Series 86 common mistakes
Series 86 · Understand the traps and how to avoid them.
Computes enterprise value as market capitalization plus total debt and then divides by EBITDA without subtracting cash and cash equivalents.
The candidate memorized only part of the EV formula and under time pressure omits the cash offset and other claims such as preferred stock and minority interest.
What to do instead
Write the full bridge before calculating: EV = market cap + total debt + preferred stock + minority interest - cash and equivalents. Verify each line against the most recent balance sheet and check that the numerator matches the metric being used.
Discounts free cash flow to the firm at the cost of equity, or discounts free cash flow to equity at WACC.
The candidate conflates the two cash flow definitions and applies whichever discount rate was most recently practiced.
What to do instead
State the cash flow definition first: FCFF is discounted at WACC because it belongs to all capital providers; FCFE is discounted at the cost of equity because it belongs only to shareholders. Label the model before entering formulas.
Sets the terminal growth rate equal to or above WACC in a Gordon growth terminal value calculation.
The candidate plugs in a high growth rate to justify a target price without checking the mathematical constraint that g must be less than WACC.
What to do instead
Cap terminal growth at a sustainable long-run rate, typically at or below nominal GDP growth. If the implied g is at or above WACC, switch to an exit multiple approach or lower g and revisit the forecast assumptions.
Uses book values of debt and equity as the weights in WACC because they are readily available on the balance sheet.
The candidate takes the shortcut of reading the balance sheet rather than estimating market values, especially for equity.
What to do instead
Use market value of equity (share price times diluted shares) and market value or yield-based value of debt. Compute weights from those market values and document the source of each input.
Compares a P/E multiple from one company directly with an EV/EBITDA multiple from another and treats the comparison as meaningful.
The candidate treats all multiples as interchangeable without matching the numerator's claim on value to the denominator's earnings measure.
What to do instead
Pair equity multiples (P/E, P/B, P/FCFE) with equity values and enterprise multiples (EV/EBITDA, EV/EBIT, EV/Sales) with enterprise values. Convert or select comparables that use the same multiple definition.
Computes diluted EPS using basic shares outstanding and ignores in-the-money options, warrants, and convertible securities.
The candidate defaults to the share count reported on the income statement face without working through the dilution schedule.
What to do instead
Apply the treasury stock method for options and warrants and the if-converted method for convertible debt and preferred. Reconcile basic to diluted shares and confirm the diluted count used in per-share valuation.
Uses reported net income as the forecast free cash flow without adding back non-cash charges or subtracting capital expenditures and changes in net working capital.
The candidate equates accounting profit with cash generation and skips the reconciliation because it is time-consuming.
What to do instead
Build free cash flow from NOPAT or net income: add back depreciation and amortization and other non-cash charges, subtract capital expenditures and the increase in net working capital. Tie each adjustment to the forecast balance sheet.
Accepts price and financial data from a single vendor feed without checking for stock splits, dividend adjustments, or restatements.
The candidate trusts the first data source under exam time pressure and does not cross-validate adjusted versus unadjusted series.
What to do instead
Compare the price series to a second source, confirm split and dividend adjustment history, and reconcile reported financials to the latest 10-K or 10-Q. Flag any unexplained discontinuity before using the data.
Forecasts revenue growth and margins on the income statement without linking working capital and capital expenditure drivers, so the projected balance sheet does not balance.
The candidate builds a single-statement model and treats the balance sheet as an afterthought.
What to do instead
Build an integrated three-statement model with explicit drivers: days sales outstanding, inventory days, days payable, capex as a percentage of sales or depreciation, and a revolver or cash plug. Check that assets equal liabilities plus equity in every forecast period.
Selects comparable companies solely by industry label and uses the simple average of their multiples without screening for size, growth, margin, or capital intensity.
The candidate prioritizes speed and a familiar industry name over comparability analysis.
What to do instead
Screen peers on revenue size, growth rate, EBITDA margin, capital intensity, and capital structure. Use median or harmonic mean to reduce outlier distortion, and document why each comparable was included or excluded.