Finance Recruiting Interview Preparation Session #1

Accounting and Enterprise Value

This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment
products or other financial product or service, or an official confirmation of any transaction.
Introduction & Limestone Capital Offering
Finance Interview Preparation Workshops Limestone Capital Offering

▪ “Preparing for finance recruiting isn’t just skimming ▪ 4 Sessions: Customized curriculum to prepare you
The Vault anymore. Students should study for to answer any technical finance questions that
recruiting like a course and do their homework, recruiters may throw at you
because the final exam is the interview.” 1. Accounting, Enterprise Value
– VP, Recruiter for Queen’s
▪ Like a course, there should be: 2. Comparable Analysis & Precedents
– “Homework:” regular readings are necessary 3. Introduction to DCFs
– Practice (mock interviews)
– Comprehensive, accessible resources for all 4. M&A & Leveraged Buyouts
interested students
▪ The most important “exam” of a finance student’s life

Rationale
▪ Candidates differentiate themselves by knowing hard M&A and LBO questions
▪ Queen’s needs to offer comprehensive resources to continue being competitive
▪ You will not learn the required knowledge from class
▪ It is insufficient to memorize an interview guide from WSO, WSP, M&I, Vault, walk into an interview, and hope you
get the same questions
▪ Start early! Recruiting is being pushed up earlier every year

2
Agenda

1 Intro to Finance Recruiting

2 Accounting

3 Enterprise Value

3
Overview: The Structure of ‘The Street’

Wall St.

Buy Side Sell Side

The buy-side is The sell-side is
comprised of the part of the
investing Investment Banking industry that is
institutions that Asset Management involved with
seek to deploy the creation,
capital into a wide promotion,
Wealth Management Sales and Trading
variety of assets. analysis, and
sale of
The buy-side securities. This
works for the group Alternative Investment is usually the
of investors that Managers (Hedge Investment Research role of an
they represent Funds) investment
(e.g. a pension bank
fund works for its
constituent pension
holders). Private Equity

Insurance

4
Financial Services Opportunities
Undergraduate Roles Are Available In…

Investment Banking Sales & Trading Equity Research

Industry Groups: Groups: Groups:
▪ Metals & Mining (BMO) ▪ Equity ▪ Equity
▪ Financials ▪ Fixed Income ▪ Fixed Income
▪ TMT (CIBC)
▪ Real Estate (TD, Brookfield) ▪ Economic ▪ Derivatives
▪ Healthcare ▪ Quantitative ▪ Currencies
▪ Consumer ▪ Sovereign ▪ Automated Trading
▪ Infrastructure ▪ Asset-Backed Securities
▪ Diversified
▪ Oil & Gas (Calgary) “Buy-Side”

Product Groups ▪ Private Equity / Venture Capital

▪ M&A ▪ Pension Funds
▪ Equity Capital Markets ▪ Asset Management
▪ Debt Capital Markets ▪ Wealth Management
▪ Syndication
▪ Restructuring

Limestone Capital’s Interview Preparation Workshops are catered towards students interviewing for Investment
Banking, and the “Buy Side”, but also contains crucial knowledge required for other career streams.

5
Summer Opportunities in Finance
First Years Second Years
▪ Business Development & Strategy Private Equity
▪ Commercial Banking, Retail Banking
▪ Unpaid/paid internships for portfolio managers,
asset managers, investment advisors (CIBC Wood
Gundy, RBC Dominion Securities, etc. See below.)
▪ Oil & Gas Companies

Wealth Management Asset Management

Inv. Banking / Corp. Banking / S&T

6
Summer Opportunities in Finance
The “Big 6” Canadian Banks “Bulge Bracket” Investment Banks

“Boutique” Investment Banks Firms That Don’t Actively Recruit Queen’s Students

7
Summer Opportunities in Finance
The “Buy Side”: Private Equity, Pension Funds, Venture Capital, Asset Managers

• Firms listed above have recruited Queen’s students, but do not necessarily come to campus
• CPPIB, OTPP, OMERS, PSP, Burgundy, and Mackenzie post position and/or come to campus
• All “Big 6” Canadian Banks also recruit for their asset management divisions
• Advisory wings of “Big 4” accounting firms (Deloitte Financial Advisory, KPMG Corporate Finance, PwC Deals, EY
M&A Advisory) will have you do the exact same work as investment banks, but for smaller clients or transactions

