300-Question Guide
Investment Banking
Questions from Real Interviews
The Most Complete Finance Interview Guide
By: Josh Jia, Wasiq Wadud, Dean Ponce
About Us
About the Author
Josh Jia has always been passionate about teaching and helping
aspiring investment banking and private equity professionals
achieve their dreams. His passion for finance began in high school
at the end of 2007, where he heard a tip on a podcast to short
homebuilders. He ended up placing first in a provincial stock market
competition and winning a scholarship, which was the beginning of
Josh’s interest in finance. He started an investment club at Queen’s
University called Limestone Capital, which has grown to an alumni
base of 150+ people around the world. Using this platform, Josh
built the first finance interview prep course at Queen’s University,
which included 6 classes and a 250 slide package.
During his time in investment banking (BMO) and private equity
(Imperial Capital), Josh has accumulated significant transaction
experience, including the C$300M IPO of Sleep Country, the
US$156M acquisition of Atlas Paper by Resolute Forest Products,
and an extensive private equity roll-up of food testing labs in the
U.S. Having worked closely with the sell side and buy side alike,
Josh knows exactly how to position candidates for success both for
the short term and the long term, and is eager to provide coaching
and share his resources in the areas of investment banking and
private equity, as well as professionals or students transitioning to
management consulting.
For fun, Josh can be found watching a Raptors game, playing chess
and Settlers of Catan, or doing performance poetry.
About the Publisher
Quarter is a group of small professionals led by James Bortolus with
graphic design from Kynan Desouza.At Quarter we have a mantra:
we believe small and medium sized businesses are the agents of
change in the world; And we want to be part of that story.
Successful branding is ensuring all your business’ marketing
elements and customer touchpoints are consistent, clear, and
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worked with Josh’s team to shape his marketing assets/ resources
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To be able to curate and work with Josh and his team on this
brand and resource has been nothing but a joy. Thank you Finance
Interview Coach!
We would also like to thank Alexander Banh and Martin Dijkhuizen
for their contributions.
Table of Contents
Behavioral & Fit - IB
pg. 5
Asked to determine if the
candidate is able to: work
under high pressure, apply
high atention to detail, tell an
engaging story, demonstrate
high motivation, and if they
have the skills to do the job
Market Knowledge - IB
pg. 65
Questions about market
knowledge are frequently
asked; this section covers stock
pitches, market forecasts, as
well as the investment banking
deal process
Accounting - IB
pg. 82
These questions test the
candidate’s understanding of
critical accounting concepts
and how they impact the three
financial statements
Enterprise Value /
Comparables - IB
pg. 138
These questions are asked to
test the candidate’s knowledge
on critical concepts such as
enterprise value and relative
valuation metrics
3
Table of Contents
DCF - IB
pg. 185
These questions are asked
to test the candidate’s
understanding of discounted
cash flows with both unlevered
and levered cash flows
M&A - IB
pg. 235
These questions test the
candidate’s understanding
of Mergers and Acquisitions,
including accretion / dilution
calculations and merger models.
Leveraged Buyouts - IB
pg. 282
These questions test the
candidate’s understanding
of leveraged buyouts (LBOs),
including LBO modeling and
IRR calculations
Other Questions: IB + PE
pg. 330
This section covers consulting
style questions that are
sometimes asked in finance
interviews, as well as some
questions asked in PE.
4
Section One
Behavioural
& Fit
5
Section 1: Behavioural & Fit - Question 001
Behavioural
& Fit
pg. 5
Next Question:
Walk me through your resume
/ tell me about yourself?
Why investment
banking?
Really why
investment banking?
Why work for
this firm?
What is your
greatest strength?
You want to tell a story about how you became interested in finance,
how you developed your professional experience and provide a
specific, step-by-step quantitative and qualitative breakdown of those
experiences. Finally, you want to conclude with why you are here today.
Market
Knowledge
pg. 65
Accounting
The reason it’s important to explain your story step-by-step is so the
pg. 82
interviewer knows that you really did the work, put some thought into the
process, and also are able to take a step back to see the bigger picture.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
Your story should be 1.5-2.5 minutes long.
pg. 185
Here’s an example of an abbreviated story which captures all these
elements:
Mergers &
Acquisitions
I was born in ABC city, and growing up I liked to play a lot of basketball
Leveraged
Buyouts
pg. 235
pg. 282
and football. One day, my basketball coach, who was also a business
teacher, encouraged me to compete in a provincial stock market
Other
Questions
competition, and I ended up placing 1st. This really piqued my interest
pg. 330
infinance, so I went to XYZ University to study Commerce. After joining
an investment club, I learned a lot about financial analysis, valuation, and
modeling, which I really enjoyed doing. For example, I recently worked
on a pitch which involved
gather
types of analysis. This required me to
, breakdown the cohort analysis to find the right multiples
for a sum of parts analysis. My passion for finance led me to an internship
at abc firm, where I got to work on a project which involved
.
I’ve really enjoyed the privilege of learning so much about finance in a
short time, which it what has led me here today.
Behavioural
& Fit
Market
Knowledge
6
Section 1: Behavioural & Fit - Question 002
Behavioural
& Fit
pg. 5
Next Question:
Why do you want to enter
investment banking?
Really why
investment banking?
Why work for
this firm?
What is your
greatest strength?
There are generally two approaches to this question. You can list a
What are your 3
greatest strengths?
number of reasons (e.g. 3) and explain each reason. This approach is the
most easy and logical. However, you can also tella story about how you
became interested in investment banking, and mention a few concrete
reasons during the story.
Market
Knowledge
pg. 65
Accounting
pg. 82
There are many reasons one may wish to enter investment banking,
including:
Enterprise Value
/ Comparables
pg. 138
•
Discounted
Cash Flow
Opportunity to work and learn from the smartest people
pg. 185
•
Ability to execute a large amount of transactions and learn the deal
process inside and out
Mergers &
Acquisitions
pg. 235
•
Passion for finance; IB provides exposure to sophisticated deals as
well as financial modeling
Leveraged
Buyouts
pg. 282
•
Fast-paced environment
•
Collegial team environment
•
Meritocracy; people who “sharpen their teeth” move up
•
More responsibility than almost any other entry level job
•
Passion for client presentation: as you move up, your job becomes
Other
Questions
pg. 330
more and more like asales role, since you spend a lot of time pitching
potential deals to large corporations
It is a faux-pas to say you just want to go into IB to go to PE or some
other exit opportunity.
Behavioural
& Fit
Market
Knowledge
7
Section 1: Behavioural & Fit - Question 003
Behavioural
& Fit
pg. 5
Next Question:
Why do you REALLY want to do
investment banking?
Why work for
this firm?
What is your
greatest strength?
What are your 3
greatest strengths?
Sometimes firms will ask this same question again to dive into your real
What is your
greatest weakness?
intentions, especially in superdays. Stay calm, and explain your points
perhaps in a different manner, showing how you’re hungry and eager
to learn and that’s what drives you. You can be more honest in this
answer, but once again, focus on what you will gain from the job and
not exit opportunities.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
01
Leveraged
Buyouts
Interview Tip:
pg. 282
Other
Questions
For a formal workplace, wear a
dark-colored suit. For women
pg. 330
this can be a tailored dress with
matching jacket or suit pants or
skirt with matching jacket. For
men, this means suit pants and
jacket with a button down shirt
and tie.
Behavioural
& Fit
Market
Knowledge
8
Section 1: Behavioural & Fit - Question 004
Behavioural
& Fit
pg. 5
Next Question:
Why this firm?
What is your
greatest strength?
What are your 3
greatest strengths?
What is your
greatest weakness?
To master the “why this firm” question, it’s best to speak to somebody
What are your 3
greatest weaknesses?
in the firm to ask what they like about the firm, and what the people
in the team are like. It’s very hard to tell the true culture or strengths of a
specific group in a specific bank.
pg. 65
Accounting
You should split your answer into two:
•
pg. 82
The strategic / execution advantages of the group and bank you’re
Enterprise Value
/ Comparables
pg. 138
interviewing for
•
Market
Knowledge
Mention industries / groups they are strong in, you can find this in
league tables which display the rankings of the banks in various
categories (e.g. #1 in cannabis, #1 in metals and mining, etc.). These
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
league tables are easily accessible online or on Bloomberg.
Leveraged
Buyouts
•
The people, team and approach of the bank. For example, you may
learn after speaking with an Associate that the seniors invests
in its juniors and have regulartouchpoints etc. This can only be
pg. 282
Other
Questions
pg. 330
deciphered by talking to people in the group and bank, but failing
that, you can always make some generic points about collegial
atmosphere, meritocracy, plenty of training, infrastructure and
support, etc.
Speaking about the people, team and approach is especially important
when it comes to big offices vs smaller offices. Big offices have more
infrastructure, deals, and more best practices. Smaller offices will have
leaner teams, more responsibility (Analyst acts more like an Associate),
unique industry positioning (sometimes), but usually less deal flow with
the exception of elite boutiques.
Behavioural
& Fit
Market
Knowledge
9
Section 1: Behavioural & Fit - Question 005
Behavioural
& Fit
pg. 5
Next Question:
What is your greatest strength?
What are your 3
greatest strengths?
What is your
greatest weakness?
What are your 3
greatest weaknesses?
This is a personal question and you should generally just be honest
What is your
biggest failure?
about your greatest strength, but make sure the wording is right.
Passion, attitude, leadership, intellectual curiosity, work ethic, resilient;
the list goes on. Don’t say something that makes you seem cocky, like
intelligence (everybody in IB is intelligent to some degree).
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
02
Leveraged
Buyouts
Interview Tip:
pg. 282
Other
Questions
Make sure to include a range of
strengths, including knowledge-
pg. 330
based skills, transferable
skills, and personal traits to
demonstrate your versatility.
Behavioural
& Fit
Market
Knowledge
10
Section 1: Behavioural & Fit - Question 006
Behavioural
& Fit
pg. 5
Next Question:
What are your three greatest
strengths?
What is your
greatest weakness?
What are your 3
greatest weaknesses?
What is your
biggest failure?
Similarly, you should just be relatively honest about your three greatest
What is your biggest
challenge?
strengths, while avoiding cocky answers like intelligence. Even if you are
intelligent, you can always use a more specific and professional term,
such as analytical. Passion, attitude, leadership, intellectual curiosity,
work ethic, resilient are some examples. It’s better to be mostly honest
so it’s easier to justify your strengths with examples if asked further.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
03
Leveraged
Buyouts
Interview Tip:
pg. 282
Other
Questions
If you’re struggling with how to
find your strengths, ask a close
pg. 330
friend or former colleague to help
you or draw upon feedback from
previous performance reviews.
Behavioural
& Fit
Market
Knowledge
11
Section 1: Behavioural & Fit - Question 007
Behavioural
& Fit
pg. 5
Next Question:
What’s your greatest weakness?
What are your 3
greatest weaknesses?
What is your
biggest failure?
What is your biggest
challenge?
Contrary to popular belief, you do want to give a real weakness
What is your greatest
achievement?
instead of a “fake” weakness. However, you must frame it in a way that
shows you have a strong awareness about this weakness, and have
made significant steps to improve.
Market
Knowledge
pg. 65
Try to avoid cheesy weaknesses like “work too hard.” Weaknesses like
“focus too much on the details, lose sight of the bigger picture”, “need to
be more thoughtful about when to speak up and when not to”, “learning
how to prioritize the right kind of work” etc. are some examples of real
weaknesses that also aren’t a deal breaker since they’re easily fixable.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Avoid red flag weaknesses like “lose motivation sometimes”, “lack
attention to detail”, etc. since motivation and attention to detail are core
elements of the job. Then tell a story about how you improved it.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
12
Section 1: Behavioural & Fit - Question 008
Behavioural
& Fit
pg. 5
Next Question:
What are your three greatest
weaknesses?
What is your
biggest failure?
What is your biggest
challenge?
What is your greatest
achievement?
List 3 weaknesses, such as the ones mentioned above, and say 2-3
Example: Time you
showed leadership.
sentences about each one. You want to show you are aware of what
the weakness is and can describe it, but can also demonstrate that
you have made steps to improve each weakness.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
04
Leveraged
Buyouts
Interview Tip:
pg. 282
Other
Questions
Be modest. You need to appear
humble and willing to learn
pg. 330
without scaring off the hiring
manager with a monumental
weakness that you can’t
overcome.
Behavioural
& Fit
Market
Knowledge
13
Section 1: Behavioural & Fit - Question 009
Behavioural
& Fit
pg. 5
Next Question:
What’s your biggest failure?
What is your biggest
challenge?
What is your greatest
achievement?
Example: Time you
showed leadership.
You can be pretty honest with this as long as it’s not a red flag failure.
Example: Resolved a
disagreement.
Whether it’s a failing business, not getting into a sports team, losing
track of your career direction for awhile, or net getting the grades you
wanted, any answer is fine as long as it shows how you bounced back
from it. You are trying to tell a story about how resilient you are and how
you’ve improved. Obviously avoid red flag failures like substance abuse,
etc.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
14
Section 1: Behavioural & Fit - Question 010
Behavioural
& Fit
pg. 5
Next Question:
What’s your biggest challenge?
What is your greatest
achievement?
Example: Time you
showed leadership.
Example: Resolved a
disagreement.
Big challenges could either be related to work, life, and school. Try
Example: Working
towards a goal
to find a more positive story and ending; for example, maybe you
really struggled to start an investment club at first because of a lack of
connections, but once you found the right people and started gaining
confidence and clout, things started improving far beyond what you
could have imagined.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
05
Leveraged
Buyouts
Interview Tip:
pg. 282
Other
Questions
Making it seem like you never
had any challenges or struggles
pg. 330
won’t make you look like some
kind of suave champ. It’ll make
the interviewer think you’re
being dishonest.
Behavioural
& Fit
Market
Knowledge
15
Section 1: Behavioural & Fit - Question 011
Behavioural
& Fit
pg. 5
Next Question:
What’s been your greatest
achievement?
Example: Time you
showed leadership.
Example: Resolved a
disagreement.
Example: Working
towards a goal
Usually, this will be more life or school related since it comes off as
Why work in
this city?
more interesting and genuine. Tell a connected story with a beginning,
middle, and end. If it’s work related, explain why it’s your greatest
achievement; for example, maybe you impacted the community positively
or brought greater awareness about something.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
16
Section 1: Behavioural & Fit - Question 012
Behavioural
& Fit
pg. 5
Next Question:
Tell me about a time you showed
leadership.
Example: Resolved a
disagreement.
Example: Working
towards a goal
Why work in
this city?
Any leadership story works, ranging from sports to the arts to school to
What do you enjoy
doing for fun?
work. The key is to explain how you obtained the leadership position,
the challenges you and your team faced, and how you helped the team
overcome the challenge and achieve a result. Say “we” instead of “I”
more.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
06
Leveraged
Buyouts
Interview Tip:
pg. 282
Other
Questions
This question allows you to
define good leadership in your
pg. 330
own words. Showcase skills
and qualities such as patience,
active listening, empathy,
positivity, reliability and team
building.
Behavioural
& Fit
Market
Knowledge
17
Section 1: Behavioural & Fit - Question 013
Behavioural
& Fit
pg. 5
Tell me about a time you
disagreed with somebody in your
team, and how you resolved it.
Next Question:
Example: Working
towards a goal
Why work in
this city?
What do you enjoy
doing for fun?
Good examples are disagreements in a school or work project, or a
What were you like
in high school?
disagreement within an organization about strategic direction. Try to use
more positive language, rather than critical language. For example,
instead of saying the leader was egotistical, you could say that their
approach wasn’t the optimal way to do things, etc.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
18
Section 1: Behavioural & Fit - Question 014
Behavioural
& Fit
pg. 5
Next Question:
Tell me about a time you worked
with a team to achieve a goal.
Why work in
this city?
What do you enjoy
doing for fun?
What were you like
in high school?
The key here is to focus on “we” instead of “I.” Explain the team’s
VP vs MD, what project
do you work on?
goal, how your role helped the team advance to this goal, and how you
communicated within the team to ensure alignment. It’s good to describe
some challenges within the team, but use positive language rather than
critical language.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
19
Section 1: Behavioural & Fit - Question 015
Behavioural
& Fit
pg. 5
Next Question:
Why do you want to work in
XYZ city?
What do you enjoy
doing for fun?
What were you like
in high school?
VP vs MD, what project
do you work on?
This question is usually only asked to people who grew up or currently
VP vs MD, what project
do you work on? Pt.2
live outside the city. It definitely helps if you have friends, family, or some
other sort of history within the city. Even if you don’t, try to tell a story
about how the city makes a lot of sense for you and all the life and
career advantages it holds.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
20
Section 1: Behavioural & Fit - Question 016
Behavioural
& Fit
pg. 5
Next Question:
What do you like to do for fun?
What were you like
in high school?
VP vs MD, what project
do you work on?
VP vs MD, what project
do you work on? Pt.2
The purpose of this question is just to see if you’re a fun person to be
What’s something not
on your resume?
around, and also to understand what your personality is like outside
of the office. List some hobbies, no need to go overboard for this. They
want to make sure you’re interesting, but no need to go on a detailed
rant about your road trip. Everybody has hobbies, whether it’s sports,
traveling, art, or more obscure things like collecting antique coins. Just
find some genuine things you like.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
21
Section 1: Behavioural & Fit - Question 017
Behavioural
& Fit
pg. 5
Next Question:
What were you like in high
school?
VP vs MD, what project
do you work on?
VP vs MD, what project
do you work on? Pt.2
What’s something not
on your resume?
You can be pretty honest with this. For example, you can say how you
Walk me through XYZ
role on your resume.
used to be more introverted, and describe quickly how you’ve grown
since then into a polished professional today.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
22
Section 1: Behavioural & Fit - Question 018
Behavioural
& Fit
pg. 5
If a VP tells you to work on a file in one way, and
an MD tells you to work on a file and another
way, who do you listen to? Both of them just
jumped on a flight and can’t be reached.
Next Question:
VP vs MD, what project
do you work on? Pt.2
What’s something not
on your resume?
Walk me through XYZ
role on your resume.
First, you want to try to understand the context of the file, the
Walk me through XYZ
M&A deal
companies / industries involved, the client’s goals, and the pros and
cons of the VP’s method and the MD’s method. Then you should
consult with other colleagues about what the best practice is, especially
colleagues within the relevant group(s).
Market
Knowledge
pg. 65
Accounting
pg. 82
If you are the only person in the office, then you need to make a
judgement on which method makes the most sense. How close the VP
is to the file vs. the MD is also a factor to consider. However, if you can’t
glean any additional insights into the project, and are not confident if one
way is better than another, you should go with the MD’s method since
they are more senior and have more experience.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
23
Section 1: Behavioural & Fit - Question 019
Behavioural
& Fit
pg. 5
A VP drops work on your desk that requires 2 hours and says he
needs it in two hours, and before you can say anything, he leaves
because he is catching a flight. Then the MD comes by and drops
work on your desk that also requires 2 hours, and he says he
needs it in two hours. Both the VP and MD are now on a plane and
you cannot contact them. Whose work do you do? How do you
deal with this situation?
Next Question:
What’s something not
on your resume?
Walk me through XYZ
role on your resume.
Walk me through XYZ
M&A deal.
Similar to the previous question, you need to understand the context of
What makes a good IB
analyst at our firm?
the file, the companies / industries involved, the client’s goals, and the
relative importance and urgency of each client’s deliverable. To get this
information, you can ask your colleagues who are either staffed on the
file or work in a similar industry/product group. Based on their insights,
you may be able to decide on the best approach, which may be to work
on the most important and urgent deliverable, or simplify the work so
that both files can be completed. If you are the only person in the office,
you contact another colleague at different office or city that may also
be working on the deal or the same industry / product group.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
If none of these methods work, and you feel like you don’t have the
seniority and expertise to decide which file to work on yourself (which
may very well be true if you are just an analyst), then you should most
likely try to do the MD’s work as quickly as possible and offer an
explanation to the VP through email, as well as phone when he lands.
This is because the MD will most likely be presenting to an important
client, and a senior’s ability to create materials on the fly is limited. The
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
VP is lower ranking in seniority, but is also closer to the analysis, so a VP
should in theory find it easier to build an ad-hoc solution. Of course, this
is still not ideal, and it’s better to use the solutions mentioned above.
Behavioural
& Fit
Market
Knowledge
24
Section 1: Behavioural & Fit - Question 020
Behavioural
& Fit
pg. 5
Next Question:
What’s something that’s not on
your resume?
Walk me through XYZ
role on your resume.
Walk me through XYZ
M&A deal.
What makes a good IB
analyst at our firm?
Any sort of extracurricular accomplishment, hobby, or achievement is
Name 3 historical
figures you would...
fair game. Whether it’s playing in a band or starting a Youtube, anything
is great as long as it’s interesting and shows a positive side of you.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
07
Other
Questions
pg. 330
Interview Tip:
Whatever that thing might be,
make sure it’s targeted toward
the specific role and make sure
you’ll be able to talk about it
for at least a few minutes. You
want to state the thing, then
back it up with details.
Behavioural
& Fit
Market
Knowledge
25
Section 1: Behavioural & Fit - Question 021
Behavioural
& Fit
pg. 5
Next Question:
Walk me through your role on
XYZ item on your resume.
Walk me through XYZ
M&A deal.
What makes a good IB
analyst at our firm?
Name 3 historical
figures you would...
First, you want to introduce the context. Explain what the firm does,
Why should we hire
you?
and why they needed you to work on a particular project. Explain what
you did in the project in as much detail as possible, making sure you
cover key numerical metrics, team dynamic / style, how you overcame
challenges, and how your work generated results for the team and for
the company.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
Here’s an example:
pg. 138
Company A provides exam prep sessions for universities all across
North America. They needed a manager to run their marketing and
operations on ABC campus, and so I was hired for the role after a series
of interviews. After I finished training, I worked with the CEO and CFO to
build a marketing plan which involved flyers, posters, social media, and
partnerships with key student groups. For example, for the ECON exam, I
was responsible for coordinating with the instructor, hiring marketers and
people to operate the front desk, ensuring the materials were delivered
properly and on-time, and managing the venue’s opening and closing.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
This broad array of responsibilities has helped me develop my leadership
skills, marketing and presentation skills, as well as my communication
skills. Through my efforts, I was able to increase revenues by 25% year
over year, and management really appreciated the hard work I put in.
Behavioural
& Fit
Market
Knowledge
26
Section 1: Behavioural & Fit - Question 022
Behavioural
& Fit
pg. 5
Next Question:
Walk me through XYZ M&A deal
on your resume
What makes a good IB
analyst at our firm?
Name 3 historical
figures you would...
Why should we hire
you?
First, you want to introduce the context of the deal. Mention the size of
Why shouldn’t we hire
you?
the deal, then give a brief company overview of the target and acquiror,
and explain the strategic rationale behind the deal. This shows you have
a high-level understanding.
Market
Knowledge
pg. 65
Next, you need to explain every key part of analysis you performed in
great detail. Only with great detail can the interviewer be confident that
you were a strong performer.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
Here’s an example:
I worked on the ($___) acquisition of Company B by Company A. We advised
Company A, which is a diversified forestry company involved in lumber,
market pulp, and specialty paper based in ABC city. Since these segments
were facing significant slowdown, Company A wanted to expand into tissue,
which was a higher growth area and an attractive area to invest their excess
cash. Company B focused solely on the higher growth tissue segment, and
the company was located in XYZ city, so this was an opportunity to Company
A to expand both their product lines as well as break into new geographic
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
areas.
