Financial Analysis puzzles, solved step by step

Put the lease liability inside EV whenever the rent is outside EBITDA. After capitalisation the leaser's EBITDA is Rs 100 crore, like the owner's. Its shares and debt are worth Rs 723 crore, so dividing those alone gives 7.2x and makes it look cheaper. Add the Rs 77 crore lease and it is 8.0x, the owner's multiple. The numerator and denominator must describe the same claims.

Why does a lease behave like debt?

Think of two families in identical flats. One bought with a home loan; the other rents on a ten year agreement it cannot walk away from. Both owe fixed payments for years. A long lease is a loan from the landlord, repaid in rent, so the rent contains both the use of the asset and the financing of it. Under IFRS 16, and Ind AS 116 in India, the leaser now shows that promise as a lease liabilityThe present value of the rent the company is contractually committed to pay over the lease term, carried on the balance sheet like a borrowing.: Rs 12 crore a year for ten years, discounted at 9%, is about Rs 77 crore.

What changes in the numbers, and what does not?

Capitalisation moves the rent out of operating costs. It comes back as depreciation on a right-of-use asset and interest on the lease, both below EBITDA. So the leaser's EBITDA jumps by the full Rs 12 crore while nothing about its stores, customers or cash has changed. The same move puts about Rs 77 crore of lease on the balance sheet. The two changes are a pair, and a fair multiple has to use both halves or neither.

Where does this bite in real comparables work?

Data providers and peer tables do not always treat leases the same way, and a peer set can mix companies reporting under different standards. Before trusting a multiple, check whether its EV includes lease liabilities and whether its EBITDA is before or after rent, then make every company in the table match. A retailer, airline or restaurant chain that leases most of its sites can look 11% cheaper than an owner purely from this mismatch, which is the whole of the gap in this example.

Say the limitation too. The capitalised figure depends on the discount rate and the lease term the company chose, so two leasers with the same rent can carry different liabilities. Lease-adjusted multiples are better, not exact.

Net income falls Rs 60 crore, cash falls Rs 10 crore and debt rises Rs 50 crore. All Rs 100 crore of interest is an expense, so pre-tax profit drops 100 and tax drops 40. On the cash flow statement, add back the Rs 50 crore paid in kind because no cash left, so cash from operations falls 10. On the balance sheet, cash is down 10, debt up 50 and retained earnings down 60: both sides fall 10.

What does paid in kind actually mean?

Think of a credit card bill where you pay half the interest and the bank adds the other half to what you owe. You have still been charged the full interest; you just have not paid all of it in cash. PIK interestPaid-in-kind interest: interest that is settled by adding it to the loan principal instead of paying cash, so the debt grows each period. is a real expense that is settled by growing the loan instead of draining the bank account. That single sentence tells you where each half goes: the expense hits profit in full, and the PIK half turns up as more debt.

How does it move through each statement?

Income statement: interest of Rs 100 crore cuts pre-tax profit by 100. Assuming all of it is deductible, tax falls by Rs 40 crore, so net income falls Rs 60 crore. Cash flow statement: start from net income, down 60, and add back the Rs 50 crore of PIK as a non-cash charge. Cash from operations falls by only Rs 10 crore, because the tax saving on the whole Rs 100 crore nearly covers the Rs 50 crore of cash interest. Balance sheet: cash down 10 on the assets side; debt up 50 and retained earnings down 60 on the other side. Both sides fall by 10.

What should you add after the walk-through?

Two points earn credit. First, the tax assumption: some tax systems limit how much interest a company can deduct, and the rules on PIK can differ, so say you have assumed full deductibility and would confirm the current rule. If the PIK half were not deductible, net income would fall Rs 80 crore and cash Rs 30 crore. Second, PIK compounds: next year's interest is charged on a loan Rs 50 crore larger, which is why lenders price it higher and why it shows up in leveraged buyouts where cash is tight early on.