8
Process, Interviewing, Offers
Timeline and Details

▪ U.S. Investment Banking processes for third-year internships being in the

Process spring of a student’s second year and continue throughout the summer
(Third Year) ▪ Toronto Investment Banking processes for third-year internships begin in
the summer and continue throughout the fall

Process ▪ Most second year summer recruiting processes will occur during the Fall
(Second Year) and continue throughout the winter semester

▪ Fit / Behavioral
Types of Questions ▪ Market-Based Question
& Preparation ▪ Technical Questions
▪ Prep: Mock Interviews, Limestone Sessions, BIWS, Rosenbaum & Pearl

▪ First Rounds: 30 minutes to 60 minutes, on-campus or phone

Interviews ▪ Second Rounds or “Superday”: 4 – 5 hours at the firms’ office

▪ Non-expiring
▪ Exploding
Offers ▪ Firms may accelerate the process for you if you have an exploding offer
▪ Game theory is necessary; know who you’re up against

9
Finance Recruiting Interview Preparation Session #1
Accounting

This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment
products or other financial product or service, or an official confirmation of any transaction.
Agenda

1 Intro to Finance Recruiting

2 Accounting

3 Enterprise Value

11
Accounting
How will $10 of additional depreciation affect the 3 financial statements?

Income Statement

Income Statement

Depreciation (10)
Pre-Tax Income (10)
Tax rate 40%
Foregone tax 4
Net Income (6)

12
Accounting
How will $10 of additional depreciation affect the 3 financial statements?

Income Statement
▪ Start with the income statement
▪ Depreciation expense goes up by $10
▪ Pre-tax income goes down by $10
▪ Ask for the tax rate, or state your tax rate assumption
̶ Usually assume a tax rate of 40% for simplicity
▪ If your company loses $10, then they won’t have to pay the 40% of tax
̶ $4 less tax
̶ After tax, net income is only down by $10 - $4 = $6
▪ You can also think of the depreciation expense as a tax shield
̶ Net income is down by $10 * (1-tax rate) = $10 * (100% – 40%) = $6

Income Statement

Depreciation (10)
Pre-Tax Income (10)
Tax rate 40%
Foregone tax 4
Net Income (6)

13
Accounting
How will $10 of additional depreciation affect the 3 financial statements?

Step 2: Cash Flow Statement

▪ Go to cash flow statement

▪ First line item is net income

▪ Net income is down by $6, as established from before Net income (6)
Add back:
▪ Add back non-cash operating expenses
Non-cash operating expenses
▪ Depreciation of $10 Depreciation 10
Increase (decrease) in cash position 4
▪ Cash increase = NI increase (decrease) + depreciation

= ($6) + $10 = $4

Step 3: Balance Sheet

▪ Go to balance sheet
▪ Cash position has increased by $4, as mentioned previously Assets
▪ Accumulated depreciation (contra-asset) has gone up by $10
Cash 4
̶ Net assets gone down by $10 Accumulated depreciation (10)
̶ Overall, assets have gone down by $6 Total assets (6)
▪ Net income is linked to retained earnings on balance sheet
Shareholder's Equity and Liabilities
▪ Therefore, retained earnings has gone down by $6
▪ The Assets and the Liabilities and Shareholder’s Equity side Retained earnings (6)

both go down by $6, so they balance

14
Accounting
How will $10 of additional depreciation affect the 3 financial statements?

Income Statement Cash Flow Statement Balance Sheet

Depreciation (10) Net income (6) Assets

Pre-Tax Income (10) Add back:
Tax rate 40% Non-cash operating expenses Cash 4
Foregone tax 4 Depreciation 10 Accumulated depreciation (10)
Net Income (6) Increase (decrease) in cash position 4 Total assets (6)