During the process, I was tasked with doing industry research to understand the competitive
dynamic in the tissue industry, as well as any risks or opportunities. I also worked on the initial
pitch to win the client, doing pro-forma merger analysis to demonstrate the value achieved.
When we had access to the dataroom, I performed intensive analysis on each product
line, and also built a production flowchart to analyze the flow of raw materials to finished
product. Finally, I built the operating model to arrive at an EBITDA forecast, and after building
precedents analysis, we were able to arrive at a multiple range. The implied price was similar
to what the client was expecting, and the deal closed after 4 months from start to finish; since
then, the client has had quite a bit of success in the tissue industry.
Behavioural
& Fit
Market
Knowledge
27
Section 1: Behavioural & Fit - Question 023
Behavioural
& Fit
pg. 5
Next Question:
What makes a good IB analyst
at our firm?
Name 3 historical
figures you would...
Why should we hire
you?
Why shouldn’t we hire
you?
The purpose of this question is to see if you understand what it takes to
5 uncommon things to
do with a brick...
excel in IB. Here are some examples of important traits:
•
Market
Knowledge
Strong work ethic
•
pg. 65
Necessary to survive the hours and stress of the business; IB
hours can be anywhere from 80 to 100 hours a week
•
pg. 82
Attention to detail
Enterprise Value
/ Comparables
•
Bankers need things both fast and accurately
•
Analysis must be completed and presented at a much higher
Positive, eager-to-help attitude
•
pg. 185
Very important since your managers are your “clients” in a way,
and attitude goes a long way to being well-liked
•
Organized
•
Good communicator
•
Strong at prioritizing deliverables
•
Intellectually curious: ask the right questions
pg. 138
Discounted
Cash Flow
standard than most people are used to
•
Accounting
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
28
Section 1: Behavioural & Fit - Question 024
Behavioural
& Fit
pg. 5
Next Question:
Name 3 historical figures you
would have dinner with.
Why should we hire
you?
Why shouldn’t we hire
you?
5 uncommon things to
do with a brick...
This is just a fun question that interviewers ask to get a sense of your
What’s your favourite
Excel shortcut?
personality and creativity.
There is no right answer, just answer 3 people that you genuinely
would like to have dinner with, whether it’s an artist, a music performer,
a Nobel prize winner, a civil rights activist, etc.
Market
Knowledge
pg. 65
Accounting
pg. 82
Make sure you can justify each answer.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
29
Section 1: Behavioural & Fit - Question 025
Behavioural
& Fit
pg. 5
Next Question:
Why should we hire you?
Why shouldn’t we hire
you?
5 uncommon things to
do with a brick...
What’s your favourite
Excel shortcut?
The interviewer is giving you a chance to perform an elevator pitch for
Stuck in an airport
with an associate...
why you should be hired. Your very first sentence should explain a few
reasons you should be hired, which is essentially a list of strengths work ethic, intellectual curiosity, attention to detail, good communicator,
etc.
Market
Knowledge
pg. 65
Accounting
pg. 82
Then you should give a quick example that demonstrates each of those
traits. Finally, you should close off by listing your strengths again and
emphasizing that you are highly motivated and would be very eager to
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
work and learn if hired.
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
30
Section 1: Behavioural & Fit - Question 026
Behavioural
& Fit
pg. 5
Next Question:
Why shouldn’t we hire you?
5 uncommon things to
do with a brick...
What’s your favourite
Excel shortcut?
Stuck in an airport
with an associate...
This is a trick question to test your confidence in being hired. Rather
Why not private
equity?
than making up reasons you shouldn’t be hired, you should say “there’s
no reason you shouldn’t hire me.” Then you can list the reasons why
they should hire you, similar to the answer above, and give examples for
each of those key reasons, before finishing off by listing the reasons you
should be hired again.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
31
Section 1: Behavioural & Fit - Question 027
Behavioural
& Fit
pg. 5
What are 5 uncommon things you
could do with a brick, not including
layering, bricking, or a paper-weight?
Next Question:
What’s your favourite
Excel shortcut?
Stuck in an airport
with an associate...
Why not private
equity?
This may seem like a strange and irrelevant question, but the interviewer
What if the PE gave
you an offer...
is just trying to test your creativity on the fly. Be ready for these types of
questions; as long as you are calm and patient, you can usually figure
them out. Feel free to tell the interviewer you need time to think.
Market
Knowledge
pg. 65
Accounting
5 uncommon uses for a brick are:
pg. 82
•
Ventilate a window
•
Fundraiser
•
Prop open a door
•
To study history (different types of bricks were used in the past)
•
As a measurement unit
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Of course, you can invent almost any usage for a brick, just be creative.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
32
Section 1: Behavioural & Fit - Question 028
Behavioural
& Fit
pg. 5
Next Question:
What’s your favourite Excel
shortcut?
Stuck in an airport
with an associate...
Why not private
equity?
What if the PE gave
you an offer...
A common answer to this would be any special paste functions, since
What’s been your
favourite course?
they are commonly used in banking.
For example, after copying a series of cells, you can use the special paste
function to paste only the format, or the numbers as an absolute value, or
column widths.
Market
Knowledge
pg. 65
Accounting
pg. 82
Any other shortcut is fine as long as it demonstrates your knowledge
Enterprise Value
/ Comparables
pg. 138
of Excel, and it’s not something that anybody would know.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
33
Section 1: Behavioural & Fit - Question 029
Behavioural
& Fit
pg. 5
If you were stuck in an airport with
an associate for four hours, what
would you want to do?
Next Question:
Why not private
equity?
What if the PE gave
you an offer...
What’s been your
favourite course?
This question is just trying to figure out how you would react in an
What’s a book you’re
reading?
unexpected and potentially stressful situation. Be realistic with your
answer.
Market
Knowledge
pg. 65
For example, you may wish to spend an hour or two to get some work
done, and when the work is done, you might go grab a bite with your
associate and relax and chat, and go over the logistics to ensure that all
the key team members and any other direct parties affected by the delay
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
are aware that you and your associate are running late.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
34
Section 1: Behavioural & Fit - Question 030
Behavioural
& Fit
pg. 5
Next Question:
Why not private equity?
What if the PE gave
you an offer...
What’s been your
favourite course?
What’s a book you’re
reading?
Although some candidates may be interested in private equity, it’s
Explain investment
banking to a 5 year old.
important to speak to your interest in investment banking.
The focus should be talking about all the advantages of investment
banking, rather than talking about the disadvantages of private
equity.
Market
Knowledge
pg. 65
Accounting
pg. 82
For example, maybe you enjoy the client presentation aspect of
investment banking, which requires you to understand what the client
wants and how the deliverable should be framed to maximize value.
The teams are generally much bigger and more collegial than in private
equity teams, which are usually quite smaller and have less junior
employees. The ability to learn quickly from a high volume of transactions
is another benefi t.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
35
Section 1: Behavioural & Fit - Question 031
Behavioural
& Fit
pg. 5
What if the PE gave you an offer
that paid more and also had less
hours; would you take it?
Next Question:
What’s been your
favourite course?
What’s a book you’re
reading?
Explain investment
banking to a 5 year old.
Even if you would rationally take the PE offer, it’s once again more
How would colleagues
describe you?
important to emphasize all the advantages of investment banking
and demonstrate a preference for investment banking. The client
presentation aspect of investment banking, the larger and more collegial
atmosphere, and the ability to learn quickly from a high volume of
transactions are all strong reasons for preferring investment banking to
private equity.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
To be fair, investment banking is generally a much more secure and
safe option outside of undergrad, since it gives you incredible latitude
in your career and your exit options are far more varied than in a private
equity shop. This is important since most people don’t know what a job is
like until they try it.
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
36
Section 1: Behavioural & Fit - Question 032
Behavioural
& Fit
pg. 5
What’s been your favourite
course?
Next Question:
What’s a book you’re
reading?
Explain investment
banking to a 5 year old.
How would colleagues
describe you?
Ideally this should be something finance related, and preferably
How would your boss
describe you?
a valuations based course or something that can be applied to
investment banking. Explain what makes the course interesting, and
what you’ve learned from it.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
37
Section 1: Behavioural & Fit - Question 033
Behavioural
& Fit
pg. 5
What’s a book you’re reading?
Next Question:
Explain investment
banking to a 5 year old.
How would colleagues
describe you?
How would your boss
describe you?
This question is to see if you’re a well read and intellectually curious
Have you managed
a team before?
individual. If you’re reading a book, all you have to do is explain the
basic premise and why you like it (or don’t like it). If you’re currently not
reading, think of one of the last books you’ve read and speak about what
makes the book interesting. Either fiction or non-fiction is fine, it’s more
about demonstrating your intellectual curiosity.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
38
Section 1: Behavioural & Fit - Question 034
Behavioural
& Fit
pg. 5
Explain what investment
banking is for a 5 year old.
Next Question:
How would colleagues
describe you?
How would your boss
describe you?
Have you managed
a team before?
The idea is that if you can communicate what investment banking is,
What’s a Friday night
out for you like?
then you are a clear communicator and you know what you’re getting
into.
Market
Knowledge
pg. 65
An apt analogy is the role of real estate agents in real estate
purchases. The real estate agent helps guide the buyer or seller
through the complexities of the real estate business, including contracts,
legal matters, finding interested parties, and valuation. In return, the
real estate agent earns a % fee on the value of the house. Similarly,
investment bankers will assist companies in the sale or acquisition
of another company, as well as raising equity financing through IPOs.
There are other things that investment bankers do, but these are the key
services and the easiest to explain.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
39
Section 1: Behavioural & Fit - Question 035
Behavioural
& Fit
pg. 5
How would your colleagues
describe you?
Next Question:
How would your boss
describe you?
Have you managed
a team before?
What’s a Friday night
out for you like?
In a way, this is a similar question to asking what your key strengths.
Tell me about XYZ
hobby in your...
It can be assumed that your colleagues are aware of your key strengths,
having worked with you side-by-side, so this is an opportunity to
speak to a few key strengths such as work ethic, communication skills,
and attention to detail. Feel free to give examples for each, as it may
strengthen your case.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
40
Section 1: Behavioural & Fit - Question 036
Behavioural
& Fit
pg. 5
How would your boss describe
you?
Next Question:
Have you managed
a team before?
What’s a Friday night
out for you like?
Tell me about XYZ
hobby in your...
Focus on the strengths that your boss may have mentioned in
Would you describe
yourself as...
performance reviews, feedback sessions, or casual conversation.
Typical strengths might be work ethic, entrepreneurial initiative,
analytical skills, etc. You can strengthen your answer by giving a couple
of examples to support your strengths.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
41
Section 1: Behavioural & Fit - Question 037
Behavioural
& Fit
pg. 5
Have you ever managed a team
before? What was your role and what
were your greatest challenges?
Next Question:
What’s a Friday night
out for you like?
Tell me about XYZ
hobby in your...
Would you describe
yourself as...
Any example from school, work, or extracurriculars is fine. Describe
From a scale of 1 to 10,
1 being intelligent...
the context of the team’s goals and how you arrived into a leadership
position. Elaborate on the challenges you faced and how you overcame
them. Make sure to communicate clearly and provide tangible details on
both the challenges and the steps you took to overcome them. Finally,
speak about how your efforts led to a positive result; if you can quantify
this result, that’s even better, although it’s not necessary. Conclude with
what you learned and gained from the experience.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
42
Section 1: Behavioural & Fit - Question 038
Behavioural
& Fit
pg. 5
What’s a good idea for a
Friday night out?
Next Question:
Tell me about XYZ
hobby in your...
Would you describe
yourself as...
From a scale of 1 to 10,
1 being intelligent...
This question is just to gauge what kind of personality you have, and
Have you ever had to
manage multiple...
if you’re a fun person to be around. Good ideas could be going out to a
comedy club, having drinks at a bar and going dancing, karaoke, video
game themed bars, etc. There is no right answer to this. Anything
you’ve enjoyed on a Friday night is generally fair game as long as it
doesn’t cross any boundaries.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
43
Section 1: Behavioural & Fit - Question 039
Behavioural
& Fit
pg. 5
Tell me about XYZ hobby in
your resume.
Next Question:
Would you describe
yourself as...
From a scale of 1 to 10,
1 being intelligent...
Have you ever had to
manage multiple...
Make sure that anything you have on your resume, you are able to
How do you know the
investment banking...
speak about. Anything on your resume is fair game and you can have
a whole interview in which they just grill you on specific points on your
resume. It is your responsibility to know everything on it and to have
a story with every point. It would be helpful to create an annotated
resume in which you can link stories and ideas to key words in your
resume.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
44
Section 1: Behavioural & Fit - Question 040
Behavioural
& Fit
pg. 5
Would you describe yourself as
more detail oriented or more high
level?
Next Question:
From a scale of 1 to 10,
1 being intelligent...
Have you ever had to
manage multiple...
How do you know the
investment banking...
This is also very dependent on you. If you choose to say detail oriented or
Let’s say you just
worked 100 hours...
high level, make sure that you always make it clear that you are good
at observing details as well. While it makes sense to look at things from
a high level and in summary once in a while, an eye to detail is always
beneficial to outline as one of your key characteristics.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
45
Section 1: Behavioural & Fit - Question 041
Behavioural
& Fit
pg. 5
From a scale of 1 to 10, 1 being
intelligent, and 10 being hard
working, what are you?
Next Question:
Have you ever had to
manage multiple...
How do you know the
investment banking...
Let’s say you just
worked 100 hours...
If your director tells
you to send a...
This answer is very dependent on how you see yourself.
It is always safe to put yourself on the hard working side to showcase
your humility and that you have a good work ethic. Remember, firms
are looking to hire good, down-to-earth hard-workers and putting
yourself closer to the hard-working side is always beneficial.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
46
Section 1: Behavioural & Fit - Question 042
Behavioural
& Fit
pg. 5
Have you ever had to manage multiple
projects at the same time and how did
you meet your deadlines?
Next Question:
How do you know the
investment banking...
Let’s say you just
worked 100 hours...
If your director tells
you to send a...
It would be best to describe a time during a hectic time at school in
How do you handle
criticism?
which you were able to manage many things at once. It could be
midterm week, or exam week or even a week in which you had many
interviews to get through. There are multiple different options and you
just need to develop a clear, concise and easy-to-follow story.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
47
Section 1: Behavioural & Fit - Question 043
Behavioural
& Fit
pg. 5
Have you ever had to manage multiple
projects at the same time and how did
you meet your deadlines?
Next Question:
Let’s say you just
worked 100 hours...
If your director tells
you to send a...
How do you handle
criticism?
This answer is to assess your fi t, acknowledge that the industry and
Where do you see
yourself in 5, 10...
job is very demanding and may be good that it depends on the fi t and
people around you. If you are able to demonstrate that it depends on the
people around you and why the bank you’re working with has that type
of people, that would be ideal to fi t in with your answer.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
48
Section 1: Behavioural & Fit - Question 044
Behavioural
& Fit
pg. 5
Let’s say you just worked 100 hours in the
previous week, and you have a vacation
planned but must be cancelled, how would
you react?
Next Question:
If your director tells
you to send a...
How do you handle
criticism?
Where do you see
yourself in 5 to...
You should always be honest about your mental and physical health
If we gave you the offer
would you accept?
when working in the industry. If you believe that you will need more time
off, be sure to make that clear with staffing. In this rare case if you are
absolutely needed in the office, it is understandable why you would need
time off after a 100 hour work week.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
49
Section 1: Behavioural & Fit - Question 045
Behavioural
& Fit
pg. 5
If your director tells you to send a
confidential document to the equity
research department, should you do it and
how would you react?
Next Question:
How do you handle
criticism?
Where do you see
yourself in 5 to...
If we gave you the offer
would you accept?
The best way to handle this situation is to be honest with all parties
Where else are you
interviewing?
involved. It would be best in this situation to tell the equity research team
that you think a direction that your director told you may be unethical.
If they also believe they can’t see it, it may be best to let your director
know that the equity research team is uncomfortable seeing such
privy information.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
50
Section 1: Behavioural & Fit - Question 046
Behavioural
& Fit
pg. 5
How do you handle criticism?
Next Question:
Where do you see
yourself in 5 to...
If we gave you the offer
would you accept?
Where else are you
interviewing?
Say that you’re obviously open to criticism and take it as a way to grow
Why do you want to
work at a boutique?
and become better. Make it clear that you have a growth mindset and
want honesty from your peers. Give them an example of a time in which
you received criticism and was able to grow and learn from that specific
experience.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
51
Section 1: Behavioural & Fit - Question 047
Behavioural
& Fit
pg. 5
Where do you see yourself in 5,
10 and 15 years?
Next Question:
If we gave you the offer would you accept?
Where else are you
interviewing?
Why do you want to
work at a boutique?
Have this question planned in advance. It is okay to say that you don’t
Why do you want to
work in this group?
know for sure but have a rough timeline that you can walk them through.
This question may be good to show bits of your personality and how
you plan to use banking to pivot in maybe 15 years to another career of
your passion.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
52
Section 1: Behavioural & Fit - Question 048
Behavioural
& Fit
pg. 5
If we gave you the offer on the
spot, would you accept it?
Next Question:
Where else are you
interviewing?
Why do you want to
work at a boutique?
Why do you want to
work in this group?
You should always say yes to this question to show your conviction
If not finance, then
what would you...
and commitment to the firm no matter what.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
53
Section 1: Behavioural & Fit - Question 049
Behavioural
& Fit
pg. 5
Where else are you
interviewing, are you in any
other processes?
Next Question:
Why do you want to
work at a boutique?
Why do you want to
work in this group?
If not finance, then
what would you...
Be honest with this question. End the question on how the firm you’re
What feedback did
you recieve in your...
interviewing at is your first choice and why it would be a good fi t for the
position.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
54
Section 1: Behavioural & Fit - Question 050
Behavioural
& Fit
pg. 5
Why do you want to work at a
boutique or bulge bracket or
Canadian or American bank?
Next Question:
Why do you want to
work in this group?
If not finance, then
what would you...
What feedback did
you recieve in your...
Both boutique and bulge brackets are tremendous firms to work for, but it
Are you more of a
leader or follower?
is key that you have set stories for both types of banks. For boutiques,
make sure to explain how you prefer a smaller team to have more
interaction between team members and may have more experience with
the deal flow and deals that you work with. For bulge brackets, you may
prefer to work in a more bureaucratic structure and be open to a pool of
people with more diverse experiences. The key for this question is to
know something specific about the firm that makes it special and why
you want to work there. For example if you’re interviewing at Moelis, it
may be great to mention as it’s the only shop that will allow you to do
restructuring and M&A at the same time.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
55
Section 1: Behavioural & Fit - Question 051
Behavioural
& Fit
pg. 5
Why do you want to work in this
group?
Next Question:
If not finance, then
what would you...
What feedback did
you recieve in your...
When is a time you
changed your...
Make sure you do your due diligence for any group or bank that you
Are you more of a
leader or follower?
interview with. The answer should never be along the lines of exit
opportunities or pay but rather something specific and unique to that
group. It could vary from culture to deal flow to a certain mentor you have
in the group. Make sure to be genuine and show your genuine passion
for the group or firm that you’d like to work for.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
56
Section 1: Behavioural & Fit - Question 052
Behavioural
& Fit
pg. 5
If you couldn’t do anything in
finance, what job would you
do?
Next Question:
What feedback did
you recieve in your...
When is a time you
changed your...
Are you more of a
leader or follower?
This is a question that is open to your discretion and will be based of
Why do you think
formatting is...
your interests. Saying an answer such as an entrepreneur if you started
your own business in high school that would be a great relationship, just
make sure you connect it to a passion of yours.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
57
Section 1: Behavioural & Fit - Question 053
Behavioural
& Fit
pg. 5
In your past job, what feedback
did you receive? Anything to
improve on?
Next Question:
When is a time you
changed your...
Are you more of a
leader or follower?
Why do you think
formatting is...
The key to this is to have a piece of feedback that you could obviously
How do you check a
model in Excel?
position a real area of improvement that you eventually got better
at. The worst thing that you could do is say that you were the perfect
employee, this question is very comparable to “what’s your biggest
weakness” question.
Market
Knowledge
pg. 65
Accounting
pg. 82
It may be helpful to follow the STAR interview response technique.
STAR stands for Situation, Task, Action and Result.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
58
Section 1: Behavioural & Fit - Question 054
Behavioural
& Fit
pg. 5
When is a time that you
changed your schedule in
support of a greater goal?
Next Question:
Are you more of a
leader or follower?
Why do you think
formatting is...
How do you check a
model in Excel?
The goal for this question is to walk them through your priorities and
What makes a
good modeller?
what you value most. You should walk them through your general
decision making philosophy followed by a concise but valuable
experience that you had in which you followed this philosophy. It would
be helpful if you could quantify your impact at the end of your answer.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
59
Section 1: Behavioural & Fit - Question 055
Behavioural
& Fit
pg. 5
Are you more of a leader or a
follower?
Next Question:
Why do you think
formatting is...
How do you check a
model in Excel?
What makes a
good modeller?
You should answer this question in a way that you can build your
What makes a
good model?
case for both. You should be situation dependent and will follow what
is needed of you in that situation. Proceed to provide an example of
your leadership and as a follower. End with how you can attribute as a
follower and tie it to the role you’re applying for, as you will most likely
be a follower much more often than a leader in an analyst position.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
60
Section 1: Behavioural & Fit - Question 056
Behavioural
& Fit
pg. 5
Why do you think formatting is
so emphasized?
Next Question:
How do you check a
model in Excel?
What makes a
good modeller?
What makes a
good model?
Formatting is key to build your attention to detail. Consistent formatting
is key to maintaining professionalism with clients and teaches analysts
to build their eye to detail and to notice any minor matters that may be
off.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
61
Section 1: Behavioural & Fit - Question 057
Behavioural
& Fit
pg. 5
Let’s say you just created a
model in Excel. How do you
check it?
Next Question:
What makes a
good modeller?
What makes a
good model?
The best way to check your model is to print it out and check if there
are any errors. It may be overwhelming to look over a model you
worked on very long on a screen, and printing it out will make it easier
to synthesize the information. As well, you can put in formulas to
automatically get balance sheet checks, ways to break down EBITDA to
UFCF and of course compared to street consensus and previous models.
As well, another great way is to re-create the model off muscle
memory in a simplified manner. If you are able to get a value in the same
ball-park as your original model, you can be confident that it is strong
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
and aligned with assumptions.
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
62
Section 1: Behavioural & Fit - Question 058
Behavioural
& Fit
pg. 5
What makes a good modeller?
Next Question:
What makes a
good model?
A good modeller is someone who is curious and tenacious. A great
model is a tedious process that involves research and looking at
numerous forms of guidance to come up with reasonable numbers and
assumptions. For example, making an intricate revenue model can be
extremely time consuming, but a good modeller is one that is able to
keep tenacious about the process and deliver with details even when
information may become overwhelming.
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
63
Section 1: Behavioural & Fit - Question 059
Behavioural
& Fit
pg. 5
What makes a good model?
Next Question:
A good model is one that is thought through with great detail and
logic. Any model that deals with intrinsic valuation such a DCF is based
on numerous assumptions and the modeler must be able to back up
their assumptions and logic when asked. A good model is one that
can be explained with sound logic and is relatively conservative with
assumptions and drivers. If the modeler were to make a certain driver
more aggressive, it would be crucial that they would be able to relate it
back to macroeconomic trends or other factors to explain that logic or
Market
Knowledge
pg. 65
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
assumption.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Behavioural
& Fit
Market
Knowledge
64
Section Two
Market
Knowledge
65
Section 2: Market Knowledge - Question 001
Market
Knowledge
pg. 65
Pitch me a stock.
