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Struggling with understanding simple revenue exhibits (M&A case)

exhibits Net Present Value Revenue analysis Valuation
Edited on Sep 21, 2023
3 Answers
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Anonymous A asked on Sep 18, 2023

In one of my case practices the following exhibit came up. I don't understand how they calculated yearly revenue from the exhibit, but I've attached the answer from the guidance. 

I have 2 Qs:

1) I know that exhibits sometimes have info left out intentionally to see if you can deduce the right questions, but here I'm struggling to see how for eg they got to a monthly profit of $100k for Tier 1 product in Q1. I would assume that $100k is the profit for the whole year for Tier 1 [ (2+2+2+4)TB x 1000GB x $10 ]. What is the bit of insight/info I'm missing?

2) Is the formula they've quoted as “discount in perpetuity formula” just the Present Value (of an asset/company) in perpetuity? So PV = free cash flow / discount rate - growth? Is this a commonly used formula? I've not seen it before, and not sure I've understood it correctly. Can I use this simplified version in future cases?

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Anonymous updated the answer on Sep 21, 2023

Dear,

Thank you for the questions. Let me see if I can be of help with the 2 points you mentioned.

Question 1

I see there might be a bit of confusion/unclarity here. At first, when I looked at the exhibit you posted, I was puzzled too. The exhibit title says “revenues in 2019” but instead here we have a quarterly split of the quantity Q of data protected sold by the company. As a side note, it is always helpful to insert a unit of measure in every chart we produce as consultants to facilitate team and client discussions. But apart from that, to crack the question “what are the revenues for our client?” we need to rely on the commonly known Revenues = Price * Quantity formula, where the quantity is given in the quarterly chart per tier (1,2, and 3) and the subscription price is given in the case instructions. However, there is also a unit of measure mismatch to factor in: prices per tier are in $/GB per month, while the quantity Q (in the chart) is in TB. 

Hence, we can say that the numbers in the chart represent the quarterly quantities of TB sold per tier (it’s not obvious, I would assume that in a mock interview, you may need to ask some clarifying questions to arrive at this conclusion). For example, in Q1 the company sold 2TB of data to Tier 1 subscriptions (i.e. 0.67TB on average per month) that, considering $10/GB per month, should be equal to $20,000 revenue at run rate (i.e., from the year after) thanks to that quarter sales.

So, the logical steps to follow to discover the yearly total revenues would be:

1. Sum the quantity Q sold in each quarter per tier to come up with the total Q

Q(Tier 1) = 2 + 2 + 2 + 4 = 10 TB

Q(Tier 2) = 2 + 7 + 8 + 8 = 25 TB

Q(Tier 3) = 10 + 10 + 10 + 10 = 40 TB

2. Transform the quantity Q from TB to GB (x1,000 multiplier) 

Q(Tier 1) = 10,000 GB

Q(Tier 2) = 25,000 GB

Q(Tier 3) = 40,000 GB

3. Multiply the Q per tier with the related P ($/GB per tier) to obtain the total revenues

R (Tier 1) = 10,000 GB * $10/GB = $100,000

R (Tier 2) = 25,000 GB * $8/GB = $200,000

R (Tier 3) = 40,000 GB * $5/GB = $200,000

Total R = $100,000 + $200,000 + $200,000 = $500,000

Now, other key info here hidden in the sentence “assume these are all inclusive profit numbers” is that these revenues translate directly and surprisingly into profits (i.e. no costs to consider).

Also, another key factor to consider is that these are subscriptions, not one-off revenues. Hence, the total revenues will be much higher than $500,000 since each month we'll get something from these subscriptions. From next year, assuming no other subscriptions will be sold, $500,000 will be the monthly revenues generated by the company. This number multiplied by 12 months will give us the yearly revenue ($6,000,000) at run rate.

Note: the yearly revenue for the year reported in the chart is a value between $500,000 and $6,000,000. To calculate it, we would need to know the exact point in time of each sale to understand how many months of subscriptions for each TB sold generated revenues.

Question 2

The perpetuity formula you posted is widely used in business. It’s simplistic but mathematically proven (and adopted). There are tons of caveats behind it, but it could be used as a first tool to have a first estimate of the present value of future cash flows generated by a company

In a nutshell, what the formula says is that if you assume to have a business that will:

  • Operate infinitely in the future (i.e. it will never end)
  • Have Cash Flows (CFs) that will grow every year at a constant rate G
  • Have a defined and known Cost of Capital

You can obtain the present value of the sum of all the future Cash Flows by dividing yearly Cash Flows at T0 by the cost of capital minus the growth rate.

If g = 0 (i.e. the company will always have constant cash flows going forward), the perpetuity formula will simply be CF/cost of capital.

Final note to know: it's not always true that Profits = Cash Flows. I'd say that 99.9% of the time they are completely different concepts. In this case, you're using profits as a proxy of cash flows which is fine in a case like this but it's important to know for your future career that this is a wrong approach.

Please let me know if I have cleared your doubts!

Feel free to ping me if you want to discuss this further.

Best,

Antonio

(edited)

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Anonymous A on Sep 19, 2023

Thank you so much for your response. See for Q1 there's still a missing link that I don't understand and which I can't see in your answer. So you showed the working out for the yearly cost am I right? So total costs is $500k (I'm assuming your $600k is a simple typo!). In the question guidance they then go on to multiply this by 12 as this is the *monthly* cost apparently! Which leaves $6mil as the yearly costs. This is what I don't understand - I managed to get to $500k, but I can't understand how they got to $6mil yearly cost. How can $500k be the monthly costs when we've added up all the data sold across the year to arrive at this number?! Do you think this might be an error in the book?

Anonymous on Sep 21, 2023

Dear, thanks for pointing this out and apologies for, indeed, the typo :) Answer above updated accordingly. Regarding your additional question, I definitely see your point. And I understand the unclarity. Without knowing much more about the case, my first guess might be that the case creator is projecting yearly revenue at a run rate. In other words, taking this year standalone, we know we sold X TB of data for the different tiers. Hence, starting from next year we know that we will have a monthly recurring revenue equal to $500,000 (because we sold in the past year, and we earn each month from them). Therefore, multiplying $500,000 by 12 will produce the projected yearly revenue at run rate

Ian
Expert
Content Creator
replied on Sep 19, 2023
#1 BCG coach | MBB | Tier 2 | Digital, Tech, Platinion | 100% personal success rate (8/8) | 95% candidate success rate

Hi there,

Antonio has already provided a fantastic answer!

I highly recommend you use rocketblocks for further practice - they have tons of charts/exhibits in case context and with explanations!

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Cristian
Expert
Content Creator
replied on Sep 19, 2023
#1 rated MBB & McKinsey Coach

Hi there!

I see you've gotten an excellent answer already.

Sharing a resource that you might find helpful - a collection of all the most common terms that show up in consulting interviews:


Best,
Cristian

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