Shareholder's Equity and Liabilities

Retained earnings (6)

All 3 Statements Connected

▪ Net income flows to cash flow statement and retained earnings
▪ Cash flow statement flows to cash position in balance sheet
▪ Always go from income statement to cash flow statement to balance sheet
̶ Methodology of addressing income statement, then cash flow statement, then balance sheet should be
applied to any accounting questions in your interviews.
̶ What happens to all three statements when inventory goes up by $10, assuming you pay for it with cash?

15
Accounting
Factory Acquisition Question, Part 1

$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
▪ Start by asking questions:
▪ What is the interest rate?
̶ Assume 10%
▪ What is the tax rate?
̶ Assume 40%
▪ What is the depreciation rate?
̶ Assume 10%

Income Statement Cash Flow Statement Balance Sheet

Depreciation - Operating cash flows Assets
Interest expense - Net income -
Pre-tax income - Add back: Cash (50)
Non-cash operating expenses PP&E 100
Tax rate 40%
Depreciation - Accumulated depreciation -
Foregone tax - Total assets 50
Net Income - Investing cash flows
Investment in factory (100) Shareholder's Equity and Liabilities

Financing cash flows Debt 50

Debt financing 50 Retained earnings -

Increase (decrease) in cash position (50)

No Change Cash down $50 Debt up $50, PP&E up $100

16
Accounting
Factory Acquisition Question, Part 1

$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
▪ Start by asking questions:
▪ What is the interest rate?
̶ Assume 10%
▪ What is the tax rate?
̶ Assume 40%
▪ What is the depreciation rate?
̶ Assume 10%

Income Statement Cash Flow Statement Balance Sheet

Depreciation - Operating cash flows Assets
Interest expense - Net income -
Pre-tax income - Add back: Cash (50)
Non-cash operating expenses PP&E 100
Tax rate 40%
Depreciation - Accumulated depreciation -
Foregone tax - Total assets 50
Net Income - Investing cash flows
Investment in factory (100) Shareholder's Equity and Liabilities

Financing cash flows Debt 50

Debt financing 50 Retained earnings -

Increase (decrease) in cash position (50)

No Change Cash down $50 Debt up $50, PP&E up $100

17
Accounting
Factory Acquisition Question, Part 1

$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
▪ Start by asking questions:
▪ What is the interest rate?
̶ Assume 10%
▪ What is the tax rate?
̶ Assume 40%
▪ What is the depreciation rate?
̶ Assume 10%

Income Statement Cash Flow Statement Balance Sheet

Depreciation - Operating cash flows Assets
Interest expense - Net income -
Pre-tax income - Add back: Cash (50)
Non-cash operating expenses PP&E 100
Tax rate 40%
Depreciation - Accumulated depreciation -
Foregone tax - Total assets 50
Net Income - Investing cash flows
Investment in factory (100) Shareholder's Equity and Liabilities

Financing cash flows Debt 50

Debt financing 50 Retained earnings -

Increase (decrease) in cash position (50)

No Change Cash down $50 Debt up $50, PP&E up $100

18
Accounting
Factory Acquisition Question, Part 1

$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
▪ Start by asking questions:
▪ What is the interest rate?
̶ Assume 10%
▪ What is the tax rate?
̶ Assume 40%
▪ What is the depreciation rate?
̶ Assume 10%

Income Statement Cash Flow Statement Balance Sheet

Depreciation - Operating cash flows Assets
Interest expense - Net income -
Pre-tax income - Add back: Cash (50)
Non-cash operating expenses PP&E 100
Tax rate 40%
Depreciation - Accumulated depreciation -
Foregone tax - Total assets 50
Net Income - Investing cash flows
Investment in factory (100) Shareholder's Equity and Liabilities