Next Question:
Pitch me another
stock.
What do you look for in
an investment?
What makes a good
investment thesis?
Feel free to take 1-2 minutes with your answer. It’s important to
What makes a good
company?
avoid stocks that everybody knows, such as Apple, Netflix, Alphabet
(Google), etc. This is because pitching these commonly known stocks
might be interpreted as a lack of knowledge of the intricacies of the
stock market. On the other hand, if you pitch a stock that comes across
as a unique and genuine idea, the interviewer may find it much more
interesting and assume you have a strong understanding of the market.
It is also ideal if you can pitch a stock in the same industry group you are
applying to. However, if you are applying to a generalist industry, any
stock is fine as long as it’s a stock that matches the geographical area
(e.g. pitch North American stocks in North America, pitch UK stocks in the
UK). As much as stock choice matters, it is important to structure your pitch in
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
a logical way that shows you understand all the components of a good stock
pitch. Below is a rough structure that you can use in your pitch.
Other
Questions
pg. 330
•
Company Outline: description of business model, location of operations,
stock price, market cap, debt, YoY revenue growth, projected revenue
growth, EBITDA margins, capex, etc.
•
Industry and Macro Overview: dynamics of macro environment and
important trends in industry
•
Investment Theses: reasons why investment is ideal at this time and
why company will succeed going forward, such as drivers of growth
(expanding into new market) or cost cutting initiatives
•
Risks and Catalysts: potential issues in the investment and short-term
events that may drive the price upwards
•
Valuation: typically just comparables to similar companies on a multiples
basis (EV / EBITDA, P / EPS)
•
Conclusion: summary of important details regarding the merits of your
pitch
Market
Knowledge
Accounting
Questions
66
Section 2: Market Knowledge - Question 002
Market
Knowledge
pg. 65
Pitch me another stock.
Next Question:
What do you look for in
an investment?
What makes a good
investment thesis?
What makes a good
company?
Sometimes, interviewers will ask for a second stock pitch. This is rare in
Pitch me an M&A
transaction...
investment banking interviews, but common in buy side interviews such
as private equity, hedge funds, or asset management. The second stock
pitch does not have to be as well prepared, but generally you should
follow a similar structure.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
•
Company Outline: description of business model, location of
operations, stock price, market cap, debt, YoY revenue growth,
pg. 185
projected revenue growth, EBITDA margins, capex, etc.
•
Industry and Macro Overview: dynamics of macro environment and
important trends in industry
•
Discounted
Cash Flow
Mergers &
Acquisitions
pg. 235
Investment Theses: reasons why investment is ideal at this time
and why company will succeed going forward, such as drivers of
Leveraged
Buyouts
pg. 282
growth (expanding into new market) or cost cutting initiatives
•
Risks and Catalysts: potential issues in the investment and short-
pg. 330
term events that may drive the price upwards
•
Other
Questions
Valuation: typically just comparables to similar companies on a
multiples basis (EV / EBITDA, P / EPS)
•
Conclusion: summary of important details regarding the merits of
your pitch
Market
Knowledge
Accounting
Questions
67
Section 2: Market Knowledge - Question 003
Market
Knowledge
pg. 65
What do you look for in an
investment? (1/2)
Next Question:
What makes a good
investment thesis?
What makes a good
company?
Pitch me an M&A
transaction...
This question is testing your investment philosophy. The typical
Tell me about a world
event you’re following...
investment philosophy that is often preferred by investment bankers
and private equity investors is deep value plays on companies with a
sustainable competitive advantage trading at relatively undervalued
multiples, similar to Warren Buffet’s style of investing. A great book to
read is The Intelligent Investor by Warren Buffet, and it is considered
required reading for anybody looking to invest seriously.
Enterprise Value
/ Comparables
pg. 138
pg. 185
Low relative valuation (multiples) compared to similar companies in
the industry
•
pg. 82
Discounted
Cash Flow
Some traits of a good investment include:
•
Accounting
Mergers &
Acquisitions
pg. 235
Even if the multiple is higher, as long as you can explain the drivers
behind that and how there is additional value to be had, then your
Leveraged
Buyouts
pg. 282
argument still remains sound
Other
Questions
•
Experienced management team
•
Dominant and unique position in industry
•
Market leader
•
Cost leader
•
Defensible and sustainable competitive advantages
•
A “moat” to prevent new entrants, such as patented technology, first
pg. 330
mover advantage in an economies of scale business, network effect
Market
Knowledge
Accounting
Questions
68
Section 2: Market Knowledge - Question 004
Market
Knowledge
pg. 65
What do you look for in an
investment? (2/2)
Next Question:
What makes a good
investment thesis?
What makes a good
company?
Pitch me an M&A
transaction...
Tell me about a world
event you’re following...
•
Strong historical and projected revenue growth
•
Double digits would be considered high growth, but depends on
industry
Accounting
pg. 82
•
Robust and stable EBITDA margins
•
Low EBITDA margins means more operating leverage, wherein a
small % change in revenue could cause a large % change in EBITDA,
therefore increasing risk
•
Low capex requirements
•
Healthy capital structure with not too much debt
•
Industry tailwinds
•
Favourable regulatory environment
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Keep in mind that in a hedge fund interview, you should tailor your
Leveraged
Buyouts
pg. 282
investment style to the style of the hedge fund, whether that be longOther
Questions
only, long-short, macro, event-driven, etc.
pg. 330
Market
Knowledge
Accounting
Questions
69
Section 2: Market Knowledge - Question 005
Market
Knowledge
pg. 65
What makes a good investment
thesis?
Next Question:
What makes a good
company?
Pitch me an M&A
transaction...
Tell me about a world
event you’re following...
A good investment thesis should present several solid and unique
Where is the market
going in the next?
explanations of why this company would be a good investment.
Accounting
pg. 82
Some examples of drivers include:
•
New market expansion that is forecasted to help create a strong
presence in a growing and high-margin business segment
•
A M&A roll-up strategy that is looking to buy companies at cheap
pg. 138
Discounted
Cash Flow
pg. 185
multiples to accelerate growth
•
Enterprise Value
/ Comparables
Efficiency initiatives that seek to eliminate expenses which do not
add value
Mergers &
Acquisitions
pg. 235
The key to a good investment thesis is that the reasons should be unique
Leveraged
Buyouts
pg. 282
to the company, and the argument should be well thought out so that you
can answer any questions as the interviewer tries to probe if you truly
understand the company’s drivers and the qualitative and quantitative
Other
Questions
pg. 330
details supporting them.
Market
Knowledge
Accounting
Questions
70
Section 2: Market Knowledge - Question 006
Market
Knowledge
pg. 65
What makes a good company?
Next Question:
Pitch me an M&A
transaction...
Tell me about a world
event you’re following...
Where is the market
going in the next?
Although this question may seem similar to “what makes a good
Explain the stock
market to a 5 year old.
investment”, keep in mind that a good company does not necessarily
mean it is a good investment. A company could be strong, but it’s
possible that the market has already recognized this in the stock price.
For a good investment, you need to argue both that the company
is a strong company, and that it is undervalued; perhaps because
investors do not see or recognize the innate advantages, but also
because the market often takes time to respond to positive catalysts.
A good company, however, may not be undervalued, and may in fact
be overvalued, but it is still a good company because it has a solid
leadership position, strong management, and growth drivers.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
Below are some examples of favourable traits:
•
Experienced management team
•
Dominant and unique position in industry
•
Market leader
•
Cost leader
•
Defensible and sustainable competitive advantages
•
A “moat” to prevent new entrants, such as patented technology, first
pg. 282
Other
Questions
pg. 330
mover advantage in an economies of scale business, network effect
•
Strong historical and projected revenue growth
•
Double digits would be considered high growth, but depends on industry
•
Robust and stable EBITDA margins
•
Low EBITDA margins means more operating leverage, wherein a small
% change in revenue could cause a large % change in EBITDA, therefore
increasing risk
•
Low capex requirements
•
Healthy capital structure with not too much debt
•
Industry tailwinds
•
Favourable regulatory environment
Market
Knowledge
Accounting
Questions
71
Section 2: Market Knowledge - Question 007
Market
Knowledge
pg. 65
Pitch me an M&A transaction
that you think should happen.
Next Question:
Tell me about a world
event you’re following...
Where is the market
going in the next?
Explain the stock
market to a 5 year old.
Again, this is a question to test your critical thinking skills. There are two
Walk me through
an IPO.
main types of mergers which include horizontal and vertical mergers,
a vertical merger is between two companies in the same production
process while a horizontal merger is between two companies that offer
similar products. I will walk through some key ideas to hit by proposing
a sample merger between Restaurant Brands International and Dunkin
Donuts.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
Some key ideas to mention on why this may work is geographic
synergies. Both these companies have leading positions in North
America with shops across the country. The synergies they may receive
by opening locations together or having shared deals can be profi table
to both companies and will give them increased pricing power as well. It
would help maintain an industry leading position in the product as well.
It can help with debt and equity financing if one company is seen to be
highly levered. Lastly, it helps with scalability and the size premium that
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
can come when having more locations and that geographic advantage.
These high-level investment-like ideas are key to consider when
proposing a potential M&A deal.
Market
Knowledge
Accounting
Questions
72
Section 2: Market Knowledge - Question 008
Market
Knowledge
pg. 65
Tell me about a world event or
trend that you’re following in
the news.
Next Question:
Where is the market
going in the next?
Explain the stock
market to a 5 year old.
Walk me through
an IPO.
A good tip for answering this question is to usually try and look for an
Walk me through a
buy-side M&A process.
interesting news item that may not be on the front page of a news source
or a newsletter, that everyone is closely following. Maybe keep turning
the pages to a new story that really interests you and can in turn capture
the interest of your interviewers when they hear a new story that no one
has proposed before. It may be also good to tailor your answer to your
personality or certain interests. For example, if you specialize in FIG for
your investment club, it may be good to consider pitching a news event
that can directly impact FIG companies to further build that brand for
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
yourself.
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Market
Knowledge
Accounting
Questions
73
Section 2: Market Knowledge - Question 009
Market
Knowledge
pg. 65
Where is the (North American)
market going in the next 6-12
months?
Next Question:
Explain the stock
market to a 5 year old.
Walk me through
an IPO.
Walk me through a
buy-side M&A process.
No one knows exactly what is going to happen in the market but this
Walk me through a sell
side M&A process.
question is testing how closely you have been following recent events
and how closely you follow the market. Follow the news and markets
carefully and based on those assumptions, make a reasonable
estimate of what to expect in the next fiscal period. It may also be good
to listen to market analysts and to get their take and base your answer
off findings along that line. Be ready to follow up to multiple questions.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Market
Knowledge
Accounting
Questions
74
Section 2: Market Knowledge - Question 010
Market
Knowledge
pg. 65
Explain the stock market to a 5
year old.
Next Question:
Walk me through
an IPO.
Walk me through a
buy-side M&A process.
Walk me through a sell
side M&A process.
Let’s think of the stock market as a valley of apple trees. Each apple
Walk me through a
typical day in IB.
tree represents a company. Some of the trees you’re allowed to pick from
and others you aren’t allowed to. Each apple you get from a tree will be
considered as one stock. The ones that you are able to pick from would
be a public company. Some trees want to remain private because they’re
not ready to be picked from and others prefer to remain unpicked. Once
you buy an apple from the tree, you can keep it or sell it. The owner of the
tree may choose to grow his tree better or make it more special therefore
increasing the value of that apple. The owner may do something
embarrassing or harmful to the tree lowering the value of the apples
produced. Overall, you can switch and sell your apples with everyone
else who owns apples depending on if you think the price of your apple
will go up or down. It also may be affected by the rain or weather, issues
out of your control like macroeconomic factors. Make sure you take those
into account when making your decision to keep or hold your apple.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Market
Knowledge
Accounting
Questions
75
Section 2: Market Knowledge - Question 011
Market
Knowledge
pg. 65
Walk me through an IPO.
Next Question:
Walk me through a
buy-side M&A process.
Walk me through a sell
side M&A process.
Walk me through a
typical day in IB.
At first, the investment bank will try to understand the client’s business
What slides would be
in a pitchbook?
in detail. Thorough due diligence will be done on the client, ranging from
accounting, tax, legal, commercial, environmental, etc. This ensures that
the investment bank’s brand is protected, as it does not want to be
involved with a client that would lower its reputation.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
The investment bank will also discuss with the client how large the IPO
should be. Typically, a company will issue new shares equal to 20-30%
of its shares outstanding. After analyzing the company, performing due
diligence, and determining the IPO size, the investment bank will begin
preparing a roadshow presentation to investors. This is a slide deck
which explains all the key aspects of the company, and it also presents
key investment highlights to potential institutional investors. Some
institutional investors will make commitments to buy IPO shares, and the
Equity Capital Markets desk will record this down in an orderbook. The
more institutional investors can commit to the IPO, the likelier the IPO will
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
succeed. If too many investors want to buy shares in the IPO, which often
happens if the IPO is underpriced or hotly anticipated, then the shares
will be distributed pro-rata. Investment banks often purposely underprice
IPOs in order to generate buzz and excitement amongst institutional
investors, and also to lower the risk that the order book will not be filled.
The investment bank will also help prepare the prospectus, which will be
available to the public on an online directory called SEDAR in Canada or
EDGAR in the U.S. Finally, a press release will be prepared, and the IPO
will commence on the corresponding date.
Market
Knowledge
Accounting
Questions
76
Section 2: Market Knowledge - Question 012
Market
Knowledge
pg. 65
Walk me through a buy-side
M&A process.
Next Question:
Walk me through a sell
side M&A process.
Walk me through a
typical day in IB.
What slides would be
in a pitchbook?
In a buy side M&A process, the investment bank is advising on the
purchase of a target company. Usually, the acquisition will be strategic
in nature, since many private equity firms do not need an advisor when
buying a company, and sometimes even have their own in-house
advisory teams.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
After identifying the target company and gaining their interest, the
target will send over a CA, which is a confidentiality agreement, and is
Discounted
Cash Flow
pg. 185
also known as an NDA (non-disclosure agreement).
Mergers &
Acquisitions
After the client (buyer) has signed the CA, they will then get a
pg. 235
confidential memorandum information (CIM), which will outline all
the key aspects of the business in 40-60 slides, such as management,
operations, financials, projections, opportunities, risks, industry trends,
etc. The buyer will send an initial bid in a letter of intent (LOI). If the bid
value is in-line with the target’s expectations, then the target will open
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
up the data room, which will contain all pertinent files to the target’s
operations and financials.
Finally, the investment bank will help the buyer conduct third-party
due diligence, such as accounting, tax, commercial / market, legal,
facility, environmental, etc.
Market
Knowledge
Accounting
Questions
77
Section 2: Market Knowledge - Question 013
Market
Knowledge
pg. 65
Walk me through a sell side
M&A process. (1/2)
Next Question:
Walk me through a
typical day in IB.
What slides would be
in a pitchbook?
In a sell side M&A process, the investment bank is advising on the sale
of a company. This is typically done through an auction, which can either
be a broad auction or a targeted auction.
Accounting
pg. 82
A broad auction reaches out to a large number of potential buyers,
which is common for companies that do not have sensitive competitive
information (e.g. proprietary processes or technology) and therefore
do not see any disadvantages to reaching out to more buyers. Broad
auctions are usually done for more generic companies that could make
sense for a large number of strategic and private equity companies.
For example, a medium-sized snack foods company may enter a broad
auction since many companies may wish to bid on it, and confidentiality is
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
less of a concern.
Leveraged
Buyouts
A targeted auction typically focuses on a smaller number of buyers,
Other
Questions
pg. 282
usually about 3-10. This is more common for companies that are unique
pg. 330
and may not make strategic or financial sense for most buyers, or for
companies that have confidential technology and processes that are
sensitive. In either case, the investment bank prepares a 1-page teaser
which shows the key financial and strategic highlights of the target
company, without revealing the name of the target company. Buyers who
are interested will sign a CA, which is a confidentiality agreement, and is
also known as an NDA (non-disclosure agreement).
Following this, the investment bank will send out confidential information
memorandum (CIMs), which typically consist of 40-60 slides and
provide key information about the business, management, the
industry, projected performance, financials, etc. The buyers will use
this information to build a preliminary model and ultimately submit a first
round bit.
Market
Knowledge
Accounting
Questions
78
Section 2: Market Knowledge - Question 013
Market
Knowledge
pg. 65
Walk me through a sell side
M&A process. (2/2)
Next Question:
Walk me through a
typical day in IB.
What slides would be
in a pitchbook?
The investment bank will work with the target company to decide on
which bids should make it to the second round, and which bids will be
excluded. After this, the target company will open up the dataroom,
which includes confidential company files which can be accessed
online only with a password. This dataroom will typically have all the
information the buyers need to build a detailed model and thorough
due diligence, and the buyers can also ask for more information if they
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
need it.
After a certain deadline, the remaining buyers will submit another bid.
At this point, the investment bank and target company will usually select
only one buyer to move on to the third round. Typically, an exclusivity
contract will be signed, which means that the remaining potential buyer
will have a period of time where they have the exclusive right to buy the
company. This gives the remaining buyer a chance to spend money on
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
third party due diligence, such as accounting, tax, commercial / market,
legal, facility, environmental, etc. Since this involves spending hard
dollars, the buyer will typically only do third party due diligence after
exclusivity is ensured.
Finally, hopefully the buyer will end up executing the acquisition, or else
the process starts again. Please note that your answer does not have to
be nearly this long; additional detail was provided so that you can fully
understand the process.
Market
Knowledge
Accounting
Questions
79
Section 2: Market Knowledge - Question 014
Market
Knowledge
pg. 65
Walk me through a typical day
in investment banking.
Next Question:
What slides would be
in a pitchbook?
A typical day in investment banking varies greatly! The day usually
starts off early, around 9:00 am and from there it can consist with calls
with clients, followed by fixing a model or making last minute changes
to a slide deck. The day can be filled with dead hours in which you’re just
waiting to be assigned work. The day changes greatly and it is key to
acknowledge the variety and changes in the day and to outline why
you’d be a great fi t for such an atmosphere.
Accounting
pg. 82
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Market
Knowledge
Accounting
Questions
80
Section 2: Market Knowledge - Question 015
Market
Knowledge
pg. 65
What slides would be in a
pitchbook?
Next Question:
The key slides in a pitchbook would primarily consist of the following:
Company Overview, Industry Overview, Investment Theses, Catalysts
& Risks, Valuation followed by an appendix of key information you think
Accounting
pg. 82
your deck may not have.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Market
Knowledge
Accounting
Questions
81
Section Three
Accounting
Knowledge
82
Section 3: Accounting - Question 001
Accounting
pg. 82
Walk me through the 3
financial statements.
Next Question:
How are the 3 financial
statements related?
Financial Statements
with 1 year of data...
Financial Statements
with 2 years of data...
If you could only use 2
financial statements...
The income statement shows how profi table or unprofi table your
business is. It typically contains revenue, COGS, SG&A, which gets you
down to EBITDA, and then contains depreciation and amortization,
Enterprise Value
/ Comparables
interest, and tax, which gets you down to net income.
pg. 138
Discounted
Cash Flow
The cash flow statement shows the cash coming in and out of your
business, how much cash you gained or lost in total, which gets you to
your current cash position. Typically, this is done by starting with net
pg. 185
Mergers &
Acquisitions
pg. 235
income, and then adding back all the non-cash items in the income
statement as well as net working capital. Afterwards, any other cash
flow numbers not included in the income statement are also added in.
Below are the three sections of the cash flow statement; this is not necessary
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
for your verbal answer, but they’re displayed here for clarity.
•
Cash flow from operations: starting for net income, we then account for
changes in net working capital, and we also add all non-cash items in
the income statement such as depreciation and amortization
•
Cash flow from investing: includes any cash outflow which results
in the purchase of an asset, such as capital expenditures (capex) and
business acquisitions
•
Cash flow from financing: includes any cash flows raised from issuance
of debt or equity, as well as any debt repayments or dividends
Finally, the balance sheet displays the assets (e.g. cash, accounts receivable,
property plant and equipment) on one side, and liabilities (e.g. accounts
payable, debt) and shareholder’s equity on the other side. Since the
assets must be either funded by liabilities or equity, assets = liabilities +
shareholder’s equity.
Accounting
Enterprise Value
/ Comparables
83
Section 3: Accounting - Question 002
Accounting
pg. 82
How are the 3 financial
statements related?
Next Question:
Financial Statements
with 1 year of data...
Financial Statements
with 2 years of data...
If you could only use 2
financial statements...
The income statement produces a net income. This net income number
What is net working
capital?
is then the first number in the cash flow statement, since we will start
from net income and add back any non-cash items, such as depreciation
and amortization. After accounting for changes in net working capital,
investing cash flows, and financing cash flows, we arrive at a cash
number. This cash number is the first number in the balance sheet, on
the assets side. However, we will also add net income to the beginning
balance of shareholder’s equity and deduct any dividends to arrive at an
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
ending shareholder’s equity number.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
84
Section 3: Accounting - Question 003
Accounting
pg. 82
If you could only use one financial
statement, and you only had one year of
data, which would you use to evaluate
an investment?
Next Question:
Financial Statements
with 2 years of data...
If you could only use 2
financial statements...
What is net working
capital?
How do changes in
net working...
We should use the cash flow statement, because it tells us the most
about a company’s financial health. Cash is king, because we ultimately
decide on a company’s value based on its cash flows. The income
statement only shows net income, but this is an accounting number and
it does not show important cash flow numbers such as changes in net
working capital, or cash flows from investing (e.g. capex) or cash flows
from financing. The balance sheet shows assets and liabilities in a given
year, but it does not show us the performance of the company year to
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
year.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
85
Section 3: Accounting - Question 004
Accounting
pg. 82
If you could only use one financial
statement, and you had two years of
data, which would you use to evaluate an
investment?
Next Question:
If you could only use 2
financial statements...
What is net working
capital?
How do changes in
net working...
We should use the balance sheet if we have two years of data. This is
Why can net working
capital be negative?
because you can effectively figure out the changes in cash flow and net
income by comparing this year’s balance sheet with the previous year’s
balance sheet.
Enterprise Value
/ Comparables
pg. 138
The change in cash can be calculated as this year’s cash balance less
last year’s cash balance.
If we know the depreciation and amortization rate (e.g. straight-line for
10 years), we can take this year’s PP&E and subtract last year’s PP&E,
then add the depreciation and amortization expense to arrive at a capex
number.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
If we look at the changes in debt from one year to another, we can calculate
the cash flows from new borrowings (debt goes up, cash inflow) or debt
repayments (debt goes down, cash outflow).
Finally, we can find net income by taking this year’s shareholder’s equity
less last year’s shareholder’s equity. Keep in mind that this assumes there
are no dividends, since dividends will reduce shareholder’s equity. If there
are dividends and we know the amount, then we can take this year’s
shareholder’s equity plus this year’s dividends less last year’s shareholder’s
equity to arrive at net income for the year.
Accounting
Enterprise Value
/ Comparables
86
Section 3: Accounting - Question 005
Accounting
pg. 82
If you could only use two financial
statements, which would you use to
evaluate an investment? Assume you
have two years of data.
Next Question:
What is net working
capital?
How do changes in
net working...
Why can net working
capital be negative?
We should use the balance sheet if we have two years of data. This is
Why do changes in
inventory affect...
because you can effectively figure out the changes in cash flow and net
income by comparing this year’s balance sheet with the previous year’s
balance sheet.
Enterprise Value
/ Comparables
pg. 138
The change in cash can be calculated as this year’s cash balance less
last year’s cash balance.
