We went ahead and we started working on the case study, the first step was

predicting the cash flow which we did we predicted the cash flow using the formula
of no pat that is EBIT into one minus tax rate plus depreciation in all the non-
cash charges and minus of fixed capital investment to get us the free cash flow,
then we discounted the free cash flow to the current time. We found the terminal
value using two different approaches and we are discounted that as well. The
discount rate was WACC which was calculated by first determining the cost of debt
which was easily determined to the cost of which was easily determined through the
10k of the company annual report we had a quite a large discussion on what is this
cost of equity and how it can be determined? We used the CAPM model to determine
the cost of equity and using the market values of debt and equity, market values of
debt I'm sorry the market values of equity and the book value of debt, we
calculated the WACC which we used in discounting the cash flow that we generated
and the terminal value as well. Then, we went on further ahead to calculate the net
debt and once we did that we subtracted it from the enterprise value to arrive at
the equity value that was then divided by the diluted shares of outstanding, find
the per share value. Once we were, once we found the per-share value, we compared
that with the current share price of the market to take a decision whether the
current share price is undervalued or overvalued and you took a call based on that
once you are done with all that we did something which is known as a sensitivity
analysis. Sensitivity analysis is just an analysis which sensitizes your output, it
shows how sensitive your output is to changes in input and that is something which
is very important because ultimately this is something that makes it way to the
pitch books and it is a good way for you to understand, what kind of ret

interview questions
So now we are in the final part of the lecture where we are going to discuss some
common interview questions that will be asked to you when you apply for investment
banking or an equity research job. This are certain questions which make bulk of
the questions that are asked in interviews. Basically, 70% of the time you will be
asked questions like this, so even if you don't get the same question you will get
a similar question so once you try to understand the answer to these questions you
will be in a position to answer all related questions as well. So the first
question is, what is higher? Cost of equity or the cost of debt and why? try to
think about it cost of equity is always higher than the cost of debt this is
primarily because the debt holders are paid to the equity holders, whenever free
cash flow is generated the first person to receive the cash is a debt holders,
after debt holders have been paid if there is a remaining value it is paid to the
preferred shareholders and after that, if any values remaining the company has a
call whether it wants to invest in new projects or pay to the cost of equity pay to
the equity holder, so equity holders are usually last inline to receive the
dividends. So hence require a larger return because they are taking additional risk
people are being paid before them hence that taking an additional risk and hence
they require an additional return for them. An additional return means a higher
return on equity, a high return on equity from a point of you culminates into
higher cost of equity for them. Also, the fact that debt is tax-deductible makes it
more cheaper on an after-tax places So you can tell this answer in the interview
this is more than what they want to know. Walk me through a typical DCF model. This
is something that you should be in a position to answer now try to frame and answer
on your own by pausing this video and once you are done, you can resume the video
and I'll tell you the answer for the same question okay, so I hope you had a try at
it. A DCF model or a discounted cash flow model is a model that is used to
ascertain the value of a company by discounting the cash flows to the company at an
appropriate cost of capital. So let me assume that we are discounting the cash
flows to the firm, so we will use a WACC that is a weighted average cost of capital
to discount a free cash flows to the firm to the present value to determine the
value of the company. So just walk you through a DCF model. We start with the
NOPAT, we get that by multiplying EBIT into 1 minus tax rate once we get that NOPAT
we add all the non-cash expenses that were subtracted initially in arriving and
that NOPAT. So we add depreciation and amortization we add stock based compensation
we remove any working capital investments after all this has been done, any
additional cash that has been left is used to invest in long fixed capital
investment models. Once that has been done the value that is remaining is known as
a cash-free cash flow to the firm. So why free cash flow it means that the firm has
full Liberty in determining what to do with this cash flows basically the company
uses these cash flow to first pay the debt holders, anyways, you get the free cash
flow your discount that using inappropriately determined cost of return that is
WACC and you find the present value of all the cash flows till now but you cannot
assume that the cash flows will grow into Infinity forever so at the point in time,
generally after 5 years. You assume that a company is going to grow at a stable
growth rate of cross to 5 to 6% depending on the economy in with the company
operates and then you are going to calculate the terminal value using either the
Gordon growth formula or by using the multiple. Once you have the terminal value
you can also discount that to the present and add the first initial stage one cash
flow so terminal value to create the total value which is known as enterprise
value, from this enterprise value you subtract the net debt you subtract the net
debt to arrive at the cash at the equity value for the company. Once you have the
equity value for the company you divide that value by dilute number of shares
outstanding to find the value of the equity per share that is the value of a per-
share price, once you have that you compare that with the currently traded share in
the market and take a call whether you want to go long that is buy the share or
whether you want to go short that is sell a share, this is the typical working of a
DCF model. The third question is how does dividend payment and share repurchase
affect FCFE? Try to think about this try to give it a little more though than what
you have been given to the other questions this is a very easy question but just
framed in a way that is bound to confuse you just try to think about this, if you
had your time let me tell you the answer, this is the trick question basically, the
short answer is that dividend share repurchases or share issues have no effect on
FFF and FCFE, the reason is very straightforward. FCFF and FCFE represent a cash
flows available to investors and shareholders respectively Before any payout