Consolidated net income is Rs 250 crore, Rs 230 crore is attributable to the parent, and non-controlling interest on the balance sheet is Rs 120 crore. Control brings in all of the subsidiary's Rs 50 crore profit. The outside holders' 40%, Rs 20 crore, is shown as profit attributable to non-controlling interest. On the balance sheet, their 40% of Rs 300 crore of book equity sits as a separate line in equity.

Why take in all of a company you only partly own?

Think of a family that controls a shop it co-owns with a cousin. The family runs it, banks its takings and pays its bills, so to describe what the family controls you count the whole shop, then note that a share of the profit belongs to the cousin. Control, not ownership share, decides consolidation, so the parent adds 100% of the subsidiary's revenue, costs, assets and debt, then shows the minority's share of profit and equity on separate lines. That is why consolidated net income is 200 plus 50, Rs 250 crore, and not 200 plus 30.

Where does non-controlling interest show up on each statement?

On the income statement, net income of Rs 250 crore is split into Rs 230 crore for the parent's shareholders and Rs 20 crore for non-controlling interest. EPS uses the Rs 230 crore. On the balance sheet, non-controlling interest of Rs 120 crore sits inside total equity, next to the parent's own equity; if the subsidiary keeps its Rs 50 crore profit for the year, the line grows by Rs 20 crore. On the cash flow statement nothing is deducted, because the minority share of profit is not a cash payment; only dividends paid to the outside holders leave as cash, in financing. Non-controlling interest is a claim on the group by other shareholders, which is why an EV bridge adds it back alongside debt.

State your assumption: the minority is measured at its share of the subsidiary's book equity, with no fair-value uplift or goodwill allocated to it on acquisition. Under the full goodwill method the line would be larger. And note the boundary case: had the parent owned 40% without control, it would use the equity method, report the same Rs 230 crore of net income, but show none of the subsidiary's revenue or debt.

The reported yield is 5.0%; with stock pay treated as a cost it is 3.1%. Market value is 10 crore shares at Rs 800, Rs 8,000 crore. Rs 400 crore over that is 5.0%; Rs 250 crore is 3.1%. You do not need a future share price: deduct stock pay as if it were cash salary, because whatever the price, the shares handed to staff are worth Rs 150 crore.

Why is stock pay a real cost when no cash leaves?

Think of a family shop that pays its manager with a slice of the business instead of a salary. The till looks fuller, but the family now owns less of the shop. Stock-based compensation is wages paid in ownership rather than cash, and adding it back to free cash flow counts the saving without counting the slice given away. For this company, Rs 150 crore of the Rs 400 crore reported, 37.5%, exists only because staff were paid in shares. Put the other way, the reported yield is 60% higher than the yield an owner actually earns.

How does stock pay reach equity value if you do not know the future share price?

There are two consistent routes. Treat stock pay as a cash expense in the DCF, leave it out of the add-backs, and divide the equity value by today's diluted share count. Or keep the add-back and forecast every share that will be issued in future, which needs the future share price you do not know. The first route avoids the circle, because the rupee value handed to staff is fixed by the grant, Rs 150 crore a year, whatever the price turns out to be. Only the number of shares depends on the price: at Rs 400 the grant is 37.5 lakh shares, at Rs 800 it is 18.75 lakh, at Rs 1,600 about 9.4 lakh. Owners give up Rs 150 crore of value each time.

What is the one line that shows you understand it?

The gap between the two yields, 5.0% less 3.1%, is 1.9%, exactly the share of the company given to employees each year. An investor who takes the 5.0% at face value is being paid partly in their own dilution. The limit to say: stock pay retains staff and may cost less than the cash salary it replaces, so it is a real expense rather than a waste. The only point is that it must be counted once, as a cost.

Goodwill is Rs 250 crore. Fair value of net assets is book equity of Rs 500 crore plus the Rs 200 crore brand, less a Rs 50 crore deferred tax liability (25% of 200): Rs 650 crore. Price paid less that is 900 - 650 = 250. On the combined balance sheet cash falls Rs 900 crore, the target's assets arrive with the brand and goodwill, a Rs 50 crore liability appears, and the target's equity disappears.

What exactly is goodwill?

