Need Help with Finance Questions!

morgan90's picture
Rank: Monkey | 57

Questions:

  1. What are the impacts on earnings if a company builds a new factory using debt? operating lease? capital lease? cash?
  2. When would you take a project with a negative NPV?
  3. How would you value a company without earnings, i.e., tech stocks?
  4. How do you go about determining how much products we're going to sell each year? (imagine a company like Apple)
  5. Suppose that you constructed a pro forma balance sheet for a company and the estimate for external funding required was negative. How would you interpret this result?
  6. How will a decrease in financial leverage affect a company's cost of equity capital, if at all? How will it affect a company's equity beta?

I am not an expert with accounting to begin with so these 2 questions are quite a problem to me, especially the second one since I thought we should only undertake projects that have a positive NPV?

Thanks

Comments (12)

Feb 23, 2012

Answer #1. Debt: Earnings are not impacted by debt immediately when the purchase is made. Debt effects are seen later with interest payments which will reduce earnings by the expense(1-tax rate). Then the Depreciation from the factory later on
Cash: Cash has essentially no effect on earnings whatsoever. One can argue that a company is losing the interest gained from holding cash but otherwise there is no effect. Obviously the Depreciation of the building again must be accounted for later on.
Operating Lease: Operating leases act as businesses expenses so reduce earnings by the lease expense
(1-tax rate) but do not include depreciation expense later on
Capital Leases: The only expense for capital lease is the depreciation expense

Feb 23, 2012
U Accrete Me:

Answer #1. Debt: Earnings are not impacted by debt immediately when the purchase is made. Debt effects are seen later with interest payments which will reduce earnings by the expense(1-tax rate). Then the Depreciation from the factory later on
Cash: Cash has essentially no effect on earnings whatsoever. One can argue that a company is losing the interest gained from holding cash but otherwise there is no effect. Obviously the Depreciation of the building again must be accounted for later on.
Operating Lease: Operating leases act as businesses expenses so reduce earnings by the lease expense
(1-tax rate) but do not include depreciation expense later on
Capital Leases: The only expense for capital lease is the depreciation expense

For the depreciation expense, do you also multiply them with (1-tax rate) too?

Feb 23, 2012

2) When choosing whether to replace machinery for example, ie. selecting whether or not replacing an old machine that has high annual costs with a newer one with lower annual costs

Feb 23, 2012

Just to clarify on 1. You can't "build" a new factory with an operating lease, you could contract out the building with solid legals, then lease it back, or lease it under a head lease and then lease it on. But at no point would the factory be yours. For it to, kinda be yours, you would need to project finance it, set up an SPV, that you 100% own, and have the aforementioned lease structure. But it wouldn't be a very bankable solution unless you were a huge corporation and found a very reputable contractor (the usual structure is to have the contractor or EPC contractor have skin in the game).

Capital lease = mortgage = debt treatment

  1. multiples (e.g. EV/Sales)
Feb 23, 2012
Oreos:

Just to clarify on 1. You can't "build" a new factory with an operating lease, you could contract out the building with solid legals, then lease it back, or lease it under a head lease and then lease it on. But at no point would the factory be yours. For it to, kinda be yours, you would need to project finance it, set up an SPV, that you 100% own, and have the aforementioned lease structure. But it wouldn't be a very bankable solution unless you were a huge corporation and found a very reputable contractor (the usual structure is to have the contractor or EPC contractor have skin in the game).

Capital lease = mortgage = debt treatment

  1. multiples (e.g. EV/Sales)

I suppose you have to use multiples. But what would be the right multiple to use? I don't think we can use multiples like EV/EBITDA or anything like that since it has no earnings

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Feb 23, 2012

Learned #3 from WSO.. You value the company by the sum of its parts or even its subscriber base.

Feb 23, 2012

Lol, I had my exam over this last night. Brutal.

Feb 23, 2012

As a response to the updated list of Qs, this is basic stuff, read some more and all these questions will become very clear to you.

Feb 23, 2012

4 and similar questions are typical market sizing problems. Do a Google search for tactics. Alteratively, get Michael Cosentino's Case in Point -- it's the de facto interview prep book for consultants but I find that financiers can get quite a bit of use from it too.

Currently: future psychiatrist (med school =P)
Previously: investor relations (top consulting firm), M&A consulting (Big 4), M&A banking (MM)

Feb 23, 2012
  1. The company is generating additional earnings that can be invested somewhere else (pay down liabilities, increase assets more, etc).
  2. A decrease in leverage will reduce a company's equity cost of capital and its beta. The company is now less risk so equity investors demand less premium.
Feb 24, 2012
Boothorbust:

5. The company is generating additional earnings that can be invested somewhere else (pay down liabilities, increase assets more, etc).
6. A decrease in leverage will reduce a company's equity cost of capital and its beta. The company is now less risk so equity investors demand less premium.

Hi, Boothorbust! Would you care to explain the answers more? Thank you

Feb 24, 2012
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