decisions dividend share repurchases and share this is on the other hand represent
uses of those cash flows as such this financial financing decisions don't affect
the level of cash flows available. Hence, dividend share repurchases or share if
you will not affect in any way the FCFE of the company. Explain Miller and
Modigliani hypothesis on capital structure of a company. This is something which
you might be new to some of you. So, I'll tell you what it means, so Miller and
Modigliani were two scientists who framed hypothesis based on the capital structure
of the company. The form two propositions and in both these propositions they had
two sub propositions. So whenever you there they have asked a question like this,
it is better to re questions and ask that which proposition do you want me to
explain it to you, if they tell your particular proposition then it's fine, if not,
then you have to explain all the propositions in short. So I am assuming that we
have to assume all the propositions in short, so I will explain the same. So Miler
and Modigliani were two scientists gave hypothesis on the capital structure of the
company. The first opposition was that the capital structure is irrelevant
basically, they prove that the value of a firm is unaffected by the capital
structure, however in this, so hypothesis that assume that there is no tax so even
if you take a 100% equity or 100% debt the value of the company won't change. There
proposition two with no taxes states that the cost of equity increases linearly as
a company increases its proportion of debt financing. Again we have assumed no
taxes over here, no cost of bankrupt in anything. Basically what this says is that
as companies increases the use of debt, the risk to equity holders increases which
in turn increases the cost of equity. Therefore the benefit of using a large
proportion of debt as a cheaper source of financing or offset by the rising cost of
equity resulting in no change in the firms weighted average cost of capital. Miller
and Modigliani is proposition one with taxes states that if we maintain the other
assumptions, the value of a company increases with increasing level of debt and the
optimal capital structure is achieved at 100% debt. The proposition two with taxes
states that the value of a firm is maximized the point where the WACC is minimised
and the WACC is minimised at the point where debt is 100% of the company is capital
structure. So this all I have explained just in short for those who want to gather
more information on the same they can always go on Google and read on Miller and
Modigliani or take up any book on corporate finance and try to understand, what it
means. What is the football field analysis? Just as we saw right now football field
analysis is a pictorial representation of the different values achieved using the
valuation methods used it give the range of the different value that have been
achieved using the different valuation method that are available at the disposal.
It is a good method for us to understand the highest value that is being generated
and the lowest value as well as a typical range that these methods are generating.
What is WACC and how do you calculate it? WACC is weighted average cost of capital
so as a name suggest it is the weighted average of a different cost of capital, the
different cost of capital the company are the cost of debt in the cost of equity.
The cost of debt can be calculated by looking at the interest rate on the market
value of the bond and a company issues just one way, the market value the cost of
equity can be ascertained using the CAPM method. Once you have the cost of debt and
the cost of equity you just need the market value of debt and equity to calculate
the relative proportion of debt and equity in its capital structure then use a
formula where you multiply the market value of equity in either cost of equity and
you multiply the market value of debt by the after-tax cost of debt to find a
weighted average cost of capital, more risky the firm more will be the WACC, less
risky the firm less will be the WACC. So, generally in big companies like JP Morgan
and Morgan Stanley they ask you try to calculate the WACC for Infosys or Hindustan
Unilever and explain me so basically we are not looking for a perfect answer they
only looking for the methodology that you used to find the WACC and how you are
thinking process is. The last question in one of the most important question that I
have kept for the last is what is beta? Explain the concept of levered and
unlevered beta. So the pure textbook definition of beta is that beta is a measure
of systematic risk of the company that is it measures the
amount of undiversifiable risk of a company. Beta is a measure of the volatility
of the stock with respect to the market a beta of one assumes no risk beta greater
than one means that the stock is more volatile with respect to the index and hence
should be traded in carefully. A beta less then one thing if I slow volatility and
a low-risk stock. Regration beta is generally used to calculate the beta but its
suffers from a lot of shortcomings hence we introduced the concept of levered and
unlevered betas. Leverage is a very important part of determinant of beta but we
cannot use that to compare me beta across firms because different firm some
different leverage and hence different beta. So we unlevered the beta of the peers
by using the formula beta levered divided by 1 + 1 - tax rate into debt by equity.
Once we have the unlevered beta for all the firms we take an average and we
reliever that using the debt to equity ratio of the subject company in
consideration and that's how we attend the levered beta for the set company that we
are more interested in. So these are some typical questions that are asked in
interviews and used whenever they are you should be prepared with these interviews
prepare with this answer try to think about these answers on your own try to find
what is a follow-up question that can be asked depending on your own the answer
that you gave like for example, when I said that cost of equity is calculated using
CAPM. The second question that might generally come is what is CAPM and do you know
any other method that is used to calculate the cost of equity so you should prepare
with such question once you are prepared with such kind of questions it is not more
than a days work but you can clear any interview like that. to reach a particular
share price? Then we saw, what is known as a football field analysis? That
basically puts in one place the results of all the valuation methods that were used
to value a company and it puts in a beautiful form which makes it easier for us to
understand, which valuation method results in the highest value and what is the
typical range that is being shown by all the methods? So once we have done with all
this, the last part of this section is some common interview questions, which I am
going to ask you going to answer on your own and then we are going to discuss this
together.