Financing cash flows Debt 50

Debt financing 50 Retained earnings -

Increase (decrease) in cash position (50)

No Change Cash down $50 Debt up $50, PP&E up $100

19
Accounting
Factory Acquisition Question, Part 1

$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
▪ Start by asking questions:
▪ What is the interest rate?
̶ Assume 10%
▪ What is the tax rate?
̶ Assume 40%
▪ What is the depreciation rate?
̶ Assume 10%

Income Statement Cash Flow Statement Balance Sheet

Depreciation - Operating cash flows Assets
Interest expense - Net income -
Pre-tax income - Add back: Cash (50)
Non-cash operating expenses PP&E 100
Tax rate 40%
Depreciation - Accumulated depreciation -
Foregone tax - Total assets 50
Net Income - Investing cash flows
Investment in factory (100) Shareholder's Equity and Liabilities

Financing cash flows Debt 50

Debt financing 50 Retained earnings -

Increase (decrease) in cash position (50)

No Change Cash down $50 Debt up $50, PP&E up $100

20
Accounting
Factory Acquisition Question, Part 2

$100 factory purchase with 50% debt, 50% cash. How does this affect all 3 financial statements?
▪ Start by asking questions:
▪ What is the interest rate?
̶ Assume 10%
▪ What is the tax rate?
̶ Assume 40%
▪ What is the depreciation rate?
̶ Assume 10%

▪ One year has passed

▪ Start with income statement
̶ $50 of debt x 10% interest rate = $5 interest expense
Depreciation - Operating cash flows Assets
̶ $100
Interest of P&E
expense * 10%
- depreciation = income
Net $10 -
Pre-tax income - Add back: Cash (50)
Non-cash operating expenses PP&E 100
Tax rate 40%
Depreciation - Accumulated depreciation -
Foregone tax - Total assets 50
Net Income - Investing cash flows
Investment in factory (100) Shareholder's Equity and Liabilities

Financing cash flows Debt 50

Debt financing 50 Retained earnings -

Increase (decrease) in cash position (50)

No Change Cash down $50 Debt up $50, PP&E up $100

21
Accounting
Factory Acquisition Question, Part 2

Income Statement Cash Flow Statement Balance Sheet

Depreciation (10)
Interest expense (5)
Pre-tax income (15)
Tax rate 40%
Foregone tax 6
Net Income (9)

▪ Pre-tax income goes down

by $10 + $5 = $15
▪ 40% tax rate
▪ Foregone tax = $15 x 40%
= $6
▪ Net income goes down by
$15 - $6 = $9
̶ Can also be
calculated as: $15 *
(100% - 40%) = $9

20
Accounting
Factory Acquisition Question, Part 2

Income Statement Cash Flow Statement Balance Sheet

Operating cash flows

Depreciation (10) Net income (9)
Interest expense (5) Add back:
Non-cash operating expenses
Pre-tax income (15)
Depreciation 10
Tax rate 40%
Foregone tax 6 Investing cash flows
Investment in factory -
Net Income (9)
Financing cash flows
Debt financing -

Increase (decrease) in cash position 1

▪ Pre-tax income goes down ▪ Go to cash flow statement

by $10 + $5 = $15 ▪ Start with net income decreasing
▪ 40% tax rate by $9
▪ Foregone tax = $15 x 40% ▪ Add back depreciation of $10
= $6 ▪ Cash goes up by $1
▪ Net income goes down by
$15 - $6 = $9
̶ Can also be
calculated as: $15 *
(100% - 40%) = $9

21
Accounting
Factory Acquisition Question, Part 2

Income Statement Cash Flow Statement Balance Sheet

Operating cash flows

Depreciation (10) Net income (9) Assets
Interest expense (5) Add back:
Non-cash operating expenses Cash 1
Pre-tax income (15)
Depreciation 10 PP&E -
Tax rate 40% Accumulated depreciation (10)
Foregone tax 6 Investing cash flows Total assets (9)
Investment in factory -
Net Income (9)
Shareholder's Equity and Liabilities
Financing cash flows
Debt financing - Debt -
Retained earnings (9)
Increase (decrease) in cash position 1