If we know the depreciation and amortization rate (e.g. straight-line for
10 years), we can take this year’s PP&E and subtract last year’s PP&E,
then add the depreciation and amortization expense to arrive at a capex
number.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
If we look at the changes in debt from one year to another, we can
calculate the cash flows from new borrowings (debt goes up, cash inflow)
or debt repayments (debt goes down, cash outflow).
Finally, we can find net income by taking this year’s shareholder’s equity
less last year’s shareholder’s equity. Keep in mind that this assumes
there are no dividends, since dividends will reduce shareholder’s equity.
If there are dividends and we know the amount, then we can take this
year’s shareholder’s equity plus this year’s dividends less last year’s
shareholder’s equity to arrive at net income for the year.
Accounting
Enterprise Value
/ Comparables
87
Section 3: Accounting - Question 006
Accounting
pg. 82
What is net working capital?
Next Question:
How do changes in
net working...
Why can net working
capital be negative?
Why do changes in
inventory affect...
Net working capital represents the money tied up in the daily operations
If a positive EBITDA
company is growing...
of the business. This includes both current assets and current liabilities.
On the current assets side, we typically include accounts receivable,
inventory, and prepaid expenses as part of net working capital. All these
items will tie up cash, but are generally necessary for the operation of
the business. For example, accounts receivable will tie up cash because
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
customers are paying with credit rather than cash.
pg. 235
Note that cash is not included. This is because cash is not being used in
the daily operation of the business. It is simply cash that is sitting unused.
Similarly, deferred tax assets are not included because tax assets are
an accounting / tax matter, and do not impact the daily operation of the
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
business.
On the current liabilities side, we typically include accounts payable and
other current liabilities. Deferred tax liabilities are not included as that is
an accounting / tax matter.
Accounting
Enterprise Value
/ Comparables
88
Section 3: Accounting - Question 007
Accounting
pg. 82
How do changes in net working
capital affect the three
statements?
Next Question:
Why can net working
capital be negative?
Why do changes in
inventory affect...
If a positive EBITDA
company is growing...
What is the difference
accrual & cash...
Changes in net working capital do not affect the income statement.
Changes in net working capital do affect the cash flow statement, since
we typically start with net income in the beginning of the cash flow
Enterprise Value
/ Comparables
pg. 138
statement. Then we have to add back non-cash changes, which include
changes in net working capital. This is because changes in net working
capital represent either more cash being put into the daily operations
of the business (e.g. through accounts receivable, inventory, or prepaid
expenses), or less cash being put into the daily operations of the business
(e.g. through more favorable terms on account payable). Therefore,
changes in net working capital directly impact the cash flow statement.
It’s usually a negative cash outflow since as businesses grow, they have
more accounts receivable and inventory.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Changes in net working capital also affect the balance sheet, since it
involves the year-over-year changes on the current assets (accounts
receivable, inventory, or prepaid expenses) and liabilities (accounts
payable, other current liabilities) on the balance sheet.
Accounting
Enterprise Value
/ Comparables
89
Section 3: Accounting - Question 008
Accounting
pg. 82
Why can net working capital be
negative?
Next Question:
Why do changes in
inventory affect...
If a positive EBITDA
company is growing...
What is the difference
accrual & cash...
What are two ways the
cash flow statement...
Some businesses will take an initial deposit from the customer and
deliver the goods or services at a later date or over a period of time.
Instead of having the customer pay on credit, which would go to
accounts receivable, you receive the deposit and end up with deferred /
unearned revenue since you still have to deliver the good or service.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
One example of this is the mattress industry. When you go to a mattress
store, you are essentially looking at their showroom. The mattresses
pg. 185
Mergers &
Acquisitions
pg. 235
on display are not the ones you actually buy, they are just there for
customers to look at and try out. When you buy a mattress, you are
paying upfront for a mattress to be delivered at a later date. The money
that the company receives is deferred / unearned revenue, since they
have not delivered the mattress yet.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
The company will then go to their supplier and order a mattress, which
will ultimately be delivered to the buyer. However, the company usually
buys the mattress on credit, so accounts payable goes up. In this way,
the company has negative net working capital since it has accounts
payable and unearned revenue, while having a much smaller accounts
receivable balance since most customers pay upfront.
Accounting
Enterprise Value
/ Comparables
90
Section 3: Accounting - Question 009
Accounting
pg. 82
Why do changes in inventory
affect the income statement?
Next Question:
If a positive EBITDA
company is growing...
What is the difference
accrual & cash...
What are two ways the
cash flow statement...
Ending Inventory = Beginning Inventory + Purchases - Cost of Goods
If the balance sheet
doesn’t balance...
Sold (COGS)
Enterprise Value
/ Comparables
Purchases do not affect the income statement, since they represent
pg. 138
purchases of unsold inventory which have not been delivered to the
customer. However, COGS does show up on the income statement, since
it represents inventory that has been sold and delivered to the customer.
Therefore, if we know ending inventory, beginning inventory, and
purchases, we can calculate what COGS is, which will directly impact the
income statement.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
91
Section 3: Accounting - Question 010
Accounting
pg. 82
If a company is growing, has positive
EBITDA margins, and growing customer
base, how could it post a loss?
Next Question:
What is the difference
accrual & cash...
What are two ways the
cash flow statement...
If the balance sheet
doesn’t balance...
What’s shareholder’s
equity represent...
Even if a company is growing and has positive EBITDA margins, it
is possible that the expenses beneath EBITDA are large enough to
counteract any positive EBITDA, ultimately resulting in a negative net
income.
Enterprise Value
/ Comparables
pg. 138
Expense items beneath EBITDA include: depreciation and amortization,
interest, and tax. These expense items, when combined with EBITDA,
could be enough to result in a negative income. There could also be
one-time expense items like litigation expenses, which are typically not
included in EBITDA but may affect net income.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
92
Section 3: Accounting - Question 011
Accounting
pg. 82
What is the difference between
accrual and cash accounting?
Next Question:
What are two ways the
cash flow statement...
If the balance sheet
doesn’t balance...
What’s shareholder’s
equity represent...
Accrual accounting is the most commonly used form of accounting. In
Why is market
capitalization not...
accrual accounting, we record revenue and expenses as they are
incurred. That is, we record when the good or service is delivered, rather
than corresponding to the timing of the cash inflow or outflow. For
Enterprise Value
/ Comparables
pg. 138
example, if a company sells an annual subscription to an online service,
the customer typically pays for a whole year upfront. However, when
looking at the net income on a quarterly basis, we cannot assume that
a whole year’s revenue is earned, even if the customer pays upfront
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
in any given quarter. This is because the online service is delivered
over time, and not all at once upfront, even if the payment was upfront.
Consequently, it must be recorded as deferred revenue, and the revenue
will only be recognized as the online service is delivered over time.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Cash accounting is the most basic form of accounting, but it is rarely
used in business today. In cash accounting, you simply record cash
inflows as revenue whenever you receive the cash, as opposed to when
you deliver the product or service. Similarly, expenses are expensed at
the same time as the corresponding cash outflows occur. This ignores
the principle of recording expenses when they are incurred, since the
accounting is based entirely on cash inflows and outflows.
Accounting
Enterprise Value
/ Comparables
93
Section 3: Accounting - Question 012
Accounting
pg. 82
What are two ways the
cash flow statement can be
displayed? Which one is better?
Next Question:
If the balance sheet
doesn’t balance...
What’s shareholder’s
equity represent...
Why is market
capitalization not...
There are two ways the cash flow statement can be prepared: the
Which liabilities on
the balance sheet...
direct method, and the indirect method.
The direct method is the easiest to understand, but rarely used in more
publicly traded companies. We just record all the cash inflows and
outflows as they happen, categorizing them between cash flow from
operations, cash flow from investments, and cash flow from financing.
For example, cash flow from operations may include cash flows from
customers, cash paid to employees, etc. The indirect method is much
more common with publicly traded companies, since it provides a
reconciliation from net income to cash. By using net income as a starting
point to calculate cash flow, the reader is able to appreciate the relationship
between net income and cash flow, and all the items in between.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
In the indirect method, we start with net income and add back all the
non-cash items in the income statement as well as net working capital.
Afterwards, any other cash flow numbers not included in the income
statement are also added in.
Below are the three sections of the cash flow statement; this is not
necessary for your verbal answer, but they’re displayed here for clarity.
•
Cash flow from operations: starting from net income, we then account
for changes in net working capital, and we also add all non-cash items in
the income statement such as depreciation and amortization
•
Cash flow from investing: includes any cash outflow which results in the
purchase of an asset, such as capital expenditures (capex) and business
acquisitions
•
Cash flow from financing: includes any cash flows raised from issuance
of debt or equity, as well as any debt repayments or dividends
Accounting
Enterprise Value
/ Comparables
94
Section 3: Accounting - Question 013
Accounting
pg. 82
If the balance sheet doesn’t
balance, what does that mean?
How can you fix that?
Next Question:
What’s shareholder’s
equity represent...
Why is market
capitalization not...
Which liabilities on
the balance sheet...
What is in Other
Current Liabilities?
Assets = Liabilities + Shareholder’s Equity
Above is the balance sheet equation, which is saying that all assets
must be funded by either liabilities (e.g. debt) or shareholder’s equity (e.g.
money from private or public investors). If the equation does not balance,
Enterprise Value
/ Comparables
pg. 138
that means there is an error in the balance sheet.
Discounted
Cash Flow
In order to find the error, first you can see if any item looks wrong in
Mergers &
Acquisitions
pg. 185
the balance sheet. For example, if there is a huge swing in inventory that
doesn’t make sense, it’s worth revisiting the math behind that number
and seeing if there are any mistakes. You can also see if assets are
pg. 235
Leveraged
Buyouts
pg. 282
higher, or liabilities + shareholder’s equity is higher. See if the difference
matches any particular line items you have forgotten.
Other
Questions
pg. 330
Another way to find out why a balance sheet does not balance is by
building lots of checks and reconciliations. For example, you can build a
bridge from EBITDA to cash flow, in order to see that the buildup makes
sense, and that the cash flow number you arrive at is consistent with the
increase in cash on the balance sheet.
You can also see if items in the cash flow statement correspond with
items in the balance sheet. For example, you can examine if changes
in net working capital in the cash flow statement - such as accounts
receivable, inventory, and accounts payable - correspond to the changes
in net working capital on the balance sheet. Another common mistake is
not linking net income from the income statement to shareholder’s equity
on the balance sheet.
Accounting
Enterprise Value
/ Comparables
95
Section 3: Accounting - Question 014
Accounting
pg. 82
What does shareholder’s
equity on the balance sheet
represent?
Next Question:
Why is market
capitalization not...
Which liabilities on
the balance sheet...
What is in Other
Current Liabilities?
Shareholder’s equity represents the portion of the assets that have
When would you
capitalize an expense?
been funded by equity as opposed to liabilities / debt. Some sources of
equity investment include:
Enterprise Value
/ Comparables
pg. 138
•
Original investment by the founder(s) to start the business
•
Additional funds invested by management
•
Investments from venture capital or private equity
•
Equity capital raised from the stock market, either through IPOs or
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
secondary offerings
Also, any dividends will be deducted from shareholder’s equity, since
they represent an outflow of cash from the company to the shareholders.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Note that shareholder’s equity is always recorded at book value. In
other words, it is recorded at the value of the initial investment. For
example, if the company issues 1,000 shares at $10 / share to raise
$10,000, which is recorded on the balance sheet. It does not matter if the
stock price has risen to $20 / share. On the balance sheet, the company
will still have $10,000 of stock, regardless of the fluctuations in market
price.
Accounting
Enterprise Value
/ Comparables
96
Section 3: Accounting - Question 015
Accounting
pg. 82
Why is market capitalization
not the same as shareholder’s
equity on the balance sheet?
Next Question:
Which liabilities on
the balance sheet...
What is in Other
Current Liabilities?
When would you
capitalize an expense?
Market capitalization is calculated by the total diluted number of shares
What is the difference
between U.S. GAAP...
outstanding (as calculated by the treasury method) multiplied by the
stock price / share. It represents the equity value of the company based
on the market price of the stock, and is considered a better indicator of
value than shareholder’s equity on the balance sheet. This is because
shareholder’s equity on the balance sheet is stagnant at the original
investment amount, while market capitalization is determined by
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
investors and traders who have their pulse on the market.
pg. 235
As mentioned above, and repeated here again for clarity, shareholder’s
equity is always recorded at book value. In other words, it is recorded at
the value of the initial investment. For example, if the company issues
1,000 shares at $10 / share to raise $10,000, which is recorded on the
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
balance sheet. It does not matter if the stock price has risen to $20 /
share. On the balance sheet, the company will still have $10,000 of stock,
regardless of the fluctuations in market price.
Accounting
Enterprise Value
/ Comparables
97
Section 3: Accounting - Question 016
Accounting
pg. 82
Which liabilities on the balance sheet
are considered debt and which liabilities
are considered working capital?
Next Question:
What is in Other
Current Liabilities?
When would you
capitalize an expense?
What is the difference
between U.S. GAAP...
Liabilities are considered debt if they require interest payments. For
Company acquires
a target, but...
example, a loan from a bank would be considered debt since you are
required to pay interest on it. However, accounts payable would not be
considered debt since you do not pay interest on it. Accounts payable
simply represents money owed to suppliers / vendors, and it is typical
for suppliers and vendors to allow payment terms of 30-60 days for the
convenience of their customers.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
98
Section 3: Accounting - Question 017
Accounting
pg. 82
What is included in Other Current
Liabilities?
Next Question:
When would you
capitalize an expense?
What is the difference
between U.S. GAAP...
Company acquires
a target, but...
How could you
confirm if a...
Other current liabilities is a catch-all bucket for non-debt liabilities
that are not covered by the usual non-debt liability accounts such as
accounts payable. They can include anything from unpaid wages and
bonuses, money owed to vendors that are not core to the business, or
sometimes tax liabilities.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
99
Section 3: Accounting - Question 018
Accounting
pg. 82
When would you capitalize an
expense?
Next Question:
What is the difference
between U.S. GAAP...
Company acquires
a target, but...
How could you
confirm if a...
If you were an investor,
(income statement)...
You would capitalize an expense if the item / service purchased is
expected to last for more than a year. For example, if the firm spent
money on computers, and they would be expected to be used for 5 years,
then the computers are considered assets. The cash outflow to purchase
the computers would be considered capital expenditures.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
However, if the firm spent money on office supplies,and they used the
office supplies in less than a year, then the cash outflow to purchase the
pg. 185
Mergers &
Acquisitions
pg. 235
office supplies would be considered an expense.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
100
Section 3: Accounting - Question 019
Accounting
pg. 82
What is the difference between
U.S. GAAP and IFRS?
Next Question:
Company acquires
a target, but...
How could you
confirm if a...
If you were an investor,
(income statement)...
U.S. GAAP is rules-based, and there is not a lot of wiggle room with how
If you were an investor,
(cash flow statement)...
the rules are interpreted. It’s used in the U.S.
IFRS is principle-based, so there is more room for interpretation. It’s used
around the world.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
One key difference is with regards to inventory reversal after an
inventory write-down has happened. For U.S. GAAP, if the market value
of the asset goes up, the write-down cannot be reversed. Under IFRS,
however, if the market value of the asset goes up, the write-down can be
reversed.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
There are many other differences, but you would not have to know more
Other
Questions
pg. 330
than this for an investment banking interview.
Accounting
Enterprise Value
/ Comparables
101
Section 3: Accounting - Question 020
Accounting
pg. 82
Let’s say one company acquires a target, but
they realize the target has less assets than
they claimed in the balance sheet. How would
this affect the financial statements?
Next Question:
How could you
confirm if a...
If you were an investor,
(income statement)...
If you were an investor,
(cash flow statement)...
If after the acquisition, the company ends up having less assets than
If you were an investor,
(balance sheet)...
they claimed in the balance sheet, then the asset would be written down.
This would decrease pre-tax income by the same amount, and therefore
would decrease net income by Write-Down x (1-Tax Rate). The writedown would then be added back in the cash flow statement, since writedowns are non-cash, and overall cash will be up by Writedown x Tax
Rate (effectively represents the tax shield). Meanwhile shareholder’s
equity will be down Write-Down x (1-Tax Rate) to reflect the decline in
net income. Assets in the balance sheet will go down by the amount of
the write-down.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
If there is no asset to write down because it never existed in the first
place, then goodwill would be written down to reflect this, and the
Other
Questions
pg. 330
impact on the three statements would be similar.
Accounting
Enterprise Value
/ Comparables
102
Section 3: Accounting - Question 021
Accounting
pg. 82
How could you confirm if a company
has the assets they claim to on the
balance sheet?
Next Question:
If you were an investor,
(income statement)...
If you were an investor,
(cash flow statement)...
If you were an investor,
(balance sheet)...
The best way would be to perform a due diligence trip to the company
How would a tech
company...
site to verify the existence of assets yourself, while taking notes and
asking key questions to decipher the quality and longevity of the assets.
Enterprise Value
/ Comparables
pg. 138
If a live visit is not possible, another way is to ask the company for
supporting documentation with shows the original purchase and life of
the asset, depreciation and amortization policies, maintenance policies,
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
photographs and maps showing the location of the assets, etc.
pg. 235
Finally, if you are just an individual investor, you can study the balance
sheet carefully, as well as the MD&A, earnings transcripts, annual
Leveraged
Buyouts
pg. 282
information forms, and equity research reports. If certain assets don’t
make sense because they are too large relative to their description, and if
Other
Questions
pg. 330
some equity research analysts are questioning the value of their assets,
then this would be a red flag.
Accounting
Enterprise Value
/ Comparables
103
Section 3: Accounting - Question 022
Accounting
pg. 82
If you were an investor, what would
you look for in the income statement?
Next Question:
If you were an investor,
(cash flow statement)...
If you were an investor,
(balance sheet)...
How would a tech
company...
How would a financial
institution’s...
As an investor, you would look for strong and consistent revenue
growth, consistent and/or improving gross margins, SG&A as a % of
revenue declining over time as a function of operating leverage (fixed
costs spread over a large revenue basue), healthy and stable EBITDA
margins, and favourable effective tax rates. You would also look to see if
depreciation and amortization were stable, since this reflects their assets
and accounting policies. You would also look at interest expense to make
sure that it can easily be covered by EBITDA, which can be used as a
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
proxy for cash flow.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
104
Section 3: Accounting - Question 023
Accounting
pg. 82
If you were an investor, what would you look
for in the cash flow statement?
Next Question:
If you were an investor,
(balance sheet)...
How would a tech
company...
How would a financial
institution’s...
As an investor, you would first look at the overall cash flows, since cash
How would an oil and
gas company...
flows are the best way to judge the financial value of a company. You
would also be particularly interested in cash flow from operations and
cash flow from investing. Cash flow from operations shows how much
cash you are making from your operations, and also shows you net
income and how changes in net working capital are impacting your cash
flow. Cash flow from investing shows the investments you are making
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
into capex or acquisitions, which is key to understanding the future
pg. 235
strategy and trajectory of the business.
Although cash flow from financing is less important, it is still useful to
look at to understand how the company is raising cash, either through
equity or debt, and how the company is delivering value back to
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
stakeholders through debt repayment and stock dividends.
Accounting
Enterprise Value
/ Comparables
105
Section 3: Accounting - Question 024
Accounting
pg. 82
If you were an investor, what would you look
for in the balance sheet? (1/2)
Next Question:
How would a tech
company...
How would a financial
institution’s...
How would an oil and
gas company...
How would a
construction...
As an investor, you would be focused on both the book value of the
company’s shares as displayed on the balance sheet, which can be
calculated as total assets less liabilities. This shows how much the
Enterprise Value
/ Comparables
company is worth based only on its accounting books.
pg. 138
Another way of thinking of the book value of a company is that we are
taking the original cost of the assets less any writedowns or depreciation
and amortization (i.e. book value of the asset). Then we are taking out
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
any liabilities to see what the company’s liquidation value would be
worth, assuming the book value reflects how much the assets can be
sold for. This number can then be compared to the market capitalization.
In fact, this is the premise in which a very commonly used multiple is
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
based upon: price / book. Price / book shows if the market capitalization
of the stock, which is determined by investors, is greater than the book
value of the company. A company with a price / book less than 1 could
be very attractive as a value investment, assuming there are no serious
issues with the company. Another commonly used multiple is price /
tangible book value, in which intangible assets, such as goodwill and
intellectual property, are taken out of the book value of the company.
Accounting
Enterprise Value
/ Comparables
106
Section 3: Accounting - Question 024
Accounting
pg. 82
If you were an investor, what would you look
for in the balance sheet? (2/2)
Next Question:
How would a tech
company...
How would a financial
institution’s...
How would an oil and
gas company...
In addition to analyzing book value, you would look carefully at which
How would a
construction...
assets are key to the operations, such as property, plant, and equipment
(PP&E), as well as how they’ve changed over time. If capital assets
Enterprise Value
/ Comparables
continue to rise, this means the company is investing and expecting
pg. 138
growth.
Discounted
Cash Flow
Similarly, you would look closely at the debt to see how it has been repaid
pg. 185
Mergers &
Acquisitions
over the years, or if the company continue to borrow at a rapid rate.
pg. 235
Finally, you would look at how net working capital has changed, since
any increases in net working capital will affect cash. A sharp rise in
Leveraged
Buyouts
pg. 282
accounts receivable would draw attention, for example, since it may
mean the company is increasing revenue only by extending credit to
Other
Questions
pg. 330
customers, and the revenue growth may not be sustainable.
Accounting
Enterprise Value
/ Comparables
107
Section 3: Accounting - Question 025
Accounting
pg. 82
How would a tech company’s accounting
be different than a consumer company’s
accounting?
Next Question:
How would a financial
institution’s...
How would an oil and
gas company...
How would a
construction...
How would a realestate company...
A tech company would likely have a lot less tangible assets than a
consumer company’s, and typically does not have inventory. Therefore, a
tech company would be less impacted by D&A and inventory accounting
policies, and require less net working capital.
Enterprise Value
/ Comparables
pg. 138
A tech company often has significant intellectual property, which may
sometimes be represented by goodwill if there have been several
acquisitions in its lifetime. However, if it is a start-up and has not
executed any acquisitions, the intellectual property may not be on the
balance sheet, and therefore the balance sheet may not be a strong
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
indicator of how much a tech company is worth.
pg. 282
However, with a consumer company, you can have an idea of what the
Other
Questions
pg. 330
floor value might be, since its assets are tangible in nature and can be
sold in case of a liquidation.
Accounting
Enterprise Value
/ Comparables
108
Section 3: Accounting - Question 026
Accounting
pg. 82
How would a financial institution’s accounting
be different than a consumer company’s
accounting? (1/2)
Next Question:
How would an oil and
gas company...
How would a
construction...
How would a realestate company...
A financial institution would typically be more focused on net income
When does goodwill
increase?
rather than EBITDA. This is because interest expense is an important
part of a financial institution’s business. Banks borrow money and
then lend it at a higher rate, so the interest expense is directly related
to driving revenue. Therefore, unlike consumer companies, EBITDA is
not treated with any importance and sometimes not even shown in the
accounting statements of financial statements.
Since financial institutions are often very dependent on borrowing at
low rates, it will also be important to display as much debt information
as possible on their financial statements and MD&A to make it easier
for investors to judge the firm’s efficiency, profi tability, and projected
performance. Debt is not as important for consumer companies, so they
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
may not place as much emphasis on debt in their financial statements
and MD&A.
Financial institutions are very dependent on their book value, since
this shows what their portfolio of investments and loans are worth.
