Question

In: Accounting

What are the advantages and disadvantages of an IPO?

 

ECM:

What are the advantages and disadvantages of an IPO?

A company makes a $140 cash purchase of equipment on January 1. How does this impact the three statements this year and next year?

How would you explain the difference between the debt capital markets and leveraged finance teams in investment banking?

Tell me how would you value a company? Which tools are most effective in this area?

Tell me a company you would invest in and why.

A company with high P/E acquires a rival with low P/E. Is this accretive or dilutive?

When would you use a PEG multiple?

What two companies are you bullish on, and what two companies are you bearish on? Why?

DCM:

Explain to me what an FX forward is.

How would you describe the difference between the DCM team of an investment bank and a leveraged finance team?

A UK company decides to issue a bond in USD. What are the reasons for doing this? What risks are they exposing themselves to? How would you mitigate against this risk?

Let’s say this company issues $xx of senior notes – what will its credit statistics look like after that debt issuance, over the next 5 years?

Explain a yield curve as you would to your grandma.

What's your opinion on the Bank of England's monetary policy? How do you see it changing next year?

What is a convertible bond? When would a company use one?

Both:

What does the capital markets division of an investment bank do?

How would you rate us against our competitors?

Wouldn’t you be better suited to working for another organization?

What exactly does the word ‘success’ mean to you?

Tell me about a challenging situation you have faced. What was this situation? How did you handle it?

What’s 567 x 4?

Solutions

Expert Solution

Advantages

Disadvantages

  1. The primary benefit of an IPO is the ability to raise capital quickly by reaching a large number of investors

Going public using an IPO is a time consuming process. It also comes with high expenses. Beyond the recurring expenses of public company regulatory compliance, the IPO transaction process comes at a hefty cost.

  1. By issuing shares, newer companies can generate publicity, thus increasing its business opportunities

Once the company becomes public, it requires to file their financial statement with the Securities and Exchange Commission every year

  1. Stakeholders get the exit opportunity

Company usually have long term view and vision of the company. Investors usually looks for “Will the company meet its quarterly earnings target?” If an company meets its target, its stock price will normally increase; if not, its stock price will normally decrease.

  1. Companies often have to pay high interest rates to receive loans from banks. An IPO lessen the difficulty of receiving additional capital through public without paying high interest rates

One major disadvantage of an IPO is founders may lose control of their company.

2.

Income Statement: A purchase of equipment is considered a capital expenditure which does not impact earnings. Further, since we are assuming no depreciation, there is no impact to net income, thus no impact to the income statement.  

Cash Flow Statement: No change to net income so no change to cash flow from operations. However we’ve got a $140 increase in capex so there is a $140 use of cash in cash flow from investing activities. No change in cash flow from financing (since this is a cash purchase) so the net effect is a use of cash of $140.  

Balance Sheet: Cash (asset) down $140 and PP&E (asset) up $140 so no net change to the left side of the balance sheet and no change to the right side. We are balanced.

3.

The key difference is that Debt Capital Market focuses on investment-grade debt issuances that are used for everyday purposes, while Leveraged Finance focuses on below-investment-grade issuances (“high-yield bonds” or “leveraged loans”) that are often used to fund control acquisitions, leveraged buyouts, and other transactions.

4.

When valuing a company as a going concern, there are three main valuation methods used by industry practitioners:

(a) DCF analysis,

(b) Comparable company analysis

(c) Precedent transactions.

When valuing a business or asset, there are three broad categories that each contain their own methods. The Cost Approach looks at what it costs to build something and this method is not frequently used by finance professionals to value a company as a going concern. Next is the Market Approach, this is a form of relative valuation and frequently used in the industry. It includes Comparable Analysis Precedent Transactions. Finally, the discounted cash flow (DCF) approach is a form of intrinsic valuation and is the most detailed and thorough approach to valuation modeling.

Comparable company analysis is a relative valuation method in which you compare the current value of a business to other similar businesses by looking at trading multiples like P/E, EV/EBITDA, or other ratios.

Precedent transactions analysis is another form of relative valuation where you compare the company in question to other businesses that have recently been sold or acquired in the same industry. These transaction values include the take-over premium included in the price for which they were acquired.