▪ Pre-tax income goes down ▪ Go to cash flow statement ▪ Cash flow statement is
by $10 + $5 = $15 ▪ Start with net income decreasing linked to balance sheet
▪ 40% tax rate by $9 ▪ Cash is up by $1 (as per
▪ Foregone tax = $15 x 40% ▪ Add back depreciation of $10 previous slide) in year 1
= $6 ▪ Cash goes up by $1 ▪ $10 of depreciation
▪ Net income goes down by decreases net assets by
$15 - $6 = $9 $10
̶ Can also be ▪ Net income down by $9 →
calculated as: $15 * Retained Earnings down by
(100% - 40%) = $9 $9
▪ Assets down by $9, S / E
down by $9

22
Accounting
Factory Acquisition Question, Part 3

What if the factory blows up in a year and we default on the debt?

Income Statement Cash Flow Statement Balance Sheet

23
Accounting
Factory Acquisition Question, Part 3

What if the factory blows up in a year and we default on the debt?

Income Statement Cash Flow Statement Balance Sheet

PP&E writedown (80)

Debt writedown 50
Pre-tax income (30)
Tax rate 40%
Foregone tax 12
Net Income (18)

▪ Start with income

statement
▪ Pre-tax income is down by
$80 from PP&E writedown
̶ 2 years of
depreciation already
in effect
▪ Pre-tax income goes up by
$50 from debt writedown
(no accrued interest)
▪ Pre-tax income is down
$30 overall
▪ Net income is down by:
$30 x (1 – tax rate) = $18

24
Accounting
Factory Acquisition Question, Part 3

What if the factory blows up in a year and we default on the debt?

Income Statement Cash Flow Statement Balance Sheet

PP&E writedown (80) Net income (18)

Debt writedown 50 Add back:
Pre-tax income (30) Writedown of PP&E 80
Tax rate 40% Less:
Foregone tax 12 Writedown of Debt (50)
Net Income (18) Increase (decrease) in cash position 12

▪ Start with income ▪ Go to cash flow statement

statement ▪ Start with net income down by $18
▪ Pre-tax income is down by ▪ Add back (subtract) non-cash
$80 from PP&E writedown expenses (revenues)
̶ 2 years of ▪ Add back $80 writedown of PP&E
depreciation already ▪ Subtract $50 writedown of debt
in effect
▪ Cash position increase = -$18 + $80
▪ Pre-tax income goes up by - $50 = $12
$50 from debt writedown
(no accrued interest)
▪ Pre-tax income is down
$30 overall
▪ Net income is down by:
$30 x (1 – tax rate) = $18

25
Accounting
Factory Acquisition Question, Part 3

What if the factory blows up in a year and we default on the debt?

Income Statement Cash Flow Statement Balance Sheet

Assets
PP&E writedown (80) Net income (18)
Cash 12
Debt writedown 50 Add back:
Net PP&E (80)
Pre-tax income (30) Writedown of PP&E 80
Total assets (68)
Tax rate 40% Less:
Foregone tax 12 Writedown of Debt (50) Shareholder's Equity and Liabilities
Net Income (18) Increase (decrease) in cash position 12
Debt (50)
Retained earnings (18)
▪ Start with income ▪ Go to cash flow statement S / E and Liabilities (68)
statement ▪ Start with net income down by $18
▪ Pre-tax income is down by ▪ Add back (subtract) non-cash ▪ Go to balance sheet
$80 from PP&E writedown expenses (revenues) ▪ Cash goes up by $12
̶ 2 years of ▪ Add back $80 writedown of PP&E
depreciation already ▪ Net PP&E goes down by $80
▪ Subtract $50 writedown of debt ▪ Assets go down by $68
in effect
▪ Cash position increase = -$18 + $80 ▪ Debt goes down by $50
▪ Pre-tax income goes up by - $50 = $12
$50 from debt writedown ▪ Retained earnings goes down by
(no accrued interest) $18
▪ Pre-tax income is down ▪ S / E + Liabilities go down by $68
$30 overall ▪ Assets and S / E + Liabilities
▪ Net income is down by: balance
$30 x (1 – tax rate) = $18