Assuming the portfolio was relatively liquid, then this is a proxy for the
liquidation value of the firm. Consequently, a lot of care and attention
is given to ensure that book values properly reflect market conditions,
and financial institutions must often follow complex rules to adjust the
book value of their investments in order to show a clear and transparent
picture to investors. Although book value is also important to consumer
companies, it is not as important and there is less emphasis on marking
book value up or down when it comes to physical property assets.
Accounting
Enterprise Value
/ Comparables
109
Section 3: Accounting - Question 026
Accounting
pg. 82
How would a financial institution’s accounting
be different than a consumer company’s
accounting? (2/2)
Next Question:
How would an oil and
gas company...
How would a
construction...
How would a realestate company...
Finally, financial institutions often have to follow a lot more accounting
When does goodwill
increase?
rules, as the industry is highly regulated, so there is a need for strong
accounting procedures in order to ensure compliance with the law.
Enterprise Value
/ Comparables
Consumer companies are not as highly regulated when it comes to
pg. 138
accounting procedures.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
110
Section 3: Accounting - Question 027
Accounting
pg. 82
How would an oil and gas company’s
accounting be different than a
consumer company’s accounting?
Next Question:
How would a
construction...
How would a realestate company...
When does goodwill
increase?
Oil and gas companies place a strong emphasis on valuing reserves and
Why would goodwill
be impaired?
production data. There are very detailed and technical guidelines on
valuing oil and gas reserves, which often comprise the majority of assets
in an oil and gas company. This is generally much more complicated and
technical than the way consumer companies value their assets, which
are typically just stores and real estate.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
111
Section 3: Accounting - Question 028
Accounting
pg. 82
How would a construction company’s
accounting be different than a
consumer company’s accounting?
Next Question:
How would a realestate company...
When does goodwill
increase?
Why would goodwill
be impaired?
Construction companies drive their revenue through construction jobs,
How would you assess
a company’s...
which often take years to finish. Consequently, they have to use the
work-in-progress accounting method to determine how much revenue
and COGS are allocated to each time period. This is very different from
consumer companies, which depend on sales of products and services
which are typically delivered very quickly.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
112
Section 3: Accounting - Question 029
Accounting
pg. 82
How would a real estate company’s
accounting be different than a
consumer company’s accounting?
Next Question:
When does goodwill
increase?
Why would goodwill
be impaired?
How would you assess
a company’s...
Consumer companies focus on EBITDA as a proxy for cash flow, while
What is a contra asset
account?
real estate companies focus on funds from operations (FFO), which is
calculated as: FFO = Net Income + Depreciation & Amortization - Gains
on Sales of Property. Companies will frequently buy real estate with
mortgages (i.e. debt), so net income is used as a starting point since
Enterprise Value
/ Comparables
pg. 138
interest expense is part of the core business.
Discounted
Cash Flow
Depreciation and amortization is added back since it is a non-cash
Mergers &
Acquisitions
pg. 185
expense. Also, any increases in real estate and land value will often be
equal to or greater than depreciation and amortization, so it makes sense
to add it back from net income.
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
Gains on sales of property are subtracted since most real estate
pg. 330
companies and real estate investment trusts (REITs) are in the business
of earning income from real estate properties, such as rental income.
They are not in the business of flipping real estate by buying low and
selling high, and so any gains on sales of property are not part of the
core business. Typically, metrics that measure the strength of the core
business are preferred since it is easier to compare to other businesses,
and is also a better indicator of future cash flows Another commonly
used metric is adjusted funds from operations.
Accounting
Enterprise Value
/ Comparables
113
Section 3: Accounting - Question 030
Accounting
pg. 82
When does goodwill increase?
Next Question:
Why would goodwill
be impaired?
How would you assess
a company’s...
What is a contra asset
account?
If the market value of the business increases to an amount greater than
How do you account
for cash that...
goodwill, the asset cannot be increased to reflect his new value. The only
way that goodwill can be increased is through the acquisition of another
company as a subsidiary.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
114
Section 3: Accounting - Question 031
Accounting
pg. 82
Why would goodwill be impaired?
Next Question:
How would you assess
a company’s...
What is a contra asset
account?
How do you account
for cash that...
Goodwill impairment occurs when a company decides to pay more than
How does $10 of
depreciation affect...
book value for the acquisition of an asset, and then the value of that
asset declines. The company must adjust the book value of that goodwill
down if it becomes impaired.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
115
Section 3: Accounting - Question 032
Accounting
pg. 82
How would you assess a
company’s liquidity from their
balance sheet?
Next Question:
What is a contra
asset account?
How do you account
for cash that...
How does $10 of
depreciation affect...
How does $30 of
additional revenue...
You can assess the company’s solvency ratios and liquidity ratios.
Solvency ratio refers to an enterprise’s capacity to meet its long-term
financial commitments. Liquidity refers to an enterprise’s ability to pay
short-term obligations.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
116
Section 3: Accounting - Question 033
Accounting
pg. 82
What is a contra asset account?
Next Question:
How do you account
for cash that...
How does $10 of
depreciation affect...
How does $30 of
additional revenue...
A contra asset account is similar to an asset account with a negative
How does $40 of
additional COGS...
balance (credit balance). For example, accumulated appreciation is a
contra asset account because it represents a negative balance, offsetting
the positive balance in the PP&E (Plant, Property, and Equipment).
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
117
Section 3: Accounting - Question 034
Accounting
pg. 82
How do you account for cash that is not
recorded as revenue because the service /
product has not been delivered yet?
Next Question:
How does $10 of
depreciation affect...
How does $30 of
additional revenue...
How does $40 of
additional COGS...
This cash inflow would be recorded as unearned revenue, which is a
How does $50 of
dividends...
liability.
Enterprise Value
/ Comparables
Since we have not delivered the service / product, we cannot record
pg. 138
the revenue yet. However, as the service / product is delivered over
time, the unearned revenue liability will be reduced, and revenue will be
recognized.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
118
Section 3: Accounting - Question 035
Accounting
pg. 82
How does $10 of depreciation affect the three
statements with a 40% tax rate?
Next Question:
How does $30 of
additional revenue...
How does $40 of
additional COGS...
How does $50 of
dividends...
$10 of depreciation would reduce pre-tax income by $10. With a 40%
How does borrowing
$80 of debt...
tax rate, the savings on tax is $10 x 40% = $4. Since ($10) + $4 = ($6),
(after-tax) net income is down by $6.
Enterprise Value
/ Comparables
pg. 138
In the cash flow statement, we start with net income down by $6. Then
we add back the $10 of depreciation because it’s a non-cash expense.
Since ($6) + $10 = $4, we finish with cash up by $4.
pg. 185
Mergers &
Acquisitions
pg. 235
On the balance sheet, we start with cash up $4. Since there is
depreciation of $10, assets will be effected negatively. Since $4 - $10
= ($6), total assets are down by $6. Since net income is down by $6,
retained earnings is also down by $6. Both sides of the balance sheet
balance.
Accounting
Discounted
Cash Flow
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
119
Section 3: Accounting - Question 036
Accounting
pg. 82
How does $30 of additional revenue affect the
three statements with a 20% tax rate?
Next Question:
How does $40 of
additional COGS...
How does $20 of PIK
interest...
How does $50 of
dividends...
First, confirm that the additional revenue has no cost attached with it.
If so, $30 of revenue will come with tax attached to it, so net income is
increased by $30 x (1-20%) = $24.
How does borrowing
$80 of debt...
Enterprise Value
/ Comparables
pg. 138
We must also confirm that the revenue is received in cash. Assuming it
was, we would increase cash by $24 and shareholder’s equity by $24.
If the sale was on credit, then we would increase accounts receivable
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
instead of cash.
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
120
Section 3: Accounting - Question 037
Accounting
pg. 82
How does $40 of additional COGS affect the
three statements given a 15% tax rate?
Next Question:
How does $20 of
PIK interest...
How does $50 of
dividends...
How does borrowing
$80 of debt...
How does a $50
dividend recap...
$40 of additional COGS would have a tax expense attached to it.
Therefore, net income would decline by $40 x (1-15%) = $34.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
121
Section 3: Accounting - Question 038
030
Accounting
pg. 82
How does $20 of PIK interest affect the three
statements? Assume a 75% tax rate.
Next Question:
How does $50 of
dividends...
How does borrowing
$80 of debt...
How does a $50
dividend recap...
$20 of PIK interest would decrease pre-tax income by $20 and after-tax
How does a $100
equity investment...
net income by $20 x (1-75%) = $5.
In the cash flow statement, net income is down $5, but we add back noncash expenses of $20, since PIK interest is non-cash. Therefore, cash is
Enterprise Value
/ Comparables
pg. 138
up $15.
Discounted
Cash Flow
In the balance sheet, cash is up $15. Debt is up $20, since the PIK debt
Mergers &
Acquisitions
pg. 185
is like an unpaid credit card balance, and the interest just accumulates
on top of the existing debt. Shareholder’s equity is down $5 since net
income is down $5.
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
122
Section 3: Accounting - Question 039
Accounting
pg. 82
How does $50 of dividends affect the three
statements?
Next Question:
How does borrowing
$80 of debt...
How does a $50
dividend recap...
How does a $100
equity investment...
Dividends will have no impact on the income statement. This will lead to
How does $80 of
deferred revenue...
a $50 decrease in the cash flows from financing section of the cash flow
statement.
Enterprise Value
/ Comparables
pg. 138
Dividends will have no impact on the income statement. Cash goes down
by $50 in the cash flows from financing section.
Discounted
Cash Flow
On the balance sheet, cash goes down by $50 and shareholder’s equity
Mergers &
Acquisitions
pg. 185
pg. 235
goes down $50, since paying dividends is like giving equity away.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
123
Section 3: Accounting - Question 040
Accounting
pg. 82
How does borrowing $80 of debt affect the
three statements?
Next Question:
How does a $50
dividend recap...
How does a $100
equity investment...
How does $80 of
deferred revenue...
Follow up: the $80 of
deferred...
Borrowing debt will have no impact in year 0 as there is no interest
expense accumulated. It will increase debt from financing by $80. In the
balance sheet, it will increase cash by $80 and increase liabilities by $80
as well.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
124
Section 3: Accounting - Question 041
Accounting
pg. 82
How does a $50 dividend recap affect the
three statements?
Next Question:
How does a $100
equity investment...
How does $80 of
deferred revenue...
Follow up: the $80 of
deferred...
A dividend recapitalization happens when a company borrows debt to
How does $150
purchase of annual...
pay a dividend to investors. There is no impact on the income statement.
Initially, in the cash flow statement, it will increase cash flows from
financing by $50, which represents the company borrowing $50. Then,
cash will go down again by $50 in the cash flows from financing section,
which represents the company distributing the cash to its investors.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Therefore, cash is unchanged overall.
On the balance sheet, cash is unchanged. Debt is up by $50. Equity is
down $50 to represent the distribution of dividends to investors, which is
like giving equity away.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
125
Section 3: Accounting - Question 042
Accounting
pg. 82
How does a $100 equity investment affect the
three statements?
Next Question:
How does $80 of
deferred revenue...
Follow up: the $80 of
deferred...
How does $150
purchase (Y0)...
A $100 equity investment will have no impact on the income statement
How does $150
purchase (Y1)...
as it does not affect revenue nor does it affect expenses. On the cash
flow statement, it will increase cash flow from financing by $100,
Enterprise Value
/ Comparables
On the balance sheet, it will increase the cash account by $100 and
pg. 138
shareholder’s equity by $100.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
126
Section 3: Accounting - Question 043
Accounting
pg. 82
How does $80 of deferred revenue affect the
three statements in Year 0?
Next Question:
Follow up: the $80 of
deferred...
How does $150
purchase (Y0)...
How does $150
purchase (Y1)...
How does prepaying
for one year...
Deferred revenue is revenue that has not yet been earned, since the
product or service has not been delivered. Therefore, there are no
changes on the income statement.
Enterprise Value
/ Comparables
pg. 138
In the cash flow statement, we receive the $80 of cash through
Discounted
Cash Flow
the Changes in Deferred Revenue line item under Cash Flow from
pg. 185
Operations. So cash is up $80.
In the balance sheet, cash is up $80. Deferred revenue, a liability account,
is up $80 as well.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
127
Section 3: Accounting - Question 044
Accounting
pg. 82
Follow up: the $80 of deferred revenue has
been recognized in Year 1. Walk me through
the impact on the three financial statements
with a 30% tax rate.
Next Question:
How does $150
purchase (Y0)...
How does $150
purchase (Y1)...
How does prepaying
for one year...
Since the $80 of deferred revenue is now recognized, revenue goes up by
Follow up: How does
prepaying for 1 year...
$80, and so does pre-tax income. After applying the tax rate, we see that
after-tax net income has gone down up by $80 x (1-30%) = $56.
Enterprise Value
/ Comparables
pg. 138
In the cash flow statement, we start with net income up $56. Since the
$80 of revenue we received is not a cash inflow; rather, it is based on
the recognition that we have delivered the product or service. Since it is
non-cash, we reverse this in the cash flow statement, and the Changes in
Deferred Revenue line item under Cash Flow from Operations goes down
by $80. Overall, cash is down $56-$80=($24).
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
The balance sheet starts with cash down ($24). Deferred revenue is
down ($80) since we no longer owe the products or services associated
Other
Questions
pg. 330
with that revenue. Shareholder’s equity is up $56, since net income is up
$56.
Accounting
Enterprise Value
/ Comparables
128
Section 3: Accounting - Question 045
Accounting
pg. 82
How does $150 purchase of annual
subscriptions affect the three statements with
a tax rate of 60% in Year 0?
Next Question:
How does $150
purchase (Y1)...
How does prepaying
for one year...
Follow up: How does
prepaying for 1 year...
If a customer purchases upfront $150 of annual subscriptions from us,
What happens if you
buy a $200...
this would be deferred revenue, and we cannot immediately recognize
the revenue since we have not delivered the service yet. Therefore, there
are no changes on the income statement.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
In the cash flow statement, cash goes up by $150 in the changes in
pg. 185
deferred revenue section.
In the balance sheet, cash goes up by $150, and deferred revenue goes
by $150. Deferred revenue is a liability account, since we still owe the
customer the service they paid for.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
129
Section 3: Accounting - Question 046
Accounting
pg. 82
How does $150 purchase of annual
subscriptions affect the three statements with
a tax rate of 60% in Year 1?
Next Question:
How does prepaying
for one year...
Follow up: How does
prepaying for 1 year...
What happens if you
buy a $200...
In year 1, we have delivered the service the customer paid for, so we
Follow up: What
happens in year 1...
recognize the revenue in year 1. Since there is a 60% tax rate, our net
income in the income statement goes up by $150 x (1-60%) = $60.
Enterprise Value
/ Comparables
pg. 138
In the cash flow statement, we start with net income up by $60. Now
we have to reverse any non-cash expenses / revenues. In this case, the
revenue is recognized in Year 1, but we did not receive any cash flow
in Year 1. Therefore, this revenue is non-cash. We have to subtract the
$150 of non-cash revenue from the cash flow statement. We started
with cash up by $60 from net income; now, cash is down by $90.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
On the assets side of the balance sheet, we start with cash down by
$90. On the liabilities side, the deferred revenue has been recognized, so
Other
Questions
pg. 330
it goes down by $150. Shareholder’s equity goes down by $60 because
net income goes down by $60, so both sides balance.
Accounting
Enterprise Value
/ Comparables
130
Section 3: Accounting - Question 047
Accounting
pg. 82
How does prepaying for one year of insurance
of $100 affect the three statements in year 0?
Next Question:
Follow up: How does
prepaying for 1 year...
What happens if you
buy a $200...
Follow up: What
happens in year 1...
Prepaying insurance in year 0 is not an expense and does not affect the
Follow up: What
happens in year 2...
income statement. This is because we are prepaying for it, though the
service has not been delivered yet.
Enterprise Value
/ Comparables
pg. 138
Cash goes down by $100 on the cash flow statement.
Discounted
Cash Flow
Cash is down $100 on the balance sheet as well, while prepaid insurance
pg. 185
Mergers &
Acquisitions
(asset) goes up by $100.
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
131
Section 3: Accounting - Question 048
Accounting
pg. 82
Follow up: How does prepaying for one year of
insurance affect the three statements in year 1
with a 35% tax rate?
Next Question:
What happens if you
buy a $200...
Follow up: What
happens in year 1...
Follow up: What
happens in year 2...
By year 1, the expense will have been recognized. We recognize $100 of
How does $40 of
goodwill...
insurance expenses, and there’s a 35% tax rate. Therefore, net income
goes down by $100 x (1-35%) = $65.
Enterprise Value
/ Comparables
pg. 138
On the cash flow statement, we start with net income down by $65.
Then we add back the $100 insurance expense as it’s non-cash. Cash is
up by $35.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
On the balance sheet, we have cash up by $35. Prepaid insurance
(asset) goes down by $100, since the expense has been recognized now.
Shareholder’s equity is down by $65 since net income is down by $65,
and both sides balance.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
132
Section 3: Accounting - Question 049
Accounting
pg. 82
What happens if you buy a $200 factory, 50%
debt, 50% equity in year 0?
Next Question:
Follow up: What
happens in year 1...
Follow up: What
happens in year 2...
How does $40 of
goodwill...
How does $70 of
inventory writedown...
The factory purchase is capex so there’s no impact on the income
statement, so we should start with the cash flow statement.
The factory is purchased with 50% debt and 50% equity. We issue the
debt for $100, the purchase of PP&E is a cash outflow for $200, so the
Enterprise Value
/ Comparables
pg. 138
net change of cash is down ($100).
Discounted
Cash Flow
On the balance sheet, that will decrease the cash by $100, increase
Mergers &
Acquisitions
pg. 185
the long-term asset factory account by $200, and increase the longterm debt account by $100. Both the changes in assets and liabilities/
shareholder’s equity equal one another, so it balances.
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
133
Section 3: Accounting - Question 050
Accounting
pg. 82
Follow up: What happens in year 1?
Next Question:
Follow up: What
happens in year 2...
How does $40 of
goodwill...
How does $70 of
inventory writedown...
Ask if you can assume that the useful life of the factory is 10 years
and the tax rate is 40%. In the income statement, there is a depreciation
expense of $200 / 10 years = $20, as well as an interest expense of $100
x 10% = $10. Pre-tax income goes down by ($30), and after applying a
40% tax rate, net income is down by ($30) x (1-40%) = ($18).
pg. 138
Discounted
Cash Flow
On the cash flow statement, you start with net income down by ($18).
We add back non-cash expenses, so the depreciation expense of $20 is
pg. 185
Mergers &
Acquisitions
pg. 235
added back. We get a net change in cash of $2.
In the balance sheet, we start with cash up by $2. The factory goes down
by ($20) because of the depreciation expense. Since net income is down
by ($18), shareholder’s equity is down by ($18).
Accounting
Enterprise Value
/ Comparables
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
134
Section 3: Accounting - Question 051
Accounting
pg. 82
Follow up: What happens in year 2 if the
factory blows up?
Next Question:
How does $40 of
goodwill...
How does $70 of
inventory writedown...
If the factory blows up in year 2, we have to write down the factory.
We also have to write down the debt, since the debt financing of the
purchase of the factory is now in default.
Enterprise Value
/ Comparables
pg. 138
After 2 years, the factory will be worth $160, since there will
Discounted
Cash Flow
be 2 years of depreciation.
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Accounting
Enterprise Value
/ Comparables
135
Section 3: Accounting - Question 052
Accounting
pg. 82
How does $40 of goodwill impairment affect
the three statements?
Next Question:
How does $70 of
inventory writedown...
Goodwill is an intangible asset and represents the premium you’ve
paid over the book value of a company during an acquisition. However,
under IFRS, we must test to see if this goodwill is impaired by calculating
the fair market value of the acquired company’s assets and seeing if they
still can justify that level of goodwill. If the acquired company’s assets
have declined significantly in value compared to before the acquisition,
then we must write-down goodwill.
In this case, goodwill is being impaired by $40, so it’s like a $40 expense
on the income statement. Assuming a tax rate of 40%, we will have a
decrease in net income of $40 x (1-40%) = $24.
Enterprise Value
/ Comparables
pg. 138
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
In the cash flow statement, we start with net income down $24.
pg. 330
However, we have to add back the $40 goodwill impairment charge
since it was a non-cash expense. We end up with cash up by ($24) + $40
= $16.
On the balance sheet, we have cash up by $16, goodwill down by $40, so
assets are down $24 overall. We have a decrease in net income of $24,
so shareholder’s equity goes down by $24, and both sides balance.
Accounting
Enterprise Value
/ Comparables
136
Section 3: Accounting - Question 053
Accounting
pg. 82
How does $70 of inventory writedown affect
the three statements?
Next Question:
Ask the interviewer to make sure that you’re using FIFO standards.
Inventory writedown is usually recognized as a contra-asset for inventory
which is a current asset.
Enterprise Value
/ Comparables
pg. 138
So if you were accounting for $70 of inventory write-down, you would
ultimately COGS for $70 and credit the value of inventory for $70 in
Discounted
Cash Flow
pg. 185
inventory write-down or the contra asset account.
In terms of the income statement, it will increase expenses, therefore
creating a larger tax bracket. If the tax rate assumption is 40%, it would
be about (1-40%)*70= $42 decrease in net income, the tax amount was
$28.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
In the cash flow statement, it would decrease the net income by $42, you
would add COGS for $70 and that would increase cash by $28.
On the balance sheet, cash would increase by $28, assets would be
down by $70 and total assets would be down $42 and retained earnings
would also be down by the same amount.
Accounting
Enterprise Value
/ Comparables
137
Section Four
Enterprise
Value / Comparables
138
Section 4: Enterprise Value / Comparables - Question 001
Enterprise Value
/ Comparables
pg. 138
What is the main difference
between equity value and
enterprise value?
Next Question:
What is the formula for
enterprise value?
Why do we add back
minority interest?
Why do you subtract
cash?
Equity value = # of stocks x price. It is the same as market capitalization,
What’s the difference
between market...
and represents the total value of equity holders’ stock. It does not include
debt.
Discounted
Cash Flow
pg. 185
Enterprise value represents the value of the company to both equity
holders and debt holders. In other words, it represents the total value of
the firm, and includes debt, unlike equity value.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
139
Section 4: Enterprise Value / Comparables - Question 002
Enterprise Value
/ Comparables
pg. 138
What is the formula for enterprise
value?
Next Question:
Why do we add back
minority interest?
Why do you subtract
cash?
What’s the difference
between market...
Enterprise value = equity value + debt - cash + preferred stock + minority
If a company has
negative enterprise...
interest
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
140
Section 4: Enterprise Value / Comparables - Question 003
Enterprise Value
/ Comparables
pg. 138
Why do we add back minority
interest?
Next Question:
Why do you subtract
cash?
What’s the difference
between market...
If a company has
negative enterprise...
Minority interest represents the portion of a subsidiary we don’t own. We
Would shareholder’s
equity ever be...
have to add it back to be consistent; see below.
Discounted
Cash Flow
Accounting rules dictate that income statement line items are
pg. 185
consolidated 100% if the Company owns more than 50% of the target.
For example, if the Company owns 75% of subsidiary A, then 100%
of revenue, COGS, SG&A, etc. are consolidated into the company. This
means that the Company’s EBITDA should contain 100% of subsidiary A.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Enterprise Value / EBITDA is the most commonly used multiple in finance,
and we need to ensure the numerator and denominator are consistent.
Other
Questions
pg. 330
The denominator, EBITDA, contains 100% of subsidiary A.