Buying a running restaurant for Rs 90 lakh when its kitchen, furniture and stock are worth Rs 50 lakh, and its name alone could be sold for Rs 20 lakh, leaves Rs 20 lakh paid for things you cannot list: the regulars, the location's habit, the team. Goodwill is the plug: price paid less the fair value of every asset and liability you can identify, including the tax that comes with them. So the work is in the identifiable side, and the brand and its tax are the two lines people miss.

Why does the brand create a tax liability?

The brand goes onto the books at Rs 200 crore, but in a share purchase the tax authorities see no new asset: its tax base stays at zero. As the brand is amortised in the accounts, no matching tax deduction arrives, so future tax bills will be higher than the book profits suggest. That future tax is a real liability, 25% of the Rs 200 crore gap, Rs 50 crore, and it is booked on day one. A liability reduces net assets, so it increases goodwill by the same Rs 50 crore. In an asset purchase where the step-up is tax-deductible, there would be no liability and goodwill would be Rs 200 crore; check which structure and which tax rules apply.

What happens to these numbers after the deal?

The target's equity vanishes because the acquirer now owns it; only the acquirer's equity survives, unchanged by a cash deal. Afterwards the brand, if it has a finite life, is amortised, and the deferred tax liability unwinds in step, which softens the hit to net income. Goodwill is not amortised under Ind AS and IFRS; it is tested for impairment at least once a year, so a disappointing acquisition shows up later as a write-down. Confirm the treatment under the standard the company reports in. The interviewer is checking that you can make the balance sheet balance and explain why each new line exists.

Net income rises Rs 7.5 crore, cash falls Rs 2.5 crore, and net fixed assets are Rs 10 crore higher. Income statement: depreciation down 10, pre-tax profit up 10, tax up 2.5, net income up 7.5. Cash flow: net income up 7.5 but the add-back down 10, so cash from operations down 2.5. Balance sheet: cash down 2.5, fixed assets up 10, assets up 7.5, matched by retained earnings up 7.5.

Why does profit rise while cash falls?

A shopkeeper who decides his delivery van will last ten years instead of five writes off half as much each year. The van is the same van, the fuel bill is the same, and no customer paid him more. Changing a useful life changes when the cost of an asset is recognised, not whether it is paid, so the extra profit is an accounting rearrangement with one real consequence: a higher tax bill. Depreciation falls 10, pre-tax profit rises 10, tax at 25% rises 2.5, and net income rises 7.5.

On the cash flow statement, start from net income, up 7.5, and add back depreciation, which is now 10 lower than before. Cash from operations is 7.5 - 10 = -2.5. Nothing changes in investing or financing, so cash falls 2.5. On the balance sheet, cash is down 2.5 and net fixed assets are up 10, because less accumulated depreciation has been charged against them: assets up 7.5. Retained earnings carry the 7.5 of extra net income, so liabilities and equity are also up 7.5.

Why is the higher profit not good news?

Because nothing about the business improved. The same machines wear out on the same schedule; the company will replace them on the same date for the same money; and it has handed Rs 2.5 crore to the tax authority earlier than it needed to. A profit increase that comes with a cash decrease and no operating change is cosmetic, and the choice to make it is itself a signal: management may be reaching for a target. It also breaks comparability with peers who kept the shorter lives, and the total charge over the asset's life is unchanged, so the profit that appears now is borrowed from later years.

What if tax depreciation did not follow book?

In practice the tax authority sets its own depreciation rates, and in India book depreciation under the Companies Act and tax depreciation under the Income Tax Act are computed separately; confirm the current rules before relying on this. Then cash tax does not change: net income still rises 7.5, but a deferred tax liabilityTax that the accounts recognise as owed on profit already reported, but that the tax return has not yet charged, so it will be paid in a later period. of 2.5 is booked instead of extra cash tax. On the cash flow statement, net income up 7.5, add-back down 10, deferred tax up 2.5: cash from operations is 0.0. The limit: in that version the change is purely cosmetic, cash untouched, which is why analysts read the depreciation policy note before they read the profit line.