26
Other Accounting Questions
Q: A:
▪ If you were stranded on a desert island, and you could
only pick one financial statement to assess the health of a
company, which statement would you choose and why?

▪ Most people say income statement

̶ But income is not cash flow

▪ Can you really evaluate the health of a company just by looking

at an accounting number?
̶ Remember the issues with earnings
̶ Ignores factors like CAPEX, changes in working capital

Q: A:
▪ If you could only pick two statements…

▪ Ask: do we assume that we have the balance sheet date for

the current year and the prior year?

▪ If yes: choose income statement and balance sheet

▪ You can build the cash flow statement from these two

▪ If no: choose cash flow statement and balance sheet

▪ You can see net income on cash flow statement

▪ Cash flow is more relevant for assessing value

▪ Balance sheet is useful for assessing credit risk, ROA, etc.

27
Other Accounting Questions
Q: A:
▪ If you were stranded on a desert island, and you could ▪ Correct answer is cash flow statement
only pick one financial statement to assess the health of a ▪ When valuing a company, we care about its cash flows,
company, which statement would you choose and why?
independent of its non-cash expenses
▪ Most people say income statement ▪ We can already get net income from the cash flow statement
̶ But income is not cash flow anyways
▪ Net income is typically stated at the beginning of a cash flow
▪ Can you really evaluate the health of a company just by looking statement
at an accounting number?
▪ We can see important items like changes in working capital
̶ Remember the issues with earnings and CAPEX
̶ Ignores factors like CAPEX, changes in working capital ▪ Growing CAPEX suggests expansion
▪ Negative CAPEX suggests rationalization or restructuring

Q: A:
▪ If you could only pick two statements… ▪ If yes: choose income statement and balance sheet
▪ Can find changes in non-cash operating expenses from Current
▪ Ask: do we assume that we have the balance sheet date for Assets / Liabilities
the current year and the prior year?
̶ Increase in accounts receivable, prepaids, accounts payable
▪ If yes: choose income statement and balance sheet ▪ Can derive investing cash flows (CAPEX) from Balance Sheet
̶ Current year fixed assets - prior year fixed assets +
▪ You can build the cash flow statement from these two depreciation
▪ Can find financing cash flows from Balance Sheet
▪ If no: choose cash flow statement and balance sheet ̶ Compare current year long term liabilities with prior year’s
▪ You can see net income on cash flow statement ▪ Deriving equity financing is harder
̶ B / S sometimes contains number of common shares
▪ Cash flow is more relevant for assessing value ▪ Assuming no secondary equity issuance…
̶ Dividends paid = Net Income – R / E (current year) + R / E
▪ Balance sheet is useful for assessing credit risk, ROA, etc. (prior year)

28
Agenda

1 Intro to Finance Recruiting

2 Accounting

3 Enterprise Value

31
Enterprise Value
How is Enterprise Value Calculated?
▪ Two ways to think about Enterprise Value (EV)
̶ Value of the firm’s entire capital structure / “value of the firm’s assets”: both debt and equity
̶ Theoretical takeover price (no control premium)

Enterprise Value = Market cap. + Preferred Equity + Minority Interest + Debt - Cash

Enterprise Value as “Slices of the Pie” Why do we use Enterprise Value?