The numerator is Enterprise Value, which is equity value + debt - cash
+ preferred stock + minority interest. The minority interest in this case is
25% of subsidiary A’s book value.
Why do we have add minority interest? We have to make sure the
numerator includes 100% of subsidiary A, since the denominator
includes 100% of subsidiary.
Even if we don’t add back minority interest, 75% of subsidiary A would
be included in the enterprise value, because that is the portion the
company owns. The stockholders will already value this 75% ownership,
and it will be reflected in the stock price / equity value. Now we have
to add the 25% of subsidiary A’s book value to the enterprise value.
Afterwards, the numerator would contains 100% of subsidiary A, which
would make it consistent with the denominator.
Enterprise Value
/ Comparables
Discounted
Cash Flow
141
Section 4: Enterprise Value / Comparables - Question 004
Enterprise Value
/ Comparables
pg. 138
Why do you subtract cash?
Next Question:
What’s the difference
between market...
If a company has
negative enterprise...
Would shareholder’s
equity ever be...
We subtract cash because, in theory, cash could be used to pay off debt.
Why do companies
issue preferred equity...
If you used the cash to pay off debt, you would actually reduce enterprise
value, since debt is a part of the enterprise value equation.
Discounted
Cash Flow
pg. 185
Another way to think about it is buying a company that already has cash
in it is redundant. You may as well tell the target company to keep the
cash, and then pay them less to make up for the difference.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
142
Section 4: Enterprise Value / Comparables - Question 005
Enterprise Value
/ Comparables
pg. 138
What’s the difference between
market capitalization and
shareholder’s equity?
Next Question:
If a company has
negative enterprise...
Would shareholder’s
equity ever be...
Why do companies
issue preferred equity...
Why do we add
preferred equity....
Market capitalization is calculated as # of shares x stock price. It
represents the equity value of the company; that is, the portion of the
company that is owned by equity holders. It is driven by the stock market.
Discounted
Cash Flow
pg. 185
Shareholder’s equity is the book value of the company’s equity. This book
value is usually recorded at cost, so it represents the beginning equity the
initial investors put in.
For example, if an investor invested $10M into a company, the accounting
entry would be: cash goes up by $10M, shareholder’s equity goes up by
$10M. However, this $10M of shareholder’s equity does not change even
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
if the value of the equity or the stock market changes, it always stays at
$10M.
Net income is also added to shareholder’s equity every year.
Enterprise Value
/ Comparables
Discounted
Cash Flow
143
Section 4: Enterprise Value / Comparables - Question 006
Enterprise Value
/ Comparables
pg. 138
If a company has negative
enterprise value, what does that
mean?
Next Question:
Would shareholder’s
equity ever be...
Why do companies
issue preferred equity...
Why do we add
preferred equity....
This means that the company must have more cash than the equity
How do you account
for convertible bonds...
value and debt value combined together. Cash is subtracted from the
enterprise value, so the larger cash is, the lower the enterprise value.
A company might have a large stockpile of cash because they are
Discounted
Cash Flow
pg. 185
preparing for an acquisition or market expansion.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
144
Section 4: Enterprise Value / Comparables - Question 007
Enterprise Value
/ Comparables
pg. 138
Would shareholder’s equity
ever be greater than market
capitalization?
Next Question:
Why do companies
issue preferred equity...
Why do we add
preferred equity....
How do you account
for convertible bonds...
How do options affect
the enterprise value...
Yes, this is possible if the stock price has declined so much that the
market capitalization, calculated as # of shares x stock price, is lower
than the original book value of shareholder’s equity. The book value of
shareholder’s equity is recorded at the amount of the initial investment.
In other words, the market value of the investment can be lower than
the initial investment amount because of factors such as lower revenue
forecasts, higher costs, higher risks, bankruptcy and any factors that
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
could contribute to a stock selloff.
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
145
Section 4: Enterprise Value / Comparables - Question 008
Enterprise Value
/ Comparables
pg. 138
Why do companies issue preferred
equity in the first place?
Next Question:
Why do we add
preferred equity....
How do you account
for convertible bonds...
How do options affect
the enterprise value...
In practice, preferred equity is more similar to debt because it earns a
If a company has net
operating losses...
fixed yield. However, it is technically classified as equity by the banks, so
issuing preferred equity is a way to gain access to a debt-like instrument
without hurting the company’s debt-to-equity ratio.
Discounted
Cash Flow
pg. 185
It also offers maximum flexibility compared to debt. Missing out on a
preferred share dividend payout will not trigger a default, whereas
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
missing an interest payment would.
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
146
Section 4: Enterprise Value / Comparables - Question 009
Enterprise Value
/ Comparables
pg. 138
Why do we add preferred equity in
the enterprise value equation?
Next Question:
How do you account
for convertible bonds...
How do options affect
the enterprise value...
If a company has net
operating losses...
Preferred equity is similar to debt because it earns a fixed yield, so we
If a company has long
term investments...
add it to EV just like we do with debt.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
147
Section 4: Enterprise Value / Comparables - Question 010
Enterprise Value
/ Comparables
pg. 138
How do you account for convertible
bonds in the enterprise value
formula?
Next Question:
How do options affect
the enterprise value...
If a company has net
operating losses...
If a company has long
term investments...
Convertible bonds are bonds that convert into equity after the stock price
If a company has
pension obligations...
reaches the conversion price. If the stock price never reaches as high as
the conversion price, then the convertible bonds will continue to be debt.
Discounted
Cash Flow
pg. 185
If the convertible bonds are “in-the-money”, meaning that the stock price
is higher than the conversion price, then they are converted into equity
and will be added to the enterprise value as equity.
If the convertible bonds are “out-of-the-money,” meaning that the stock
price is lower than the conversion price, then they remain as debt and will
be added to the enterprise value as debt.
Enterprise Value
/ Comparables
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
148
Section 4: Enterprise Value / Comparables - Question 011
Enterprise Value
/ Comparables
pg. 138
How do options affect the
enterprise value formula?
Next Question:
If a company has net
operating losses...
If a company has long
term investments...
If a company has
pension obligations...
Options provide the right to buy a stock at a given exercise price. If the
If a company has
capital leases...
stock price is at the exercise price or higher, then they are in-the-money.
If the stock price is at the exercise price or higher, then they are out-themoney.
Discounted
Cash Flow
pg. 185
If the options are in-the-money, then the optionholders will exercise
their options and new shares shall be created. Using the treasury stock
method, the cash received from the optionholders will be used to pay
back debt as per the treasury stock method. Therefore, in-the-money
options increase equity value and decrease debt.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Out-of-the-money have no impact on debt.
Enterprise Value
/ Comparables
Discounted
Cash Flow
149
Section 4: Enterprise Value / Comparables - Question 012
Enterprise Value
/ Comparables
pg. 138
If a company has net operating losses,
and you are evaluating an acquisition,
how would you adjust the enterprise
value?
Next Question:
If a company has long
term investments...
If a company has
pension obligations...
If a company has
capital leases...
Net operating losses (NOLs) can be used to reduce tax burden in the
What are some
common EV multiples?
future. Different countries have different rules determining how much
of the NOLs can be used to shield, and how many years they have to be
spread over.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
Forecast the tax savings based on what’s allowed in the legal
pg. 235
jurisdiction, and then discount this to the present period. This is the
Leveraged
Buyouts
incremental NPV from the NOL tax savings.
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
150
Section 4: Enterprise Value / Comparables - Question 013
Enterprise Value
/ Comparables
pg. 138
If a company has long term investments
or equity investments (investments in
associates), how would you adjust the
enterprise value?
Next Question:
If a company has
pension obligations...
If a company has
capital leases...
What are some
common EV multiples?
What are some common price multiples?
We subtract long term investments and equity investments from
enterprise value. Both long term investments and equity investment
could theoretically be sold for cash, which can be used to pay off debt.
Less debt means less enterprise value.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
151
Section 4: Enterprise Value / Comparables - Question 014
Enterprise Value
/ Comparables
pg. 138
If a company has pension
obligations, how would you adjust
the enterprise value?
Next Question:
If a company has
capital leases...
What are some
common EV multiples?
What are some common price multiples?
Pension obligation is similar to debt in the sense that it’s a liability that
Why does P/EBITDA
not make sense?
has to be paid, so it’s added to enterprise value.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
152
Section 4: Enterprise Value / Comparables - Question 015
Enterprise Value
/ Comparables
pg. 138
If a company has capital leases,
how would you adjust the
enterprise value?
Next Question:
What are some
common EV multiples?
What are some common price multiples?
Why does P/EBITDA
not make sense?
Why would you use
EV/EBITDA over P/E?
When somebody takes a capital lease, it’s similar to borrowing the
money and buying the asset. Therefore, capital leases are considered like
debt, and are added to enterprise value.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
153
Section 4: Enterprise Value / Comparables - Question 016
Enterprise Value
/ Comparables
pg. 138
What are some common EV
multiples?
Next Question:
What are some common price multiples?
Why does P/EBITDA
not make sense?
Why would you use
EV/EBITDA over P/E?
The most common EV multiples are EV / EBITDA, EV / Revenue (useful for
When would you use
P/E over EV/EBITDA?
negative EBITDA companies such as startups), and EV / EBIT.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
154
Section 4: Enterprise Value / Comparables - Question 017
Enterprise Value
/ Comparables
pg. 138
What are some common price
multiples?
Next Question:
Why does P/EBITDA
not make sense?
Why would you use
EV/EBITDA over P/E?
When would you use
P/E over EV/EBITDA?
Price / earnings and price / book are common. Price / book is often to
What type of multiples
would you use...
compare their stock price with the book value of equity. It’s often used by
banks or manufacturing companies, as both categories rely heavily on
their assets for valuation.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
155
Section 4: Enterprise Value / Comparables - Question 018
Enterprise Value
/ Comparables
pg. 138
Why does P/EBITDA not make
sense?
Next Question:
Why would you use
EV/EBITDA over P/E?
When would you use
P/E over EV/EBITDA?
What type of multiples
would you (energy)...
Price is an equity value metric, meaning that it only accounts for the
What type of multiples
would you (tech)...
equity value and does not account for the debtholders.
EBITDA is an enterprise value metric, meaning that it goes to both equity
holders and debt holders.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
You can’t use an equity value metric in the numerator and enterprise
pg. 235
Leveraged
Buyouts
value metric in the denominator because it’s not apples-to-apples.
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
156
Section 4: Enterprise Value / Comparables - Question 019
Enterprise Value
/ Comparables
pg. 138
Why would you use EV/EBITDA over
P/E?
Next Question:
When would you use
P/E over EV/EBITDA?
What type of multiples
would you (energy)...
What type of multiples
would you (tech)....
EV / EBITDA is generally a better metric than P/E because EBITDA is a
What type of multiples
would you (mining)....
proxy for operating cash flow. EBITDA is also:
•
Before interest, therefore capital structure neutral
•
Before taxes, therefore tax jurisdiction neutral
•
Before D&A, therefore accounting policy neutral
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
On the other hand, P/E is driven by earnings. Earnings is an accounting
Leveraged
Buyouts
pg. 282
number and can be influenced in many ways outside of the core
business, such as through taxes, interest, and D&A.
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
157
Section 4: Enterprise Value / Comparables - Question 020
Enterprise Value
/ Comparables
pg. 138
When would you use P/E over EV/
EBITDA?
Next Question:
What type of multiples
would you (energy)...
What type of multiples
would you (tech)....
What type of multiples
would you (mining)....
EV / EBITDA is generally a better metric than P/E because EBITDA is a
What type of multiples
would you (FIG)....
proxy for operating cash flow. EBITDA is also:
•
Before interest, therefore capital structure neutral
•
Before taxes, therefore tax jurisdiction neutral
•
Before D&A, therefore accounting policy neutral
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
On the other hand, P/E is driven by earnings. Earnings is an accounting
Leveraged
Buyouts
pg. 282
number and can be influenced in many ways outside of the core
business, such as through taxes, interest, and D&A.
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
158
Section 4: Enterprise Value / Comparables - Question 021
Enterprise Value
/ Comparables
pg. 138
What type of multiples would you
use for a company in energy?
Next Question:
What type of multiples
would you (tech)...
What type of multiples
would you (mining)....
What type of multiples
would you (FIG)....
•
P / # of reserves
•
EV / Barrels of Oil Produced per Day
•
P / DACF (Debt-Adjusted Cash Flow, adjusts for effects of a
What type of multiples
would (real estate)....
Discounted
Cash Flow
company’s capital structure)
•
pg. 185
EV / Tonnes Produced per Day
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
159
Section 4: Enterprise Value / Comparables - Question 022
Enterprise Value
/ Comparables
pg. 138
What type of multiples would you
use for a company in technology?
Next Question:
What type of multiples
would you (mining)....
What type of multiples
would you (FIG)....
What type of multiples
would (real estate)....
When evaluating a
stock purchase...
You would use the normal multiples such as EV / EBITDA and EV /
Revenue. For internet companies, you could use EV / # of Users or
Subscribers and EV / # of Clicks as well.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
160
Section 4: Enterprise Value / Comparables - Question 023
Enterprise Value
/ Comparables
pg. 138
What type of multiples would you
use for a company in technology?
Next Question:
What type of multiples
would you (FIG)....
What type of multiples
would (real estate)....
When evaluating a
stock purchase...
When evaluating a
private equity...
•
EV / # of Reserves
•
EV / Tonnes Produced per Day
•
P / NAV (Net Asset Value, which is a separate DCF on each mine,
adding them together and subtracting out corporate costs; NAVs
are typically provided by equity research analysts.
•
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
P/ DACF
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
161
Section 4: Enterprise Value / Comparables - Question 024
Enterprise Value
/ Comparables
pg. 138
What type of multiples would you
use for a company in FIG (Financial
Institutions Group)?
Next Question:
What type of multiples
would (real estate)....
When evaluating a
stock purchase...
When evaluating a
private equity...
We don’t use EBITDA here since interest expense is often part of the core
If the price of gold is
going up...
business. For FIG companies, interest expense is often the cost of the
capital which they will invest, almost like a cost of goods sold. They will
try to achieve a higher return than their cost of capital, similar to how a
company will sell a product at a higher price than its original cost to make
a margin. So net income is more relevant than EBITDA as it will have
interest expense already deducted.
•
P/E Per Share
•
P / Book
•
P / Assets under Management
Enterprise Value
/ Comparables
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
162
Section 4: Enterprise Value / Comparables - Question 025
Enterprise Value
/ Comparables
pg. 138
What type of multiples would you
use for a company in real estate?
Next Question:
When evaluating a
stock purchase...
When evaluating a
private equity...
If the price of gold is
going up...
1.
P / FFO Per Share
2.
P / AFFO Per Share
3.
P / NAV Per Share
How would you choose
your comparable...
Discounted
Cash Flow
pg. 185
•
FFO = Funds from Operations, which adds D&A and subtracts
capital gains
Mergers &
Acquisitions
pg. 235
•
AFFO = FFO + capital expenditures + rent increases
•
Interest is core to business, so debt is considered
•
NAV = Net Asset Value (Assets – Liabilities) -> Note that this is a
different type of NAV than in mining
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
163
Section 4: Enterprise Value / Comparables - Question 026
Enterprise Value
/ Comparables
pg. 138
When evaluating a stock
purchase, is it better to use
forward or trailing multiples?
Next Question:
When evaluating a
private equity...
If the price of gold is
going up...
How would you choose
your comparable...
Forward multiples are multiples driven off of future cash flows, such as
What’s the difference
between capital...
EV / NTM (Next Twelve Months) EBITDA or P / E (NTM).
If available, it’s better to use forward multiples because a stock’s value
is determined by future cash flows, so forward multiples are a better
indicator of a stock’s relative value.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
164
Section 4: Enterprise Value / Comparables - Question 027
Enterprise Value
/ Comparables
pg. 138
When evaluating a private equity
acquisition, is it better to use
forward or trailing multiples?
Next Question:
If the price of gold is
going up...
How would you choose
your comparable...
What’s the difference
between capital...
Trailing multiples are multiples driven off of past cash flows, such as EV /
Would a company
with a capital lease...
LTM (Last Twelve Months) EBITDA or P / E (LTM).
In private equity, it’s often more appropriate to use trailing multiples
because many of the companies being analyzed are private. Private
companies will not have forecasts as readily available as public
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
companies, so using trailing multiples is easier.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
165
Section 4: Enterprise Value / Comparables - Question 028
Enterprise Value
/ Comparables
pg. 138
If the price of gold is going up,
why would P/NAV for gold mining
companies be over 1?
Next Question:
How would you choose
your comparable...
What’s the difference
between capital...
Would a company
with a capital lease...
Which industries place
a low importance...
The P in the numerator stands for price, or stock price, which is
determined by stock market investors. Stock market investors are very
quick to react to the price of gold going up, and may buy gold stocks
indiscriminately to catch the trend. P represents the equity value of the
business based on stock market investors.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
NAV stands for Net Asset Value, which is like doing a DCF on each
mine separately (as different geographies / mines may have different
Leveraged
Buyouts
pg. 282
risk profiles and discount rates), combining the present values, and
subtracting out the headquarter corporate costs and any liabilities. NAV
represents the intrinsic equity value of the business based on modeling
Other
Questions
pg. 330
out the cash flows.
NAV is determined by equity research analysts, who would be more
cautious than stock investors and slower to react. Updating their models
for a rising gold price takes time, and analysts also do want to appear
inconsistent by constantly changing their recommendations. As a result,
in a rising gold environment, price often moves up faster than NAV, so P/
NAV ends up being over 1.
Enterprise Value
/ Comparables
Discounted
Cash Flow
166
Section 4: Enterprise Value / Comparables - Question 029
Enterprise Value
/ Comparables
pg. 138
How would you choose your
comparable company universe?
Next Question:
What’s the difference
between capital...
Would a company
with a capital lease...
Which industries place
a low importance...
First, we would seek to understand the industry by reading through
Which industries place
a high importance...
industry research and equity research reports, as well as the annual
report / 10k. Competitors are often listed here which could be good
comparables.
Discounted
Cash Flow
pg. 185
After creating a list of potential comparables, we would look at other
metrics that measure size and profi tability. In terms of size, we would
look at the market cap, enterprise value, and revenue, and exclude any
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
that are way off.
To assess profi tability, we would look at gross margin, EBITDA margin,
Other
Questions
pg. 330
and net income margin, and exclude any that are way off.
Enterprise Value
/ Comparables
Discounted
Cash Flow
167
Section 4: Enterprise Value / Comparables - Question 030
Enterprise Value
/ Comparables
pg. 138
What’s the difference between
capital and operating leases?
Next Question:
Would a company
with a capital lease...
Which industries place
a low importance...
Which industries place
a high importance...
A capital lease is like buying the asset with debt. You pay interest and
If you had stock-based
compensation...
principal repayments.
An operating lease is like renting the asset, so you pay rent expense.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
168
Section 4: Enterprise Value / Comparables - Question 031
Enterprise Value
/ Comparables
pg. 138
Would a company with a capital lease
have a higher or lower EV / EBITDA
multiple compared to an operating
lease?
Next Question:
Which industries place
a low importance...
Which industries place
a high importance...
If you had stock-based
compensation...
A company with a capital lease would have a lower EBITDA multiple. A
If you had a one-time
cost, how would...
capital lease involves paying interest and principal repayments, which
are both cash flows that happen below EBITDA. EBITDA would be higher
as a result, and since EBITDA is in the denominator of EV / EBITDA, the
multiple would be lower.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
An operating lease would have a higher EBITDA multiple. An operating
lease involves paying rent, which is an expense that is above EBITDA.
pg. 235
Leveraged
Buyouts
pg. 282
This would make EBITDA lower and EV / EBITDA higher.
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
169
Section 4: Enterprise Value / Comparables - Question 032
Enterprise Value
/ Comparables
pg. 138
Which industries place a low
importance on comps?
Next Question:
Which industries place
a high importance...
If you had stock-based
compensation...
If you had a one-time
cost, how would...
A company with a capital lease would have a lower EBITDA multiple. A
If you acquired a
company in the...
capital lease involves paying interest and principal repayments, which
are both cash flows that happen below EBITDA. EBITDA would be higher
as a result, and since EBITDA is in the denominator of EV / EBITDA, the
multiple would be lower.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
An operating lease would have a higher EBITDA multiple. An operating
lease involves paying rent, which is an expense that is above EBITDA.
pg. 235
Leveraged
Buyouts
pg. 282
This would make EBITDA lower and EV / EBITDA higher.
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
170
Section 4: Enterprise Value / Comparables - Question 033
Enterprise Value
/ Comparables
pg. 138
Which industries place a high
importance on comps?
Next Question:
If you had stock-based
compensation...
If you had a one-time
cost, how would...
If you acquired a
company in the...
Industries with standard business models like consumers or industrials
If two companies have
the same historical...
businesses often have a lot of comparable companies, and place a high
importance on comps.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
171
Section 4: Enterprise Value / Comparables - Question 034
Enterprise Value
/ Comparables
pg. 138
If you had stock-based
compensation, how would you
adjust the EV/EBITDA multiple?
Next Question:
If you had a one-time
cost, how would...
If you acquired a
company in the...
If two companies have
the same historical...
What do you do when
you get a negative...
Stock-based compensation represents shares or options paid to
management, but it is an accounting number. No actual cash is given
to management, so we add back the stock-based compensation from
EBITDA to get a better proxy for cash flow and create an adjusted
Discounted
Cash Flow
pg. 185
EBITDA. This adjusted EBITDA would be higher than the unadjusted
EBITDA, which would make the EV / EBITDA multiple lower.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
172
Section 4: Enterprise Value / Comparables - Question 035
Enterprise Value
/ Comparables
pg. 138
If you had a one-time cost, how
would you adjust the EV/EBITDA
multiple?
Next Question:
If you acquired a
company in the...
If two companies have
the same historical...
What do you do when
you get a negative...
One-time costs are not expected to happen again, so they are added
Would you rather buy a
company with 4x...
back to unadjusted EBITDA to arrive at an adjusted EBITDA number.
Since they increase adjusted EBITDA, the EV / EBITDA multiple is lower.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
173
Section 4: Enterprise Value / Comparables - Question 036
Enterprise Value
/ Comparables
pg. 138
If you acquired a company in the
middle of the year, how would you
adjust EV/EBITDA?
Next Question:
If two companies have
the same historical...
What do you do when
you get a negative...
Would you rather buy a
company with 4x...
If we acquire a company in the middle of the year, we would only have
What is the cost of
equity for a company...
half of the target company’s EBITDA. However, we would have acquired
100% of the company’s enterprise value.
Discounted
Cash Flow
pg. 185
When we look at EV / EBITDA, we need to make the numerator
consistent with the denominator. Therefore, we add back half of the
target company’s EBITDA so that the new EBITDA number reflects the
entire year, not just half of the year. This is also known as calendarizing
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
for an acquisition.
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
174
Section 4: Enterprise Value / Comparables - Question 037
Enterprise Value
/ Comparables
pg. 138
If two companies have the same historical and
projected financials, same management team,
same industry, and same strategy, why might
one company be trading at 10x EV / EBITDA and
the other company at 12x EV / EBITDA?
Next Question:
What do you do when
you get a negative...
Would you rather buy
a company with 4x...
What is the cost of
equity for a company...
The company trading at the higher multiple is more valuable likely for
How would you adjust
the EV/EBITDA...
qualitative reasons, since the historical and projected financials are the
same.