Discounted Cash Flow (DCF) analysis is an intrinsic value approach where an analyst forecasts the business’ unlevered free cash flow into the future and discounts it back to today at the firm’s Weighted Average Cost of Captial (WACC).

A DCF analysis is performed by building a financial model in Excel and requires an extensive amount of detail and analysis. It is the most detailed of the three approaches, requires the most assumptions, and often produces the highest value. However, the effort required for preparing a DCF model will also often result in the most accurate valuation. A DCF model allows the analyst to forecast value based on different scenarios, and even perform a sensitivity analysis.

5.

Other things being equal, if the Price to Earnings ratio (P/E) of the acquiring company is higher than the P/E of the target, then the deal will be accretive to the acquirer’s Earnings per Share (EPS). This is because the acquirer has to pay less for each dollar of earnings than the market values its own earnings.

6.

The Price/Earnings to Growth Ratio allows you to determine a stock's value, like with the P/E ratio, while also taking into consideration the company's earnings growth. This forward-looking component allows the PEG ratio to give you a more complete picture of a stock's fundamentals than you would get with the P/E alone.

You can calculate the PEG ratio by taking the P/E ratio and dividing it by the projected or actual growth in earnings:

7. I will invest in IPCA Laboratories

Reasons for investing:

The company remain confident that it will outperform industry with 14-15% CAGR in DF Segment over the next three years

Considering increasing demand for captive consumption and eternal sales, the company has earmarked cape of Rs.2.5 bn over the next 12-15 months to enhance API and intermediaries capacity

The company has acquired land at Dewas 35 acres and is in the process to get environment clearance. Expects this site to be commercialized by FY2022

The company has acquired Noble Explochem recently with the intention to manufacture key starting materials, APIs and thus reduce dependency on external sourcing

DCM

1.

A currency forward is a binding contract in the foreign exchange market that locks in the exchange rate for the purchase or sale of a currency on a future date.

2.

To Reduce the Cost of Capital

To Gain the Benefit of Leverage

To Effect Tax Saving

To Widen the Sources of Funds

To Preserve Control

Risks

Interest Rate Risk

Rising interest rates are a key risk for bond investors. Generally, rising interest rates will result in falling bond prices, reflecting the ability of investors to obtain an attractive rate of interest on their money elsewhere.

Credit Risk

This is the risk that an issuer will be unable to make interest or principal payments when they are due, and therefore default. volatility.

Inflation Risk

Inflation reduces the purchasing power of a bond’s future coupons and principal. As bonds tend not to offer extraordinarily high returns, they are particularly vulnerable when inflation rises. Inflation may lead to higher interest rates which is negative for bond prices.

Reinvestment Risk

When interest rates are declining, investors may have to reinvest their coupon income and their principal at maturity at lower prevailing rates.

Liquidity Risk

This is the risk that investors may have difficulty finding a buyer when they want to sell and may be forced to sell at a significant discount to market value.

3.

A convertible bond is a fixed-income debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares.

Advantages

Disadvantages

  1. The primary benefit of an IPO is the ability to raise capital quickly by reaching a large number of investors

Going public using an IPO is a time consuming process. It also comes with high expenses. Beyond the recurring expenses of public company regulatory compliance, the IPO transaction process comes at a hefty cost.

  1. By issuing shares, newer companies can generate publicity, thus increasing its business opportunities

Once the company becomes public, it requires to file their financial statement with the Securities and Exchange Commission every year

  1. Stakeholders get the exit opportunity

Company usually have long term view and vision of the company. Investors usually looks for “Will the company meet its quarterly earnings target?” If an company meets its target, its stock price will normally increase; if not, its stock price will normally decrease.

  1. Companies often have to pay high interest rates to receive loans from banks. An IPO lessen the difficulty of receiving additional capital through public without paying high interest rates

One major disadvantage of an IPO is founders may lose control of their company.

2.

Income Statement: A purchase of equipment is considered a capital expenditure which does not impact earnings. Further, since we are assuming no depreciation, there is no impact to net income, thus no impact to the income statement.  

Cash Flow Statement: No change to net income so no change to cash flow from operations. However we’ve got a $140 increase in capex so there is a $140 use of cash in cash flow from investing activities. No change in cash flow from financing (since this is a cash purchase) so the net effect is a use of cash of $140.  

Balance Sheet: Cash (asset) down $140 and PP&E (asset) up $140 so no net change to the left side of the balance sheet and no change to the right side. We are balanced.

