Investment Banking interview questions technical
Probably the most common valuation metric used in banking is Enterprise Value (EV)/EBITDA. Some others include EV/Sales, EV/EBIT, Price to Earnings (P/E) and Price to Book Value (P/BV).
The best way to answer this question is to say that you calculate a valuation range for each of the three methodologies and then “triangulate” the three ranges to conclude a valuation range for the company or asset being valued. You may also put more weight on one or two of the methodologies if you think that they give you a more accurate valuation. For example, if you have good comps and good precedent transactions but have little faith in your projections, then you will likely rely more on the Comparable Company and Precedent Transaction analyses than on your DCF.
Other valuation methodologies include leverage buyout (LBO) analysis, replacement value and liquidation value.
Firstly, the Precedent Transactions methodology is likely to give a higher valuation than the Comparable Company methodology. This is because when companies are purchased, the target’s shareholders are typically paid a price that is higher than the target’s current stock price. Technically speaking, the purchase price includes a “control premium.” Valuing companies based on M&A transactions (a control based valuation methodology) will include this control premium and therefore likely result in a higher valuation than a public market valuation (minority interest based valuation methodology).
The Discounted Cash Flow (DCF) analysis will also likely result in a higher valuation than the Comparable Company analysis because DCF is also a control based methodology and because most projections tend to be pretty optimistic. Whether DCF will be higher than Precedent Transactions is debatable but is fair to say that DCF valuations tend to be more variable because the DCF is so sensitive to a multitude of inputs or assumptions.
The formula for enterprise value is: market value of equity (MVE) + debt + preferred stock + minority interest – cash.