▪ Market cap. only measures the equity value
̶ Ignores the rest of the capital structure
▪ Enterprise value represents the value of the firm to
both debt and equity holders
̶ The market value of all capital invested in
the business
▪ Multiples using EV are more “comparable”

Equity Net Debt

Preferred Shares Minority Interest

31
Enterprise Value
Why do we subtract cash from the capital structure in the EV calculation?

Theoretical Takeover Price Paying Off Debt with Cash

▪ Imagine buying a company that consisted of the ▪ If a company only has $10 of debt and $10 of cash
following: on its balance sheet, it has an Enterprise Value of
zero
▪ Piggy bank with $99 inside
̶ You can pay off the $10 of debt with $10 of
▪ The “piggy” is worth $1 cash; this company is worthless
̶ Debt - Cash = Net Debt
▪ EV represents the theoretical takeover price
▪ Let the owner keep the $99, pay $1 for the piggy
▪ Buying cash with cash is redundant, so we net it out

33
Minority Interest
What is minority Interest?
▪ Also known as “non-controlling interest”

▪ If we own more than 50% of a subsidiary, we consolidate our financial statements with the subsidiary’s

▪ Even if we own only 51% of Company S, 100% of Company S’s income statement line items are added to our income statement line items

▪ However, only 51% of Company S’s balance sheet line items are added to our balance sheet items

▪ The other 49% of Company S’s assets go into one item: “minority interest”

▪ Minority interest is the part of a subsidiary that we don’t own

▪ Found in equity section of balance sheet (IFRS)

Graphical Representation of Consolidation / Minority Interest Accounting

ParentCo. SubCo.
• Income Statement • Income Statement
• Balance Sheet • Balance Sheet

Consolidated Entity
(Reported by Parent Corporation)
• Combined Balance Sheet, line-by-line
• Combined Income Statement, line-by-line
• Eliminate things like
̶ Inter-company gains and losses
̶ Inter-company balances (Assets/Liabilities)
̶ Parent’s investment in the subsidiary company
• Minority interest reported (the percent of the subsidiary not owned by the parent) on both statements

34
Minority Interest
Why do we add minority interest to get EV?
▪ EV = Market Cap + Preferred Equity + Debt – Cash + Minority Interest

▪ In enterprise multiples, EV is the numerator, and an income statement line item is often the denominator

▪ APPLES TO APPLES
̶ Denominator: Income statement line items are consolidated and include 100% of the subsidiary’s (Company S) income statement
line items
̶ Numerator: Market Cap + Preferred Equity + Debt accounts for 51% of Company S
̶ The 49% we don’t own is not factored into the prices of the parent’s stock, bonds, or preferred shares
̶ To make the numerator consistent with the denominator, we add in the 49% of Company S we don’t own (minority interest)

Graphical Representation of EV / EBITDA Multiple Mechanics

▪ Add the portion of the subsidiary that ParentCo does not own so numerator and denominator are consistent

EV = Market Capitalization + Minority Interest + Preferred Equity + Debt - Cash

Subsidiary consolidated by
ENTERPRISE VALUE
adding minority interest
Subsidiary consolidated from
EBITDA
accounting rules

35
Equity Method & Short / Long-term Investments
What if we only own 20 – 50% of a company? Short Term Investments
▪ Use the Equity Method ▪ Short-term investments with less than 20% control
▪ Proportionate Consolidation: If we bought 20% of ̶ Also known as investments held for trading
Company E, we get 20% of Company E’s net ▪ Mark-to-market
income on our Income Statement
̶ Ignore Company E’s stock price ▪ Unrealized gains or losses flow straight to Net
Income
▪ Company E is worth $100, we pay $20
̶ Balance sheet item: Asset (Investment in
Company E: $20)
▪ If Company E reports $10 of net income, we get
20% of that = $2
̶ Investment in Company goes up by $2 Long Term Investments
(Debit)
̶ Investment income goes up by $2 (Credit) ▪ Long-term investments with less than 20% control
̶ Also known as investments available for sale
▪ Unrealized gains or losses flow through Other
Comprehensive Income (OCI)
̶ Only flows through net income after
investment is sold

36