3.

The key difference is that Debt Capital Market focuses on investment-grade debt issuances that are used for everyday purposes, while Leveraged Finance focuses on below-investment-grade issuances (“high-yield bonds” or “leveraged loans”) that are often used to fund control acquisitions, leveraged buyouts, and other transactions.

4.

When valuing a company as a going concern, there are three main valuation methods used by industry practitioners:

(a) DCF analysis,

(b) Comparable company analysis

(c) Precedent transactions.

When valuing a business or asset, there are three broad categories that each contain their own methods. The Cost Approach looks at what it costs to build something and this method is not frequently used by finance professionals to value a company as a going concern. Next is the Market Approach, this is a form of relative valuation and frequently used in the industry. It includes Comparable Analysis Precedent Transactions. Finally, the discounted cash flow (DCF) approach is a form of intrinsic valuation and is the most detailed and thorough approach to valuation modeling.

Comparable company analysis is a relative valuation method in which you compare the current value of a business to other similar businesses by looking at trading multiples like P/E, EV/EBITDA, or other ratios.

Precedent transactions analysis is another form of relative valuation where you compare the company in question to other businesses that have recently been sold or acquired in the same industry. These transaction values include the take-over premium included in the price for which they were acquired.

Discounted Cash Flow (DCF) analysis is an intrinsic value approach where an analyst forecasts the business’ unlevered free cash flow into the future and discounts it back to today at the firm’s Weighted Average Cost of Captial (WACC).

A DCF analysis is performed by building a financial model in Excel and requires an extensive amount of detail and analysis. It is the most detailed of the three approaches, requires the most assumptions, and often produces the highest value. However, the effort required for preparing a DCF model will also often result in the most accurate valuation. A DCF model allows the analyst to forecast value based on different scenarios, and even perform a sensitivity analysis.

5.

Other things being equal, if the Price to Earnings ratio (P/E) of the acquiring company is higher than the P/E of the target, then the deal will be accretive to the acquirer’s Earnings per Share (EPS). This is because the acquirer has to pay less for each dollar of earnings than the market values its own earnings.

6.

The Price/Earnings to Growth Ratio allows you to determine a stock's value, like with the P/E ratio, while also taking into consideration the company's earnings growth. This forward-looking component allows the PEG ratio to give you a more complete picture of a stock's fundamentals than you would get with the P/E alone.

You can calculate the PEG ratio by taking the P/E ratio and dividing it by the projected or actual growth in earnings:

7. I will invest in IPCA Laboratories

Reasons for investing:

The company remain confident that it will outperform industry with 14-15% CAGR in DF Segment over the next three years

Considering increasing demand for captive consumption and eternal sales, the company has earmarked cape of Rs.2.5 bn over the next 12-15 months to enhance API and intermediaries capacity

The company has acquired land at Dewas 35 acres and is in the process to get environment clearance. Expects this site to be commercialized by FY2022

The company has acquired Noble Explochem recently with the intention to manufacture key starting materials, APIs and thus reduce dependency on external sourcing

DCM

1.

A currency forward is a binding contract in the foreign exchange market that locks in the exchange rate for the purchase or sale of a currency on a future date.

2.

To Reduce the Cost of Capital

To Gain the Benefit of Leverage

To Effect Tax Saving

To Widen the Sources of Funds

To Preserve Control

Risks

Interest Rate Risk

Rising interest rates are a key risk for bond investors. Generally, rising interest rates will result in falling bond prices, reflecting the ability of investors to obtain an attractive rate of interest on their money elsewhere.

Credit Risk

This is the risk that an issuer will be unable to make interest or principal payments when they are due, and therefore default. volatility.

Inflation Risk

Inflation reduces the purchasing power of a bond’s future coupons and principal. As bonds tend not to offer extraordinarily high returns, they are particularly vulnerable when inflation rises. Inflation may lead to higher interest rates which is negative for bond prices.

Reinvestment Risk

When interest rates are declining, investors may have to reinvest their coupon income and their principal at maturity at lower prevailing rates.

Liquidity Risk

This is the risk that investors may have difficulty finding a buyer when they want to sell and may be forced to sell at a significant discount to market value.

3.

A convertible bond is a fixed-income debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares.


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