Discounted
Cash Flow
pg. 185
For example, the company trading at 12x may have a more diverse
customer base and therefore less customer concentration. The company
trading at 10x may rely on only a few large customers, and if one of those
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
customers leaves, it would result in a big revenue drop.
pg. 282
Another example is regarding the certainty of revenue. The company
trading at 12x may have 3-5 year contracts with their customers, so
Other
Questions
pg. 330
their future revenue is contracted and has a high certainty of occurring.
The company trading at 10x may have one-time customers that rarely
repeat, so there is a higher risk that they can’t achieve their projected
revenue.
Enterprise Value
/ Comparables
Discounted
Cash Flow
175
Section 4: Enterprise Value / Comparables - Question 038
Enterprise Value
/ Comparables
pg. 138
What do you do when you get a
negative multiple?
Next Question:
Would you rather buy
a company with 4x...
What is the cost of
equity for a company...
How would you adjust
the EV/EBITDA...
This usually happens when the denominator is negative. For example, for
How would issuing
shares affect the...
a start-up company, earnings may be negative, so price / earnings would
be negative. If EBITDA is negative, then EV / EBITDA would be negative
too.
Discounted
Cash Flow
pg. 185
Instead of displaying the negative multiple, we replace it with the initials
NMF, which stands for not meaningful.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
176
Section 4: Enterprise Value / Comparables - Question 039
Enterprise Value
/ Comparables
pg. 138
Would you rather buy a company with
4x, 5x, and 6x EV/EBITDA multiples for
2019, 2020, and 2021 respectively, or 6x,
5x, and 4x?
Next Question:
What is the cost of
equity for a company...
How would you adjust
the EV/EBITDA...
How would issuing
shares affect the...
We would prefer to buy the company with 6x, 5x, and 4x EV / EBITDA.
How would issuing
debt affect...
Since enterprise value is constant, a declining multiple means that
EBITDA is growing, since EBITDA in the denominator. EBITDA is
declining in the other example, so we would prefer a company with
growing EBITDA.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
177
Section 4: Enterprise Value / Comparables - Question 040
Enterprise Value
/ Comparables
pg. 138
What is the cost of equity for a
company that trades at 10x P/E?
Next Question:
How would you adjust
the EV/EBITDA...
How would issuing
shares affect the...
How would issuing
debt affect...
The cost of equity is the inverse of price / earnings. Therefore, since P/E is
How would issuing
debt affect P/E?
10x, cost of equity = 1/10 = 10%.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
178
Section 4: Enterprise Value / Comparables - Question 041
Enterprise Value
/ Comparables
pg. 138
How would you adjust the EV/
EBITDA multiple for rent expense
for retail businesses?
Next Question:
How would issuing
shares affect the...
How would issuing
debt affect...
How would issuing
debt affect P/E?
Some retail businesses will choose to own their stores, and others will
What are 4 ways to
value a company?
choose to rent. Those who choose to rent will have a lower EBITDA
because rent expense reduces EBITDA.
Discounted
Cash Flow
pg. 185
In order to compare EV / EBITDA multiples without penalizing companies
who choose to rent, we can add back the rent expense from EBITDA.
This equals EBITDAR, or EBITDA before rent. We can look at EV /
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
EBITDAR multiples to compare companies within the retail space.
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
179
Section 4: Enterprise Value / Comparables - Question 042
Enterprise Value
/ Comparables
pg. 138
How would issuing shares affect
the EV / EBITDA multiple?
Next Question:
How would issuing
debt affect...
How would issuing
debt affect P/E?
What are 4 ways to
value a company?
When a company issues shares, they raise cash from investors while also
Which of these 4
valuation methods...
increasing their equity value (market capitalization) by the same amount.
There is no change to EV / EBITDA because the increase in equity value
is offset by the increase in cash, since cash is deducted from enterprise
value.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Enterprise value = equity value + debt - cash
Leveraged
Buyouts
(assuming no preferred stock or minority interest)
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
180
Section 4: Enterprise Value / Comparables - Question 043
Enterprise Value
/ Comparables
pg. 138
How would issuing debt affect EV /
EBITDA?
Next Question:
How would issuing
debt affect P/E?
What are 4 ways to
value a company?
Which of these 4
valuation methods...
Issuing debt would not affect EV / EBITDA because EBITDA is before
interest, and therefore it is before the impact of debt. EV / EBITDA is a
capital structure neutral multiple.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Enterprise Value
/ Comparables
Discounted
Cash Flow
181
Section 4: Enterprise Value / Comparables - Question 044
Enterprise Value
/ Comparables
pg. 138
How would issuing debt affect P/E?
Next Question:
What are 4 ways to
value a company?
Which of these 4
valuation methods...
Issuing debt would usually increase the risk to equity investors, so they
will sell off the stock. This will cause price to go down, which is the
numerator in P/E, so P/E will go down as well.
Discounted
Cash Flow
pg. 185
Mathematically, an increase in debt raises levered beta, which is a key
component of the cost of equity. With a higher cost of equity, stocks will
be valued using a higher discount rate, so the stock price goes down.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
There is an exception to this: sometimes, issuing debt is a positive
signal to the market because it allows the company to keep surviving, or
because the debt was raised for a specific project or acquisition that will
Other
Questions
pg. 330
boost the value of the company. An example is how Tesla’s stock price
increases when they borrow money because it allows the company to
continue to exist.
Enterprise Value
/ Comparables
Discounted
Cash Flow
182
Section 4: Enterprise Value / Comparables - Question 045
Enterprise Value
/ Comparables
pg. 138
What are 4 ways to value a
company?
Next Question:
Which of these 4
valuation methods...
4 ways to value a company are:
•
Comparable companies: looking at similarly sized companies in
similar industries and seeing which multiples they trade at, then
applying this multiple to the target company
•
Precedent transactions: looking at past acquisitions and seeing
which multiples they were acquired at, then applying this multiple to
the target company
•
Discounted cash flow (DCF): forecasting future cash flows and
discounting them to the present period
•
Leveraged buyout (LBO) model: figure out the acquisition value
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
using debt to buy the company at a given IRR (internal rate of
return), usually 20%
Enterprise Value
/ Comparables
Discounted
Cash Flow
183
Section 4: Enterprise Value / Comparables - Question 046
Enterprise Value
/ Comparables
pg. 138
Which of these 4 valuation methods
provides the highest valuation? What
about the lowest valuation?
Next Question:
Precedent transactions provide the highest valuation, since it reflects the
multiple at which similar companies were acquired at. With acquisitions,
there is a control premium, since companies will pay extra to own a
company. Ownership provides control, and lets the owner decide what
to do with the business, such as where to grow revenue or where to pull
back spending. Since control has the potential to add value, people will
pay a premium for it.
Discounted
Cash Flow
pg. 185
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
LBO models will usually provide the lowest valuation, since they
represent a floor value for the company. Usually, private equity
companies will only buy companies for relatively cheap so that they can
Other
Questions
pg. 330
earn an outsized return when they sell the company 5 years later.
Usually DCFs provide a higher valuation than comparables because
of aggressive assumption management, but it won’t be as high as
precedent transactions usually.
Enterprise Value
/ Comparables
Discounted
Cash Flow
184
Section Five
Discounted
Cash Flow
185
Section 5: Discounted Cash Flow - Question 001
Discounted
Cash Flow
pg. 185
What is the formula for unlevered
free cash flow?
Next Question:
What is the formula for
levered free cash flow?
What is the difference
between unlevered...
What do you use for
the discount rate...
What do you use for
the discount rate for...
Unlevered Free Cash Flow (UFCF) = EBIT x (1 - Tax Rate) +
Depreciation and Amortization - Capital Expenditures - Change in Net
Working Capital
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
186
Section 5: Discounted Cash Flow - Question 002
Discounted
Cash Flow
pg. 185
What is the formula for levered
free cash flow?
Next Question:
What is the difference
between unlevered...
What do you use for
the discount rate...
What do you use for
the discount rate for...
Levered Free Cash Flow = Net Income + Depreciation and Amortization
How do you calculate
WACC?
- Capital Expenditures - Change in Net Working Capital + Debt
Borrowings - Mandatory Debt Repayments
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
187
Section 5: Discounted Cash Flow - Question 003
Discounted
Cash Flow
pg. 185
What is the difference between
unlevered and levered free cash
flow?
Next Question:
What do you use for
the discount rate...
What do you use for
the discount rate for...
How do you calculate
WACC?
Unlevered means without the effects of debt. Therefore, unlevered free
How do you account
for preferred...
cash flows are cash flows before the effects of debt. They do not include
interest or any debt payments or borrowings.
Mergers &
Acquisitions
pg. 235
Levered means with the effect of debt. Therefore, levered free cash flows
are cash flows with the effects of debt. They include after-tax interest
Leveraged
Buyouts
pg. 282
expenses as well as any debt payments or borrowings.
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
188
Section 5: Discounted Cash Flow - Question 004
Discounted
Cash Flow
pg. 185
What is the difference between
unlevered and levered free cash
flow?
Next Question:
What do you use for
the discount rate for...
How do you calculate
WACC?
How do you account
for preferred...
Is WACC higher or
lower than cost...
WACC is a blended weight-average between the cost of equity, the
after-tax cost of debt, and the cost of preferred equity.
You would use the weighted-average cost of capital (WACC) to discount
unlevered free cash flow. UFCFs represent cash flows that are available
to ALL stakeholders in the business, which includes both shareholders
pg. 235
Leveraged
Buyouts
pg. 282
and debtholders. As such, it makes sense to use a discount rate that
Other
Questions
considers the respective cost of capital for each of these types of
pg. 330
investors.
Discounted
Cash Flow
Mergers &
Acquisitions
Mergers
& Acquisitions
189
Section 5: Discounted Cash Flow - Question 005
Discounted
Cash Flow
pg. 185
What do you use for the discount
rate for levered free cash flow and
why?
Next Question:
How do you calculate
WACC?
How do you account
for preferred...
Is WACC higher or
lower than cost...
When would WACC
be higher than...
We use the cost of equity to discount levered free cash flow, because
levered free cash flow represents cash flow going to equity holders only.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
190
Section 5: Discounted Cash Flow - Question 006
Discounted
Cash Flow
pg. 185
How do you calculate WACC?
Next Question:
How do you account
for preferred...
Is WACC higher or
lower than cost...
When would WACC
be higher than...
Is debt or equity more
expensive?
The weighted average cost of capital weights out the three sources of
capital: common shares, debt, and preferred shares.
WACC formula= % Equity x Cost of Equity + % of Debt x Cost of Debt x
(1- Tax Rate) + % of Preferred Shares x Cost of Preferred Shares
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
191
Section 5: Discounted Cash Flow - Question 007
Discounted
Cash Flow
pg. 185
How do you account for preferred
stock in WACC?
Next Question:
Is WACC higher or
lower than cost...
When would WACC
be higher than...
Is debt or equity more
expensive?
When would debt be
more expensive...
Preferred stock is calculated as a weighted cost within the WACC; see
the formula in the previous answer. It has no tax shielding benefi ts like
the cost of debt.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
192
Section 5: Discounted Cash Flow - Question 008
Discounted
Cash Flow
pg. 185
Is WACC higher or lower than cost
of equity?
Next Question:
When would WACC
be higher than...
Is debt or equity more
expensive?
When would debt be
more expensive...
The WACC is usually lower than the cost of equity. The weighted cost of
What would be an
appropriate WACC...
equity gets diluted in the WACC by the weighted net cost of debt. Cost of
debt is usually cheaper than the cost of equity.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
193
Section 5: Discounted Cash Flow - Question 009
Discounted
Cash Flow
pg. 185
When would WACC be higher than
the cost of equity?
Next Question:
Is debt or equity more
expensive?
When would debt be
more expensive...
What would be an
appropriate WACC...
The WACC would be higher than the cost of equity in situations where
How do you calculate
cost of equity?
the cost of debt is greater than the cost of equity. This might happen if
the company is very distressed and has a high bankruptcy chance but
also has a chance of turning around and becoming much more valuable.
It might also happen with a startup where there is lots of equity growth
potential but debt is very expensive. Companies with a low cashflow but
a lot of potential could be in this situation as well.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
194
Section 5: Discounted Cash Flow - Question 010
Discounted
Cash Flow
pg. 185
Is debt or equity more expensive?
Next Question:
When would debt be
more expensive...
What would be an
appropriate WACC...
How do you calculate
cost of equity?
The cost of equity is more expensive than the cost of debt. Equity bears
How do you find the
cost of debt?
more risk since debt holders will have first claim on the assets in case of
bankruptcy, but equity holders also get more upside.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
195
Section 5: Discounted Cash Flow - Question 011
Discounted
Cash Flow
pg. 185
When would debt be more
expensive than equity?
Next Question:
What would be an
appropriate WACC...
How do you calculate
cost of equity?
How do you find the
cost of debt?
What is the risk-free
rate?
Debt could be more expensive with more distressed companies where
lenders are less willing to lend money, but there is significant potential for
equity growth.
Mergers &
Acquisitions
pg. 235
Another situation would be fairly new start-ups who don’t have the
cashflow yet to guarantee the debt payments, but have a bright potential
to become a big company.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
196
Section 5: Discounted Cash Flow - Question 012
Discounted
Cash Flow
pg. 185
When would debt be more
expensive than equity?
Next Question:
How do you calculate
cost of equity?
How do you find the
cost of debt?
What is the risk-free
rate?
What do you think the
equity risk...
10% is commonly used in the industry.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
197
Section 5: Discounted Cash Flow - Question 013
Discounted
Cash Flow
pg. 185
How do you calculate cost of
equity?
Next Question:
How do you find the
cost of debt?
What is the risk-free
rate?
What do you think the
equity risk...
What is beta?
Use the Capital Asset Pricing Model (CAPM), the formula is below.
CAPM Formula
Mergers &
Acquisitions
Cost of equity= risk free rate + Beta x (risk free rate – risk premium)
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
198
Section 5: Discounted Cash Flow - Question 014
Discounted
Cash Flow
pg. 185
How do you find the cost of debt?
Next Question:
What is the risk-free
rate?
What do you think the
equity risk...
What is beta?
What are ways to
calculate beta?
If it’s a public company, you can look up the cost of debt on Bloomberg
or in their company filings. Different types of debt are often listed in the
notes to the financial statements in a quarterly or annual report and the
interest rate is sometimes provided.
Mergers &
Acquisitions
pg. 235
If it’s a private company, you can create “debt comps” by finding public
companies that are comparable and finding their median cost of debt.
Leveraged
Buyouts
pg. 282
Other
Questions
Finally, you can try to calculate the cost of debt as a key benchmark
plus a spread, such as LIBOR + 500 bps (500 bps = 5%. The spread will
pg. 330
depend on the credit risk of the company, determined by the stability of
their cash flows as well as many qualitative factors.
Discounted
Cash Flow
Mergers
& Acquisitions
199
Section 5: Discounted Cash Flow - Question 015
Discounted
Cash Flow
pg. 185
What is the risk-free rate?
Next Question:
What do you think the
What is beta?
equity risk...
What is beta?
What are ways to
calculate beta?
The risk-free rate is the rate at which governments can borrow. In the US
What are beta
comps?
it is the 10 year treasury bond. In Canada, it is the Prime-rate of the 10
year government bond,
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
200
Section 5: Discounted Cash Flow - Question 016
Discounted
Cash Flow
pg. 185
What do you think the equity risk
premium is, and how would you
find it?
Next Question:
What is beta?
What are ways to
calculate beta?
What are beta
comps?
If Company A is 30%
equity...
Equity risk premium = average stock market return - risk free rate. It
represents the excess return over the risk free rate.
You can find published reports on equity risk premium from companies
like the Big 4 accounting firms such as Deloitte. All you have to do is
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
google search it, it’s usually around 6%.
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
201
Section 5: Discounted Cash Flow - Question 017
Discounted
Cash Flow
pg. 185
What is beta?
Next Question:
What are ways to
calculate beta?
What are beta
comps?
If Company A is 30%
equity...
Walk me through a
revenue model...
Beta shows how much of a stock’s return can be explained by the
general market. It is a measure of systematic risk, which is the broader
risk from the general market. Below are some examples:
Mergers &
Acquisitions
pg. 235
•
Beta of 1 = move in-line with the general market
•
Beta of 2 = move two-fold to every movement in the market
•
Beta of -1= move in the opposite direction of the market
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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202
Section 5: Discounted Cash Flow - Question 018
Discounted
Cash Flow
pg. 185
What are different ways to
calculate beta?
Next Question:
What are beta
comps?
If Company A is 30%
equity...
Walk me through a...
(cell phone company)
Walk me through a...
(manufacturing)
Beta can be calculated in several ways. It can be calculated on the
Bloomberg by typing in BETA. It can also be calculated by plotting
an individual stock’s return on the Y axis against the average stock
Mergers &
Acquisitions
market on the X axis. The slope of the line is the beta.
pg. 235
Finally, beta can be calculated using beta comps. This involves finding
Leveraged
Buyouts
The four steps to do this are:
Other
Questions
pg. 282
pg. 330
1.
Create a list of comparable companies who are similar in industry
and size from the same market.
2.
Unlever the beta to get the betas without the debt impact
3.
Average the unlevered Beta’s
4.
Re lever the peers average unlevered Beta towards the companies
capital structure.
Discounted
Cash Flow
Mergers
& Acquisitions
203
Section 5: Discounted Cash Flow - Question 019
Discounted
Cash Flow
pg. 185
What are beta comps?
Next Question:
If Company A is 30%
equity...
Walk me through a...
(cell phone company)
Walk me through a...
(manufacturing)
Walk me through a...
(natural gas)
Beta comps can be used to find beta for a private company or a new
company with not enough public trading history.
Mergers &
Acquisitions
The four steps to do this are:
1.
pg. 235
Create a list of comparable companies which are similar in industry
and size
2.
pg. 282
Unlever the betas to remove the impact of debt using Unlevered
Other
Questions
Beta = [1+(1 - tax rate) x Debt / Equity] / Levered Beta
3.
Find the median unlevered beta
4.
Re-lever the median unlevered beta using the target company’s
Leveraged
Buyouts
pg. 330
capital structure: Levered Beta = Unlevered Beta x [1+(1-tax rate) x
Debt / Equity]
Discounted
Cash Flow
Mergers
& Acquisitions
204
Section 5: Discounted Cash Flow - Question 020
Discounted
Cash Flow
pg. 185
If Company A is 30% equity, 70% debt currently,
but will have a capital structure of 50% equity,
50% debt in year 5, which capital structure do
you use for your DCF?
Next Question:
Walk me through a...
(cell phone company)
Walk me through a...
(manufacturing)
Walk me through a...
(natural gas)
Walk me through a
DCF.
•
The 50/50% capital structure would be used
•
When calculating WACC, we assume the target capital structure,
which is the capital structure the company will have in the long term
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
205
Section 5: Discounted Cash Flow - Question 021
Discounted
Cash Flow
pg. 185
Walk me through a revenue model
for a cell phone company.
Next Question:
Walk me through a...
(manufacturing)
Walk me through a...
(natural gas)
Walk me through a
DCF.
What are some
common errors...
The revenue model of a cell phone company is subscribers x price.
However, new subscribers may be charged a higher price than existing
subscribers, and the new price will increase every year. A certain % of
Mergers &
Acquisitions
subscribers will also be lost to attrition every year.
pg. 235
Leveraged
Buyouts
Therefore, the first step would be to build a subscribers schedule
pg. 282
showing beginning subscribers, new subscribers, lost subscribers, and
finally ending subscribers.
Other
Questions
pg. 330
The second step would be to build a price schedule. The price is also
often referred to as ARPU (average revenue per unit). We would forecast
the annual prices (or ARPU) new subscribers would sign up at which will
likely increase every year. We would also forecast the average price or
ARPU of subscribers lost, as well as the ARPU for existing subscribers.
We can find revenue from new subscribers by taking the new subscribers
and multiplying by the new subscribers ARPU. We can find revenue
lost by taking lost subscribers and multiplying by the lost subscribers
ARPU. We can calculate revenue from existing subscribers by taking the
previous subscriber base and multiplying it by the existing subscribers
ARPU. Finally, we can sum all of these components to calculate total
revenue.
Discounted
Cash Flow
Mergers
& Acquisitions
206
Section 5: Discounted Cash Flow - Question 022
Discounted
Cash Flow
pg. 185
Walk me through a revenue model
for a manufacturing company.
Next Question:
Walk me through a...
(natural gas)
Walk me through a
DCF.
What are some
common errors...
Revenue for manufacturing companies can usually be calculated as price
How do you calculate
terminal value?
x quantity.
First, we should categorize the revenue based on the different categories
of products.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
After this, we should forecast the amount produced, which we can guess
using historical information as well as industry research.
Other
Questions
pg. 330
Then we should forecast the price based on past pricing trends and
expected future trends.
Finally, we can multiply quantity and price to get revenue.
Discounted
Cash Flow
Mergers
& Acquisitions
207
Section 5: Discounted Cash Flow - Question 023
Discounted
Cash Flow
pg. 185
Walk me through a revenue model
for a natural gas company.
Next Question:
Walk me through a
DCF.
What are some
common errors...
How do you calculate
terminal value?
How many years do
you discount...
The revenue for a natural gas company can usually be calculated as
production x price. Production is usually measured in thousands of
barrels, and price is based off of the commodity price in the open market,
or to previously agreed contracted prices if the government is the main
customer.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
208
Section 5: Discounted Cash Flow - Question 024
Discounted
Cash Flow
pg. 185
Walk me through a DCF.
Next Question:
What are some
common errors...
How do you calculate
terminal value?
How many years do
you discount...
•
Understand the company and the industry in which it operates on a
Why can’t the
perpetuity rate...
forward-looking basis
•
Mergers &
Acquisitions
Make key assumptions about revenue growth, gross margins,
pg. 235
SG&A, capex, etc.
•
•
•
Leveraged
Buyouts
Project unlevered free cash flows
pg. 282
Typically 5 - 10 years
Other
Questions
Derive terminal value
•
pg. 330
Can use perpetuity growth method or the EBITDA exit multiple
method
•
Discount free cash flows and terminal value using WACC
•
Add cumulative present value of UFCFs and present value of
terminal value to obtain enterprise value
•
Subtract net debt from enterprise value to get to equity value
•
Divide equity value by fully diluted shares outstanding to obtain
implied share price
•
Perform sensitivity analysis
•
Sensitize DCF assumptions: WACC, perpetuity growth rate or
exit multiple
•
Sensitize operating assumptions: revenue growth, EBITDA
margin, capex, etc.
Discounted
Cash Flow
Mergers
& Acquisitions
209
Section 5: Discounted Cash Flow - Question 025
Discounted
Cash Flow
pg. 185
What are some common errors
when making a DCF?
Next Question:
How do you calculate
terminal value?
How many years do
you discount...
Why can’t the
perpetuity rate...
How do you decide
on the exit...
Common errors include:
•
Inputting historicals wrong
•
Formula errors, like having inconsistent formulas
•
Having overly aggressive or conservative growth assumptions
•
Having too much of the enterprise value driven by terminal value
•
Calculating unlevered free cash flow incorrectly
•
Not having the right assumptions to calculate WACC, such as using
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
pg. 330
the wrong target capital structure
Discounted
Cash Flow
Other
Questions
Mergers
& Acquisitions
210
Section 5: Discounted Cash Flow - Question 026
Discounted
Cash Flow
pg. 185
How do you calculate terminal
value?
Next Question:
How many years do
you discount...
Why can’t the
perpetuity rate...
How do you decide
on the exit...
