How to value a company. How to evaluate investment decisions. What’s the optimal way to finance those investments—through debt or equity? Corporate Finance studies all these questions.
A negative sum of discounted FCFF is rare. Usually, forecasts are positive and on top of that, there’s the terminal value. A negative forecasted cash flow in some years of your projection window shouldn’t stop you from using the DCF…
Equity beta is the overall business risk of the company, including both operational and financial risk. Asset beta on the other hand, excludes the effects of leverage on the capital structure, thus assuming the business is funded by equity only.…
You’re calculating the unlevered beta of a company and need the debt beta, but don’t know how to find it? Then this is for you. You can extract the implied debt beta from the CAPM formula by equating the formula…
Asset-intensive industries are industries that require big investments in fixed assets such as property, plant, and equipment (PP&E) to produce the goods or services they sell. Companies will have a high assets-to-sales ratio. Depreciation has a big impact on the…
The present value index tells you how promising an investment project is. You calculate it by dividing the present value of a project’s future expected cash flows by its initial investment cost. The higher the result the better. Financial analysts…
The difference is MOIC takes into account the value of both realized and unrealized gains and compares it to the invested capital. Thus, it is a gross measure of return that doesn’t take into account fund fees. Meanwhile, DPI compares…
RVPI in private equity compares the estimated remaining fair value of the fund’s investments that have not yet been exited, to all the capital the fund has received from investors. It gives you perspective on the performance of the fund’s…
Both TVPI and DPI are widely used in private equity to evaluate fund performance. TVPI compares the total value of a private equity fund (realized and unrealized gains and losses) to the capital the fund has received from its investors.…
The key difference between MOIC and ROIC is in the purpose of each metric. MOIC is mostly used in private equity to assess fund performance. In contrast, analysts use ROIC to evaluate how well a company allocates money from its…
To calculate the WACC you need the cost of equity, cost of debt, the proportions of equity and debt in the total value of the company, and the corporate tax rate. But what if you’re given the debt-to-equity ratio only,…
Working capital items such as accounts receivable, inventory, and accounts payable don’t go directly to the cash flow statement. However, the variation in the value of these items from the previous year to the current one is indeed included in…
Both paid-in capital and invested capital are used in private equity. Paid-in capital is the cumulative amount of committed capital that has been drawn down. In other words, the money that limited partners have actually transferred to the fund. On…
The cost of equity is the return equity investors demand in order to be willing to risk their money in the company. The Return on Equity is the profitability of that money. When the cost of equity is lower than…
It depends. If you want to evaluate the company’s ability to meet short-term obligations, you calculate working capital as the difference between total current assets and current liabilities. Current assets include cash and cash equivalents. If you want to compute…
Excess cash is cash balance beyond what a business requires to fulfill its daily operational money needs. Usually, analysts consider 2% of the revenues of a company as the cash it really needs to function properly. Thus, the remaining cash…
If you, as a shareholder, choose to do nothing or not subscribe to a rights issue, the company sells them in the market, and you receive the net proceeds. Your existing shareholdings will be worth less money (at least in…
Working cash is the cash balance a company has on hand to cover its day-to-day expenses and cash needs. In contrast, excess cash and marketable securities are non-operating assets the company does not employ in its business (having or not…
Yes. Private companies pay dividends either from net income, retained earnings, or newly issued debt, just like public companies do. The only significant difference is more regulation in public companies. That’s the gist of it. For a more comprehensive look…
Both TVPI and MOIC measure fund performance using the total value (realized plus unrealized) of private equity investments. The difference is in the denominator. MOIC divides the total value of the investment or fund by the total invested capital, whereas…
When a company goes public, its existing shareholders will see their shares lose controlling power in the company. However, this equity dilution only happens when the company issues new shares to raise capital. If the shares sold to the public…
If a SPAC fails to merge with a target company within the specified time frame (typically 2 years), it is liquidated and the funds raised in its IPO are returned. This means investors get their money back—minus any fees or…
Real options increase the expected returns of an investment opportunity by allowing adjustments to the investment strategy in response to changing market conditions or new information. In other words, having more flexibility in investment and disinvestment increases the value of…
Depreciation should not exceed capital expenditures in the terminal year of a DCF model unless you want to assume the value of the company’s assets will go to zero. When estimating the Enterprise Value of a firm through a DCF…
If maintenance/repair costs are capitalized into a fixed asset, inflation results in an increase in depreciation. Still confused? Keep reading for a more comprehensive answer: Depreciation is the non-cash expense that accounts for the decline in value of an asset…
Return on Invested Capital. Return on Investment. Wondering how the hell are these two things different? Then this is for you. The ROIC measures how efficiently a company employs the capital it received from its investors (both equity and debt…
