Interview questions can be broken into two categories: behavioral questions and technical questions. Behavioral questions consist of anything regarding your story, resume, previous experiences, or background in general. Typically, these questions do not necessarily have a “right” answer. Technical questions, on the other hand, usually have a correct answer. These questions consist of anything regarding different valuation methods, finance concepts, accounting concepts, and so on. Let’s explore several examples of both types of questions below.
Why do you want to go into banking?
Example 1. I want to pursue a career that is rewarding and challenging. I enjoy digging deep into analysis and learning a lot about a company/industry, especially in the context of a pending deal. I am a driven individual and entering banking will surround me with other hard workers.
Example 2. TBD
I could say that about a dozen jobs. Why banking specifically?
Although many careers have hard workers, banking specifically avoids the “40 hour a week” office mentality. It is very merit based and I know I can produce in pressure situations. The work seems engaging and again, I have a high level of interest specifically in learning about transactions.
How will you feel when I tell you that you need to stay and make edits to a pitch at 2am?
I feel if anyone told you they would enjoy staying past 2am on a regular basis they would not be telling the truth. At the time I would probably prefer to go home than stay at the office. However, I would look at the situation from a big picture viewpoint and realize that in the longer term, I am adding value to a potential transaction and helping out your firm. I want to be the best employee possible and add value to the company, and this would motivate me to stay at the office and continue producing high quality work at any hour necessary.
What are the different ways to value a company?
The four main ways to value a company include discounted cash flow (DCF) analysis, comparable company analysis, comparable transaction multiples, and leveraged buyout (LBO) analysis.
Which comparable method produces a higher valuation and why?
Transaction multiples typically produce a higher valuation because the buyer is paying an “acquisition premium” – the buyer pays extra to purchase a controlling number of shares compared to the public markets where buyers are investing minority stakes in the companies.
Walk me through a DCF in 15 seconds
A DCF involves first forecasting the free cash flows of the business for a certain period of time, for example five years. After this period of time, we must calculate a terminal value. This represents our estimate of the value at year five of all future cash flows of the business. Finally, we need to turn all these future cash flows into a “present value”. To do this we discount all cash flows at the weighted average cost of capital.
How do you calculate unlevered free cash flow?
Free cash flow is EBITDA, less tax, less capital expenditure, plus/minus changes in net working capital.
Why do you subtract increases in working capital when calculating free cash flow?
When working capital increases things such as inventory will increase, A/R will increase, and A/P will decrease. All of these items do not impact the income statement, but they do decrease cash (e.g. you pay cash for inventories, you pay cash to decrease A/P, and you get less cash than sales dollars when A/R increases). You must account for these decreases when thinking about total free cash flow.
What is WACC?
WACC stands for the weighted average cost of capital. It is the discount rate typically used to bring cash flows to a present value in a DCF model. It represents the blended cost of capital to debt and equity holders. The formula for WACC is:
How do you calculate cost of equity?
We calculate cost of equity using a model such as CAPM. The CAPM states that the cost of equity is the risk free rate plus the company’s beta times the market risk premium. Risk free rate is generally a long term US treasury rate and beta is the company’s riskiness compared to the overall market.
What is a larger part of the value, forecasted cash flows or terminal value?
This depends. Typically, terminal value is a larger part of the value calculation for a firm because it takes into account all future years of the business as opposed to just five future years. However, forecasted cash flows are sometimes a larger component of value. For example, a startup may have an extremely high discount rate so its cash flows after five years have little value. Another example is a pharmaceutical company that has expiring patents and thus very few projected cash flows after the forecasted period.
How do you calculate terminal value?
There are two main ways to calculate terminal value. One is to use a terminal multiple. We look at a metric (such as EBITDA) in our year five projections and multiply it by an appropriate multiple. We can find this multiple by using comparable public companies.
Alternatively, we can use the perpetuity growth method. We assume a growth rate beyond the projection period and multiply this by last projection year’s cash flow (e.g. year 5’s cash flow * (1 + growth rate)). We then divide this number by (discount rate – growth rate).
What if (r-g) is equal to zero?
In the context of the equation it does not make sense because we cannot divide by zero. In the real world this means our projected growth rate is the same as our discount rate (WACC). We have to re-examine our assumptions. Maybe our long term growth rate is too optimistic – it should generally be conservative (such as the GDP growth or inflation). If we feel confident in our growth assumptions and in our WACC, then our model does not work in this case and we should use the terminal multiple method to arrive at our terminal value instead.
What are the five drivers of an LBO model?
The five drivers of an LBO model are purchase price (entrance multiple), sales price (exit multiple), free cash flows, duration of the investment period, and capital structure (financing the deal with debt vs. equity).
What are some typical sources of cash in an LBO transaction?
Typical sources of cash include current cash, term loans (bank loans), subordinated notes / bonds, revolving line of credit, and management equity.
What are some typical uses of cash in an LBO transaction?
Typical uses of cash include payment to the current owners/management, financing costs, transaction costs, funding of cash balance, and pay down of existing debt.
Would you use EV/Earnings as a valuation metric?
No. This is not an “apples-to-apples” comparison. Enterprise value is a measure of value for both debt and equity holders so it is theoretically not dependent on the capital structure. However, earnings include things such as interest so it is dependent on the firm’s capital structure. Thus, changing capital structure can greatly distort a multiple such as EV/Earnings even if nothing has fundamentally changed about the company. It does not make sense to use a valuation metric that includes one unlevered measure and one levered measure.
Why do you use EBITDA as a valuation metric?
EBITDA multiple excludes interest payments (so is capital structure neutral), taxes, which are subject to manipulation and don’t reflect underlying operations, and depreciation, which again, isn’t necessarily the result of current core operations. Overall, EBITDA margin reflects profitability of core operations.
What are three financial statements and how do they link together?
Three financial statements are income statement, balance sheet, and cash flow statement. Net income from the income statement is used to calculate the retained earnings that later go to the balance sheet. Net income is also used to calculate cash flows for the current year. Furthermore, changes in current assets and liabilities are reflected in operating cash flow section on the cash flow statement. Total cash flows are then added to the cash account on the balance sheet.
What is the difference in equity and debt?
Equity means having ownership in the firm. It is the riskiest type of investment but also with the greatest upside.
Debt means borrowing money and hoping to get it back with some interest payments on top. Debt is a safer investment than equity because if anything goes wrong with the company, debt-holders get paid first. However, if things go well, debt-holders’ upside is capped by the amount of interest they charged the borrower.