coke and shipbuilding are very different companies and one must logically have a lower EV/ebitda right?
I guess for question 2, we all generally agree its because the company is still growing due to the high level of capex vs depreciation right?
I agree with the shipbuilding company having a higher EV/EBITDA because the business is a lot more capital intensive and the company probably has more debt on its bs.
Another point (feel free to correct me), because of the low turnover, the shipbuilding company would have a higher EV/EBITDA since Coca-Cola is an established brand and doesn't have that much room to grow (relatively low risk). However, if the ship company announces it's building a new boat, it would probably contribute a lot more to growth expectations than if Coca-Cola were to announce say a new soft drink.
1) The right answer to this question for an interview is anything that shows you understand what drives trading multiples. Growth prospects, a brand-name premium, state of industry cycles, cash flow conversion from EBITDA, financial risk, etc. are all things to think about. Capital structure does not necessarily have a direct correlation. For example Ford has a lot of debt on its b/s whereas Apple has none. However I'd be willing to bet that Apple trades at a higher EBITDA multiple than Ford. The real question to answer is: how valuable is a dollar of EBITDA to investors?
2) PSS243 did a good job explaining this. The business seems to be investing money beyond regular replacement/maintenance capex so EBIT should potentially grow in the future. Also when you estimate a terminal value your assumptions should be reasonable into perpetuity. Capex and depreciation should converge.
Higher EV/EBITDA for shipbuilder? Why would you pay a higher EBITDA multiple for a business with:
If anyone ever asks you "which business has the higher multiple" question, pick the business with:
Keep it simple. Enterprise value is the present value of future free cash flow less net cash. If you ran a DCF using the return/growth profile of Coke versus a shipbuilder, Coke will have the much higher EV.
Hi,
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Guys,
The answer to the 2nd question is the D&A vs capex issue (as most of you have noted). Regardless of what's going on to cause the difference between capex/D&A, you need to know if that difference will last forever or not (for most businesses, probably not). Also, the 20% tax rate looks like it might be low (if it's a US company, anyway). Is that sustainable forever? Are they burning through NOLs or other tax credits that will eventually go away and their tax rate will go up?
Please refer to MPM's answer for the 1st question. The value of an asset (i.e., TEV for a company) is the value of it's discounted future cash flows (important to note that it's cash flow, not EBITDA). I will try to add a few things, but please be warned that this may not be articulate or concise.
Coke is essentially selling sugar water yet they can charge a premium price for it. They can do this because of their strong brand name (i.e., their big intangible asset which doesn't require capital investment to maintain). They don't have to invest much capital to generate EBITDA. The generic shipbuilder, meanwhile, has to invest lots of capital (i.e., spend capex) to generate EBITDA. Thus, for a given amount of EBITDA, Coke's free cash flow is higher (more free cash flow = more TEV, all else being equal). Looking at Coke's EBITDA vs their invested capital (i.e., their cumulative Capex...approxmiately), their return on capital is higher.
Think of the valuation in terms of a multiple of FCF, instead of EBITDA (again, asset value/TEV is based on discounted FCF, not EBITDA). The FCF multiple incorporates the growth rate and discount rate of the cash flows (If you use an EBITDA multiple, that multiple also incorporates an assumption for the company's EBITDA to FCF conversion rate). Assume Coke and ShipCo each make 100M of FCF. Now assume for the sake of the example that they have the same discount rate (i.e., same risk for their cash flows) and the same expected free cash flow growth rate. It follows that they will each have the same FCF multiple. Let's say that this multiple is 10x. So 10 * 100 = 1,000 in TEV. For simplicity, assume that both companies have 0 taxes and 0 change in WC, so FCF = EBITDA - Capex. Now assume that Coke pays 10M in capex and ShipCo pays 50M. Coke's EBITDA = 100 FCF + 10 capex = 110. ShipCo's EBITDA = 100 FCF + 50 Capex = 150. Coke's EBITDA multiple = 1,000 TEV / 110 EBITDA = 9.1x. ShipCo's EBITDA multiple = 1,000 TEV / 150 EBITDA = 6.7x. All else assumed to be equal, Coke has the higher EBITDA multiple because its EBITDA to FCF conversion is better (i.e., it has less capex / is less capital intensive / has a higher ROIC).
Shipbuilding is riskier so it gets a higher discount rate. All else equal, a higher discount rates results in a lower TEV results in a lower TEV multiple. Shipbuilding is cyclical so its cash flows are more volatile and more risky (Coke is a consumer staple and not as cyclical). It's also more capital intensive (as discussed before) which increases risk. Say the economy is hot and ShipCo spends a bunch of cash to build capacity for more ships (i.e., invests in more plant and equipment). Then the economic cycle turns, a recession hits, and nobody wants to buy new ships. ShipCo had to spend a ton of cash to build plants and now they are not generating revenue and they still have to spend a lot of maintenance capex on all their fixed assets. They are eff'd (and they probably issued debt to get cash to pay for the increase in PP&E, so they are doubly eff'd because now they need to pay off interest and debt amortization).
Growth rate. All else equal, a higher growth rate equals higher TEV and higher TEV multiple. As for which company will grow faster, a generic shipbuilder vs Coke, I have no idea, so this would not figure into my answer to the interview question. Coke can expand sales into emerging markets which should grow relatively fast, but most of their sales will still be in slower growth developed markets. The shipbuilder can sell to China too. Maybe all of their ships are sold to China...who knows. In that case, the shipbuilder would grow faster (but I would give them a big eff'ing discount rate).
do you work at piper jaffray? I see where you are coming from, but your out of scope.
Care to elaborate?
1) Shipbuilder has lower multiple. More capital intensive business, means higher depreciation expense, which means larger EBITDA, all else equal. This will reduce the EV/EBITDA multiple.
2) It's been covered, but Capex can't exceed Depreciation in the long run.
Dude jankynoname are u an idiot, EBITDA= before depreciation its not just earnings
EV= Enterprise Value not equity value. Instead of just glancing over the answers, maybe try to be more detail oriented.
Otherwise you will not even break banking ever in your life. Go and be a mcdonalds worker.
Anyways #1: Depends how you answer, but probably Shipping since it carries so much debt
Hi
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if a company is loaded up with debt, won't that be reflected in the market price of its equity?
also, EBITDA is before depreciation (hopefully that isn't actually confusing to anyone). I imagine the margins for Coca-Cola are much slimmer than a shipbuilding company.
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