Every concept, endless questions
Each concept is a small financial model. Read how it works, then draw a real interview question from it: forwards, backwards or what-if, with fresh numbers and a worked solution every time.
Forward runs a concept the usual way. Inverse runs it backwards, which is what separates understanding from memorizing.
DCF & Valuation
6 conceptsUnlevered free cash flow build
Unlevered free cash flow is the cash the operations throw off before anyone is paid for financing it — so it is available to lenders and shareholders alike, and it pairs with WACC in a DCF. Start from operating profit, take tax on that profit as if there were no debt, add back depreciation because it is not cash, then subtract the two things the business must reinvest to keep going: capital expenditure and any cash tied up in working capital. Interest never appears: that is a financing cost, and it is already inside the discount rate.
WACC from capital structure and CAPM
WACC is the blended return the whole capital structure demands. Equity is more expensive than debt because equity holders are paid last; debt is cheaper still after tax because interest is deductible. Weight each by its share of the capital structure at market value, not book. Cost of equity comes from CAPM: the risk-free rate plus beta times the equity risk premium.
Terminal value: perpetuity growth versus exit multiple
The explicit forecast stops after a few years, but the business does not. Terminal value captures everything after that. The perpetuity method grows the final cash flow one more year and capitalises it at WACC minus growth — a small change in either input swings the answer. The exit multiple method applies a market multiple to final-year EBITDA. The two should agree roughly; when they do not, one of your assumptions is out of line with the market, and each method can be inverted to show which.
Mid-year convention and discount factors
A discount factor turns a future dollar into a present one: divide by one plus the rate, once for every year of waiting. The end-of-year convention pretends each year’s cash arrives on 31 December. In reality it arrives all year long, so on average it lands halfway through — the mid-year convention discounts year n by n minus a half. Every cash flow is discounted half a year less, so every present value is higher by the same factor: the square root of one plus the rate.
Levering and unlevering beta
A stock’s beta measures two things at once: how risky the business is, and how much debt sits on top of it. Debt makes equity returns swing harder, so a levered beta is higher than the business alone deserves. To borrow a peer’s beta you first strip out its leverage — unlever — to get the pure business risk, then put your own company’s leverage back on — relever. The tax term is there because interest deductibility softens the effect of debt on equity holders.
Implied share price and WACC sensitivity
A DCF ends in a share price: discount the forecast cash flows and the terminal value to get enterprise value, bridge to equity by taking off debt and adding cash, and divide by the diluted share count. Most of the value sits in the terminal value, and the terminal value is a cash flow divided by WACC minus growth — so a one-point move in WACC swings the price far more than a one-point move in any single year’s cash flow. That is why a DCF is presented as a sensitivity table, and why the market price can be read backwards as the WACC investors are using.