Modelling questions

[trophyhunter]

Hello. So I had an interview at IB recently where I was asked how I would proceed with bulding a simple model. During my asnwer I started explaining about FCFF and how to find it from EBIT(1-t). When I mentioned that we need to add depreciation back, the interviewer asked: what kind of depreciation - one we find in financial statements or statements that companies prepare for tax purposes, assuming that they are different. The correct answer was the latter but I have no idea why, was it mentioned in the curriculum ? I think it just says depreciation but doesnt mention what kind.
The second question was how would I find required return on equity for Bulgarian company using CAPM. The correct answer was to use US risk free and add the difference in inflation between US and Bulgaria & use S&P500 as market return (as opposed to my answer to use bulgurian stock index). Are these things mentioned in the cirriculum at all ? I have passed two levels and honestly these questions really got me thinking.
Could you recommend any books where such specifics are discussed ?

 

[Phallacy]

This is my take on the correct answers that you were given:
1. Use the tax return depreciation statement because it will 99% of the time be more than what is stated on a company’s financial report to investors. Most companies show straight line depreciation on their statements for presentation but use accelerated or MACRS for taxes. It would increase the amount of depreciation and thus cash available to the firm. I have a feeling this is what the interviewer was trying to say but others will chime in with more experience.
2. I’m postulating here but because you are using the US rfr adjusted for inflation in Bulgaria the SP500 return as a proxy for market makes more sense because in a sense of the ‘market,’ it’s more encompassing. The beta coefficient will probably be higher as well. Another reason I probably would have said is that Bulgaria is a frontier market with a relatively small capital market so using the SOFIX (just looked it up) returns may not shine the right light on the situation. Though CAPM isn’t that used for these types of markets. Usually it’s a macro / factor based model to derive required return.

 

[Oscar]

Honestly I think the banker was wrong.
Regarding the depreciation I think the correct way would be to add back the depreciation from the financial statements.
In a second step the difference between accounting taxes and paid taxes is corrected by adding back the change in deffered taxes position so that you come to the CF.
At least that’s the way I do it and the way it is shown in valuation literature.