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Terminal Value Perpetual Growth Beta: Size of The Market
Terminal Value Perpetual Growth Beta: Size of The Market
1) The terminal value represents a disproportionately large amount of the value of the total business, and the
assumptions used to calculate the terminal value (perpetual growth or exit multiple) are very sensitive.
2) Another issue is that the discount rate used to calculate net present value is very sensitive to changes in
assumptions about the beta, risk premium, etc.
3) Finally, the entire forecast for the business is based on operating assumptions that are nearly impossible to
precisely pin down.
1) Synergies = Synergies enable the acquiring company to realize value by enhancing revenue or reducing
operating costs
2) The form of consideration (cash vs shares)= The mix of cash vs share consideration can have a major
impact on accretion/dilution of per share metrics (such as EPS). To make a deal more accretive, the
acquirer can add more cash to the mix and issue fewer shares.
3) Purchase price and takeover premium.
What indicators would quickly tell you if an M&A deal is accretive or dilutive?
The quickest way to tell if a deal between two public companies would be accretive is to compare their P/E
multiples. The company with a higher P/E multiple can acquire lesser valued companies on an accretive basis
(assuming the takeover premium is not too high). Another important factor is the form of consideration and mix of
cash vs share.
1) The total leverage the business can service (typically based on the debt/EBITDA ratio)
2) The cost of debt
3) The acquisition or exit multiple assumptions. In addition, operating assumptions for the business play a
major role as well.
Given two companies (A and B), how would you determine which one to invest it?
Business model – how they generate money, how the company works
Market share/Size of the market – how defensible is it, opportunities for growth
Margins & cost structure – fixed vs. variable costs, operating leverage and future opportunity
Capital requirements – sustaining vs. growth CapEx, additional funding required
Operating efficiency – analyzing ratios such as inventory turnover, working capital management, etc.
Risk – assessing the riskiness of the business across as many variables as possible
Customer satisfaction – understanding how customers regard the business
Management team – how good is the team at leading people, managing the business, etc.
Culture – how healthy is the culture and how conducive to success
All of the above criteria need be assessed in three ways: how they are in (1) the past, (2) the near-term future and (3)
the long-term future. This will be the basis of a DCF model (which will have multiple operating scenarios), and the
risk-adjusted NPV for each business can be compared against the price the business might be purchased at.
What do you know about us and why do you want to work at our firm?
Have a solid understanding of the firm’s approach to investing, their track record, who the founders and
management team are, and most important, what you like about their approach.
Business model
Management team
The transaction the PE firm acquired them in
The industry they operate in
Their competitors
Whatever else you can find out about them
How do you manage risk in your personal life? How do you get to free cash fl ow? Walk me through an LBO that you
worked on. How would you model it? They grilled me on my deals, asking if I thought they were good ones — basically
anything on my resume was fair game.
Accretion and Dilution refer to a simple test that determines the impact of an acquisition or
merger on the buying firm’s Earnings per Share (EPS). Accretion Dilution analysis helps the
acquirer (buyer) weight the consequences of the merger, incorporating all factors and
complexities.
Accretion
An accretive acquisition or merger is one where the pro forma (post-deal) Earnings per Share is
greater than the acquirer’s (buyers) EPS before the deal is made.
Dilution
A dilutive acquisition or merger is one where the pro forma (post-deal) EPS is less than the EPS
of the acquiring business when it stands alone/ before the deal is made.
Value Added is the extra value created over and above the original value of something. It can
apply to products, services, companies, management, and other areas of business. In other
words, value-added is the enhancement made by a company/individual to a product or service
before offering it to the end customer.
Economic Value-Add is used to measure the value that a company generates from the funds
invested into it.
Where:
NOPAT – Net Operating Profit After Tax is the profit generated by a company through
its operations after adjusting for cash taxes but before adjusting for financing costs and
noncash costs.
CE – Capital Employed is the amount of cash that is invested in the business.
WACC – Weighted Average Cost of Capital is the minimum rate of return expected by
the provider of capital, that is, the investors of the business.
EVA helps to quantify the cost of investing capital into a project. It also helps to assess whether
the project is generating enough cash to be considered a good investment. EVA indicates the
performance of a company on the basis of where and how the company created wealth.
Customer’s perspective – To understand what customers from the target market want
from the product or service of the company. Doing business according to customers’
expectations is something that many businesses miss out or fall short on.
Improving customer satisfaction – To get the customer’s feedback through surveys
about the product or service, and then continue working to enhance customer satisfaction
delivered through the product or service.
Customer experience – To provide customers with not only a satisfactory product or
service but also with satisfactory after-sales services to create a memorable experience
for the customer.
Marketing – To implement a marketing strategy after well-informed market
research about what customers expect and what is the best way to make the product or
service available to customers.