25.06.12 Technicals

1. Accounting

Q: What happens on the 3 financial statements when inventory goes up by $10, assuming you pay for it with cash?

A: Inventory increase of $10 doesn’t affect the income statement. On the cash flow statement, it appears as a negative change in working capital, reducing cash flow by $10. On the balance sheet, inventory increases by $10 under current assets and cash decreases by $10, keeping it balanced.

2. Enterprise / Equity Value

Q: Why do you subtract cash in the formula for enterprise value? Is that always accurate?

A: Cash is subtracted in the enterprise value formula because it’s a non-operating asset and reduces the net purchase price. A buyer can use the target's cash to pay down debt or fund operations, so it’s not part of the core business valuation.

3. Valuation

Q: When would you not use a DCF in valuation?

A:  A DCF is not ideal when cash flows are highly volatile or unpredictable, such as in early-stage startups, commodity businesses, or during industry disruptions. It’s also less useful when projections are unreliable or the business is better valued on asset basis.

4. Discounted Cash Flow (DCF)

Q: How do you calculate WACC?

A: 

WACC = (E / (D+E)) × Cost of Equity + (D / (D+E)) × Cost of Debt × (1 – Tax Rate)
Where:

• Cost of Equity = Risk-Free Rate + Beta × Equity Risk Premium
• Cost of Debt = interest rate on new debt

5. Merger Model

Q: Is there a rule of thumb for calculating whether an acquisition will be accretive or dilutive?

A:  A deal is accretive if the buyer’s post-transaction EPS increases, and dilutive if it decreases. A quick rule: if the buyer has a higher P/E than the seller, the deal is more likely to be accretive when paid in stock.