1. What is it?
Business Valuation is a special type of Guesstimate question where the target variable is the value of a company or a business line. An example of a real McKinsey Business Valuation question is how much is Singapore Airlines worth today?
Generally, you will still follow the same 4-step approach of Guesstimate questions: (1) Clarify, (2) Breakdown, (3) Solve, and (4) Consolidate. However, with Business Valuation questions, step (2) and step (4) require a little more technical knowledge. We will be showing you two of the most popular Business Valuation methods. Usually, you shouldn’t need more complicated financial techniques in a case interview.
a. Finance 101 – Discounted Case Flow method
The rationale behind this method is this: how much money do you need to have in the bank now to generate a specified amount of annual Cash Inflow (Income).
- General method: Find the cash flow and discount it to the present.
- Detailed Calculation: Value of a Business = Expected Annual Cash Flow/Annual Interest Rate
Question: How much is Singapore Airlines worth today?
Candidate: To find out the value of Singapore Airlines, I need to know its (1) annual cash-flow (or net profit) and (2) the market interest rate.
(1) Let’s estimate the annual net profit of Singapore Airlines…… So according to this estimation, Singapore Airline’s net profit is $200 million.
(2) Assume that the market interest rate is 10%, it that a fair assumption?
With the annual net profit of $200 million and the market interest rate of 10%, Singapore Airlines is worth approximately $200 million / 10% = $2 billion