The difference between the Return on Invested Capital and the Return on Equity is that the ROIC measures how effective is the company’s employment of all sources of capital at increasing the operating income, while the ROE compares the capital…
A price to book below 1 indicates the stock is undervalued. It means the market values the company below its accounting net worth. This could be an investment opportunity, or a sign the business lacks future growth opportunities. Here’s a…
Here’s a table showing you the equivalent ratings between the big three credit rating agencies: S&P Moody’s Fitch AAA Aaa AAA AA+ Aa1 AA+ AA Aa2 AA AA- Aa3 AA- A+ A1 A+ A A2 A A- A3 A- BBB+…
To calculate the cost of equity using the CAPM, you need the beta of the company. The problem is that beta is a volatility measure based on the stock market. What if the company you’re evaluating isn’t publicly traded? The…
The fundamental difference between ROIC and ROA lies in the difference between invested capital and total assets. The Return on Invested Capital compares operating income to money shareholders and lenders have put into the company, which tells you its ability…
No. Invested capital is the sum of the book value of equity and the debt that pays interest to investors minus the non-operating assets. Total assets on the other hand, is the sum of total equity and total liabilities. Want…
Welcome. In this article, we’ll look at three examples of real options valuation in capital budgeting. You’ll learn how to compute the value of three different types of real options, no matter if they’re American or European-style options, using both…
The expanded net present value (ENPV) is the total value of a project, including the value of being able to adapt to new market conditions. It is equal to the NPV of the investment plus the value of real options.…
The most common way to forecast capital expenditures (CapEx) in a discounted cash flow (DCF) analysis is to get the historical average CapEx as a percentage of revenue and use that to calculate its future value as a function of…
The revenue multiple is better when you’re dealing with young companies that are not profitable yet, companies that are sensitive to market cycles, or that are in industries with an established profit margin. The EBITDA multiple is better to capture…
When the IRR (Internal Rate of Return) is greater than the WACC (Weighted Average Cost of Capital), it means the investment’s rate of return covers the costs of financing it. Therefore, the project should be accepted. For a deeper understanding…
Asset transformation can be described as the process through which banks transform customers’ deposits into loans for borrowers. This is how banks make most of their money. It is the bread and butter of the banking business model. However, to…
Multiple on Invested Capital (MOIC) is a return metric commonly used in private equity to track fund performance. It is calculated by dividing realized value and unrealized value by the amount invested. Still confused? Keep reading. We’ll start by diving…
No. Stock prices and dividend payments are not connected directly. However, if the dividend stays the same and the stock price goes down, the dividend yield goes up. This does not mean the company changed its dividend policy. That’s the…
A negative debt-to-equity ratio means the company is in financial distress. Why? Because it implies shareholders’ equity is negative as well, which means total liabilities exceed total assets. This is bad, as it indicates the company’s net worth is negative.…
The gross IRR tells you the rate of return you can expect from an investment, before taking into account the costs the investment fund charges you, as an investor, such as management and performance fees. The net IRR takes these…
Equity financing is more expensive than debt financing because as a shareholder you partake in more risk than a bondholder. Because of this, shareholders want to receive higher returns to compensate for the additional risk they take. Now, you may…
Capital budgeting decisions are generally based on a company’s long-term investment plans and objectives. Have you ever wondered how businesses decide which investments to make? The process of evaluating and choosing long-term investment options is called capital budgeting. In this…
The advantages of a stock split are: The disadvantages of a stock split: Wanna know more? In this post I explain stock split and its pros and cons: What is Stock Split A stock split happens when a company issues…
As an investor, student, or financial analyst, you may have come across the terms CAPM and WACC. If you think they are similar, you are mistaken, as they are quite different. However, despite having distinct applications in the world of…
Net Present Value (NPV) is negative when the present value of a project’s benefits is lower than the present value of its costs. Generally, a project is considered acceptable if its net present value is positive. Taking on a negative…
Both WACC and APV help you get the present value of a project or asset that will generate future cash flows. The difference between APV and WACC is that APV incorporates the value of the interest tax shield generated from…
If you’re calculating a firm’s free cash flow to figure out its valuation, you may be wondering why changes in working capital are a cash flow. An increase in net working capital means a cash outflow because it indicates the…
Earnings before interest, taxes, depreciation, and amortization (EBITDA), and revenue are key metrics of profitability and health of a business. Both indicate financial performance, but the main difference is that revenue tells you how much the company sells in total,…
Net working capital (NWC) is the difference between current assets and current liabilities in a company’s balance sheet. When the value of the current liabilities exceeds the value of the current assets, the company has a negative net working capital.…