Since we can only project cash flows reasonably for a limited number of
Why is it better to give
a range for...
years, usually 5-10 years, we have to calculate the value of the company
after this projection period. Terminal value represents the cumulative free
cash flows that a company would accumulate after the projection period
(eternally). It essentially acts as the “plug” for a DCF model – PV of
UFCFs + PV of Terminal Value = Implied Enterprise Value. Enterprise
Value can be thought of as the total present value of free cash flows the
company would obtain throughout its lifetime
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Two ways to calculate terminal value
•
Mergers &
Acquisitions
EBITDA Multiples Method: the EBITDA multiple you believe market
sentiment would pay for your company once it reaches a stage of
maturity
•
Terminal value = EBITDA multiple x final projected EBITDA (typically
year 5 or 10) in unlevered free cash flow method
•
EBITDA is commonly found through performing a comparable
companies analysis using ONLY mature peers and finding a median or
average EBITDA multiple amongst them
•
Perpetuity Growth Rate Method: growth rate at which your company’s
unlevered free cash flows would increase on a yearly basis once it has
become mature (after projection period)
•
Terminal value = (Final Projected Year UFCF x
(1 - Perpetuity Growth Rate)) / (WACC - Perpetuity Growth
Rate)
•
Growth rate is typically 1 - 2% depending on the market position,
strength of sustainable competitive advantages, and growth
outlook of your company
•
A 2% perpetuity rate is common for companies with neutral
outlooks in North America, as it aligns with the GDP growth rate;
the perpetuity rate should never be higher than the GDP growth
rate
Discounted
Cash Flow
Mergers
& Acquisitions
211
Section 5: Discounted Cash Flow - Question 027
Discounted
Cash Flow
pg. 185
How many years do you discount
terminal value?
Next Question:
Why can’t the
perpetuity rate...
How do you decide
on the exit...
Why is it better to give
a range for...
•
You discount by the final projected year in your cash flow projection
How do you find fully
diluted...
(typically 5 or 10)
•
A common mistake is to discount by the number of projected
Mergers &
Acquisitions
years + 1, for example, discounting the terminal value back by 6
pg. 235
years instead of 5. Even though the first cash flow is received in
year 6, the terminal value really starts in year 5, so we discount by
5 years
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
212
Section 5: Discounted Cash Flow - Question 028
Discounted
Cash Flow
pg. 185
Why can’t the perpetuity rate be
greater than the GDP growth rate?
Next Question:
How do you decide
on the exit...
Why is it better to give
a range for...
How do you find fully
diluted...
If this were to happen, the company would eventually grow to be bigger
When does discounting UFCF and LFCF...
than the economy, which is unrealistic.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
213
Section 5: Discounted Cash Flow - Question 029
Discounted
Cash Flow
pg. 185
How do you decide on the exit
multiple?
Next Question:
Why is it better to give
a range for...
How do you find fully
diluted...
When does discounting UFCF and LFCF...
Why would you
discount LFCF...
After the projection period, it can be assumed that the company is at
a “mature” stage. To find the exit multiple, we can take the median
EBITDA multiple from a set of mature comparables. These companies
Mergers &
Acquisitions
should be larger and more mature, and therefore have a lower EV
pg. 235
/ EBITDA multiple compared to fast growth companies. They are
representative of what a mature company should be trading at in their
industry.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
If there are no mature comparables, we can take a blue-chip stock
average to be conservative.
Discounted
Cash Flow
Mergers
& Acquisitions
214
Section 5: Discounted Cash Flow - Question 030
Discounted
Cash Flow
pg. 185
Why is it better to give a range
for the implied share price from a
DCF?
Next Question:
How do you find fully
diluted...
When does discounting UFCF and LFCF...
Why would you
discount LFCF...
How would you sensitize your DCF?
The implied share price is the share price the company would be
worth if all assumptions in the model are correct. However, it’s
unrealistic to guess every assumption correctly, so we give a range
Mergers &
Acquisitions
of implied share prices by sensitizing a key variable such as WACC or
pg. 235
perpetuity growth rate / exit multiple.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
215
Section 5: Discounted Cash Flow - Question 031
Discounted
Cash Flow
pg. 185
How do you find fully diluted
shares outstanding?
Next Question:
When does discounting UFCF and LFCF...
Why would you
discount LFCF...
How would you
sensitize your DCF?
If you’re in the tech
sector, would...
The treasury stock method is used to calculate fully diluted shares
outstanding. Typically, companies will tell you common shares
outstanding and options outstanding in the MD&A section of their
Mergers &
Acquisitions
financial statements.
pg. 235
Options give people the right to buy stocks at a specific price, also known
as the strike price. Usually, options will be listed at various different
tranches of strike prices. If the strike price is lower than the stock price,
then the option is “in-the-money,” meaning the option holder would earn
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
a profi t if they bought the stock at the strike price and then immediately
sold it for the higher stock price.
For example, if the stock price is $10, and there are three tranches of
options with strike prices of $6, 12, and $15, then only the tranche of $6
options are “in-the-money.”
In the treasury stock method, we assume these in-the-money options
are exercised, meaning that the optionholder uses their right to buy
the stock. This means we effectively add the number of in-the-money
options to the share count. However, the company also receives cash
for this exercise of options, since the optionholders have to pay for the
shares, even if they are just paying for the strike price. The amount of
cash received is equal to the strike price x number of ITM options. We
assume that this cash received will be used to buy back shares at the
strike price, so the share count is reduced by that amount, and we arrive
at fully diluted shares outstanding.
Discounted
Cash Flow
Mergers
& Acquisitions
216
Section 5: Discounted Cash Flow - Question 032
Discounted
Cash Flow
pg. 185
When does discounting UFCF and
LFCF produce the same value?
When do they not?
Next Question:
Why would you
discount LFCF...
How would you
sensitize your DCF?
If you’re in the tech
sector, would...
How do you choose a
projection
The UFCF method relies on assuming a target capital structure
throughout the projection period. However, LFCF may have their capital
structure change throughout the projection period as the company pays
back debt or borrows more. As a result, they usually result in slightly
Mergers &
Acquisitions
pg. 235
different values. However, if the target capital structure and the actual
capital structure ends up being the same throughout the projection
Leveraged
Buyouts
pg. 282
period, then in theory the values would be the same.
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
217
Section 5: Discounted Cash Flow - Question 033
Discounted
Cash Flow
pg. 185
Why would you discount LFCF
instead of UFCF?
Next Question:
How would you
sensitize your DCF?
If you’re in the tech
sector, would...
How do you choose a
projection...
LFCF contains the effects of debt and interest expense, while UFCF does
If you’re modeling an
infrastructure...
not. UFCF is generally used for most companies as it is simpler and does
not require complex debt schedule calculations.
Mergers &
Acquisitions
pg. 235
However, if interest expense is a core part of the business, then it would
be important to include the effects of debt and use LFCF. This is true for
many financial institutions such as banks and hedge funds, which would
typically discount LFCF.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
218
Section 5: Discounted Cash Flow - Question 034
Discounted
Cash Flow
pg. 185
How would you sensitize your DCF?
Next Question:
If you’re in the tech
sector, would...
How do you choose a
projection...
If you’re modeling an
infrastructure...
What are the top 5
questions you...
You would sensitize model assumptions like WACC and perpetuity
growth rate / exit multiple. You can also sensitize operating metrics like
revenue growth, EBITDA margin, and capex. Finally, you can also look at
different upside, base case and downside scenarios.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
219
Section 5: Discounted Cash Flow - Question 035
Discounted
Cash Flow
pg. 185
If you’re in the tech sector, would
you rely on DCFs or comps?
Next Question:
How do you choose a
projection...
If you’re modeling an
infrastructure...
What are the top 5
questions you...
How would an increase
in net working...
A technology company typically has very rapid, unpredictable cash
flows, making it very difficult to accurately make DCF projections. In this
case, we would rely on comps.
Mergers &
Acquisitions
pg. 235
On the other hand, some technology start-ups are first movers in their
Leveraged
Buyouts
sector and don’t have direct competitors or comparable companies. In
pg. 282
this case, we would rely on DCF.
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
220
Section 5: Discounted Cash Flow - Question 036
Discounted
Cash Flow
pg. 185
How do you choose a projection
period in the DCF?
Next Question:
If you’re modeling an
infrastructure...
What are the top 5
questions you...
How would an increase
in net working...
How would a decrease
in net working...
Typically, you project 5-10 years because it’s expected that the
company will be a mature company after the projection period. Also, it’s
often very difficult to project beyond that. Once the company is mature,
we can apply a terminal value.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
221
Section 5: Discounted Cash Flow - Question 037
Discounted
Cash Flow
pg. 185
If you’re modeling an
infrastructure company, what is
the projection period?
Next Question:
What are the top 5
questions you...
How would an increase
in net working...
How would a decrease
in net working...
Why do so many
investors use a DCF?
Infrastructure companies with contracted cashflows with the
government may have a much longer projection period, such as up to 50
or even 100 years. This is because in these cases, pricing and revenue is
determined by pre-written contracts that will not change for a very long
time.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
222
Section 5: Discounted Cash Flow - Question 038
Discounted
Cash Flow
pg. 185
What are the top 5 questions you
would ask management if you
were building a DCF?
Next Question:
How would an increase
in net working...
How would a decrease
in net working...
Why do so many
investors use a DCF?
1.
How does your revenue model work, what are your growth drivers
What % of enterprise
value should...
for revenue and how does revenue growth look going forward?
2.
What are your gross margins and do you expect improvement?
3.
How is SG&A driven (eg % change vs. % of sales) and how does
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
that look going forward
4.
pg. 282
Who are your competitors and how are you positioned relative to
Other
Questions
them?
pg. 330
•
Knowing the competitive landscape and how the company is
positioned will help you better forecast revenue and costs
•
This can help with doing beta comps and finding an exit
multiple for terminal value
5.
How much capex are you planning to spend in the next 5 years?
Discounted
Cash Flow
Mergers
& Acquisitions
223
Section 5: Discounted Cash Flow - Question 039
Discounted
Cash Flow
pg. 185
How would an increase in net
working capital affect your DCF?
What does that mean?
Next Question:
How would a decrease
in net working...
Why do so many
investors use a DCF?
What % of enterprise
value should...
What’s the difference
between intrinsic...
An increase in net working capital would decrease unlevered free
cash flow. It represents more money being tied up in the daily operations
of the business. For example, an increase in inventory would tie up more
cash.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
224
Section 5: Discounted Cash Flow - Question 040
Discounted
Cash Flow
pg. 185
How would a decrease in net
working capital in your DCF? What
does that mean?
Next Question:
Why do so many
investors use a DCF?
What % of enterprise
value should...
What’s the difference
between intrinsic...
If the revenue growth
for 2020 is 5%...
A decrease in net working capital would increase unlevered free cash
flow. It represents less money being tied up in the daily operations of the
business. For example, an increase in the number of days it takes us to
pay our suppliers (also known as days payable outstanding) would
free up cash.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
225
Section 5: Discounted Cash Flow - Question 041
Discounted
Cash Flow
pg. 185
Why do so many investors use a
DCF?
Next Question:
What % of enterprise
value should...
What’s the difference
between intrinsic...
If the revenue growth
for 2020 is 5%...
How do you project
capex?
A DCF model is very useful for understanding a business’s finances
inside and out, and seeing how certain changes in revenue growth, gross
margins, etc. could effect the company’s enterprise value.
Mergers &
Acquisitions
pg. 235
Although a DCF can very rarely guess the exact price of a stock or value
of a company, it can provide investors with a range of prices and values.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
226
Section 5: Discounted Cash Flow - Question 042
Discounted
Cash Flow
pg. 185
What % of enterprise value should
terminal value be?
Next Question:
What’s the difference
between intrinsic...
If the revenue growth
for 2020 is 5%...
How do you project
capex?
How do you account
for convertible...
Usually 60-80% is normal. Anything above 80% would be a red flag
because too much of the model’s value would be driven by the terminal
value instead of the projected cash flows.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
227
Section 5: Discounted Cash Flow - Question 043
Discounted
Cash Flow
pg. 185
What’s the difference between
intrinsic and relative valuation?
Next Question:
If the revenue growth
for 2020 is 5%...
How do you project
capex?
How do you account
for convertible...
Intrinsic valuation is based on future cash flows, while relative valuation
If you had to do a DCF
in 15-30 minutes...
is based on the multiples that comparable companies are trading at.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
228
Section 5: Discounted Cash Flow - Question 044
Discounted
Cash Flow
pg. 185
If the revenue growth for 2020 is 5%,
followed by (10%), 14%, and (8%), what
questions would you ask about the
business?
Next Question:
How do you project
capex?
How do you account
for convertible...
If you had to do a DCF
in 15-30 minutes...
I would ask what is causing the decline in revenue in 2nd and 4th year. In
Is there an interest tax
shield in UFCF...
particular, I would try to figure out if this is a pricing or volume problem,
and if it’s cyclical (ie driven by the economy) or non-cyclical. If it’s noncyclical, I would try to evaluate if the revenue downfalls are one-time or
if volatility is a regular feature of the business.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
229
Section 5: Discounted Cash Flow - Question 045
Discounted
Cash Flow
pg. 185
How do you project capex?
Next Question:
How do you account
for convertible...
If you had to do a DCF
in 15-30 minutes...
Is there an interest tax
shield in UFCF...
Why do investment
banks create...
Management will often make indications if they are going to be
investing more heavily in capex than usual. This information and
commentary can be found in earnings transcripts, annual reports, and
Mergers &
Acquisitions
the MD&A section of quarterly filings.
pg. 235
Leveraged
Buyouts
Based on management guidance, we can either put in the capex
pg. 282
directly as a $ amount, or drive capex as a % of revenue if we aren’t
given exact numbers from management.
Discounted
Cash Flow
Other
Questions
pg. 330
Mergers
& Acquisitions
230
Section 5: Discounted Cash Flow - Question 046
Discounted
Cash Flow
pg. 185
How do you account for convertible
bonds in a DCF?
Next Question:
If you had to do a DCF
in 15-30 minutes...
Is there an interest tax
shield in UFCF...
Why do investment
banks create...
If the convertible bonds are in-the-money, meaning that the stock price
is higher than the conversion price, then the bonds will convert into
equity. This means more shares will be created, which will dilute the
Mergers &
Acquisitions
share price since the same enterprise value has to be spread over a
pg. 235
larger share count.
Leveraged
Buyouts
pg. 282
If the convertible bonds are out-of-the-money, meaning that the stock
price is lower than the conversion price, then the bonds will stay as
Other
Questions
pg. 330
bonds.
However, in a DCF, we value the company using unlevered free cash
flows (UFCF), which is the free cash flows without the effects of debt,
so we don’t care about this interest expense. In a DCF, we assume
a target capital structure for the entire projection period, which is
reflected in the WACC, so any temporary changes in debt won’t
matter since the cost of debt is already reflected in the discount rate.
Therefore, nothing will happen to the DCF implied value of the stock if
the convertible debt is not in-the-money.
Discounted
Cash Flow
Mergers
& Acquisitions
231
Section 5: Discounted Cash Flow - Question 047
Discounted
Cash Flow
pg. 185
If you had to do a DCF in 15-30 minutes,
which parts would you simplify? Why
those specific parts of the model?
Next Question:
Is there an interest tax
shield in UFCF...
Why do investment
banks create...
•
D&A (just percent of Capex instead of building PP&E schedule)
•
Capex (just percent of revenue)
•
Change in NWC (constant or just percent of change in revenue)
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
These parts take up time since typically, separate models and
pg. 282
schedules are built for them. However, they have relatively less of an
impact on the valuation output compared to revenue growth, EBITDA
pg. 330
margin expansion, WACC, and terminal value.
Discounted
Cash Flow
Other
Questions
Mergers
& Acquisitions
232
Section 5: Discounted Cash Flow - Question 048
Discounted
Cash Flow
pg. 185
Is there an interest tax shield in
UFCF and why?
Next Question:
Why do investment
banks create...
No, Unlevered Free Cash Flows do not account for interest income or
interest expense UFCF is before the effects of debt. Therefore, there is
no tax shield.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
Mergers
& Acquisitions
233
Section 5: Discounted Cash Flow - Question 049
Discounted
Cash Flow
pg. 185
Why do investment banks create
more DCF models than LBO
models?
Next Question:
LBO Models are typically built by private equity firms or for private
equity firms trying to do a leveraged buyout; they involve 3 statements
and are quite time consuming. DCFs are much more common for most
non-PE companies, and most of a bank’s clients are non-PE.
Mergers &
Acquisitions
pg. 235
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Discounted
Cash Flow
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& Acquisitions
234
Section Six
Mergers &
Acquisitions
235
Section 6: Mergers & Acquisitions - Question 001
Mergers &
Acquisitions
pg. 235
Why do most M&A deals fail?
Next Question:
Why would one
company want to...
What are the methods
to value an M&A...
Which yields a higher
value?...
•
Management egos looking to run a larger and more prestigious
What’s a difference
between a merger...
company
Leveraged
Buyouts
•
Lack of culture and fi t
•
Integration more expensive than expected
•
Synergies not realized (at all / or in insufficient time)
Mereger’s
& Acquisitions
pg. 282
Other
Questions
pg. 330
Leveraged
Buyouts
236
Section 6: Mergers & Acquisitions - Question 002
Mergers &
Acquisitions
pg. 235
Why would one company want to buy another
company?
Next Question:
What are the methods
to value an M&A...
Which yields a higher
value?...
What’s a difference
between a merger...
Pitch me an M&A
deal.
Strategic
•
Horizontal: buying businesses that offer similar product/service
offering to reduce competition, enhance market position/share, and
ultimately increase customer base and revenues
•
Vertical: buying businesses on different levels of the supply chain
in an effort to reduce markup or distribution costs
•
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Conglomerate: buying businesses that may or may not lead to
synergies, but doing so may diversify the company’s exposures
to certain risks. A key example is Warren Buffett’s Berkshire
Hathaway. These used to be more common but now the common
theory is that managing a portfolio of businesses is too distracting
for a single CEO.
Financial sponsors: buying businesses with lots of debt to amplify
return for investors
Mereger’s
& Acquisitions
Leveraged
Buyouts
237
Section 6: Mergers & Acquisitions - Question 003
Mergers &
Acquisitions
pg. 235
Why would one company want to buy another
company?
Next Question:
Which yields a higher
value?...
What’s a difference
between a merger...
Pitch me an M&A
deal.
Walk me through an
accretion...
Strategic
•
Horizontal: buying businesses that offer similar product/service
offering to reduce competition, enhance market position/share, and
ultimately increase customer base and revenues
•
Vertical: buying businesses on different levels of the supply chain
in an effort to reduce markup or distribution costs
•
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Conglomerate: buying businesses that may or may not lead to
synergies, but doing so may diversify the company’s exposures
to certain risks. A key example is Warren Buffett’s Berkshire
Hathaway. These used to be more common but now the common
theory is that managing a portfolio of businesses is too distracting
for a single CEO.
Financial sponsors: buying businesses with lots of debt to amplify
return for investors
Mereger’s
& Acquisitions
Leveraged
Buyouts
238
Section 6: Mergers & Acquisitions - Question 004
Mergers &
Acquisitions
pg. 235
Why would one company want to buy another
company?
Next Question:
What’s a difference
between a merger...
Pitch me an M&A
deal.
Walk me through an
accretion...
A strategic acquisition will yield a higher value because there are often
What are the types
of synergies...
strategic benefi ts they will get from buying the target. For example,
maybe they are trying to expand into an adjacent market, and the target
can provide expertise and client relationships. Perhaps they are acquiring
a supplier and saving on supplier costs.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
However, a sponsor (private equity) acquisition is done often without any
strategic synergies and is trying to earn a return off the cash flows, so
they will pay a lower price.
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& Acquisitions
Leveraged
Buyouts
239
Section 6: Mergers & Acquisitions - Question 005
Mergers &
Acquisitions
pg. 235
What’s a difference between a merger and an
acquisition?
Next Question:
Pitch me an M&A
deal.
Walk me through an
accretion...
What are the types
of synergies...
A merger is usually a “merger-of-equals” between two similarly sized
Are revenue synergies
or cost synergies...
companies and it’s presented as more cooperative. An acquisition is
usually done in a straightforward way and it’s clear who the acquiror is
right away. In reality though, other than image and public perception,
there are not many financial differences.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
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& Acquisitions
Leveraged
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240
Section 6: Mergers & Acquisitions - Question 006
Mergers &
Acquisitions
pg. 235
Pitch me an M&A deal.
Next Question:
Walk me through an
accretion...
What are the types
of synergies...
Are revenue synergies
or cost synergies...
Prepare a 30 second M&A pitch which covers the strategic reasons why
Give me some
examples of revenue...
the acquiror would want to buy the target. It’s great if your idea follows
a current industry trend, such as consolidation of a certain sector by
larger players, and can point to past successful acquisitions in the space.
Finally, any knowledge of key numbers, such as revenue, EBITDA, and
the EV / EBITDA multiple of the target is very helpful. Take a guess at
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
what the post-acquisition EV / EBITDA multiple might look like as there
will be a 20-30% control premium for an M&A deal on top of the normal
market multiple.
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& Acquisitions
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241
Section 6: Mergers & Acquisitions - Question 007
Mergers &
Acquisitions
pg. 235
Walk me through an accretion / dilution
analysis.
Next Question:
What are the types
of synergies...
Are revenue synergies
or cost synergies...
Give me some
examples of revenue...
•
Make transaction assumptions: consideration (cash, debt, or equity),
Give me some
examples of cost...
transaction fees, synergies, etc.
•
Combine income statements of the acquirer and target
•
Adjust income statement and shares outstanding accordingly to
Leveraged
Buyouts
pg. 282
Other
Questions
financing terms
pg. 330
•
•
Add synergies
•
Adjust for additional expenses (transaction fees)
•
Add additional shares
•
Subtract forgone interest on cash
•
Subtract additional interest expense on debt
Calculate EPS by dividing combined net income by post-merger
shares outstanding of acquiring company
•
Compare combined EPS with acquirer’s current EPS to determine if
deal is accretive or dilutive
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& Acquisitions
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242
Section 6: Mergers & Acquisitions - Question 008
Mergers &
Acquisitions
pg. 235
What are the types of synergies in an M&A deal?
Next Question:
Are revenue synergies
or cost synergies...
Give me some
examples of revenue...
Give me some
examples of cost...
There are revenue synergies and cost synergies.
Walk me through an
M&A deal on...
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
Leveraged
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243
Section 6: Mergers & Acquisitions - Question 009
Mergers &
Acquisitions
pg. 235
Are revenue synergies or cost synergies more
tangible?
Next Question:
Give me some
examples of revenue...
Give me some
examples of cost...
Walk me through an
M&A deal on...
Usually cost synergies are more tangible because they involve cutting a
Walk me through an
M&A deal on...
specific expense. For example, after an acquisition, there is no need for
2 headquarters, so they may shut down one headquarters and save on
rent expense.
Leveraged
Buyouts
pg. 282
Other
Questions
Revenue synergies are less tangible since it is harder to guess the exact
pg. 330
increase in revenue as a result of synergies; it’s usually much more of an
estimate.
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& Acquisitions
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244
Section 6: Mergers & Acquisitions - Question 010
Mergers &
Acquisitions
pg. 235
Give me some examples of revenue synergies.
Next Question:
Give me some
examples of cost...
Walk me through an
M&A deal on...
Walk me through an
M&A deal on...
Why would you not
do an M&A deal...
Examples of revenue synergies include:
•
Improvement in units/services sold or higher pricing
•
Geographic expansion
•
Cross-sell products to new customers
•
New products to existing customers
•
Increased market power/position
Mereger’s
& Acquisitions
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Leveraged
Buyouts
245
Section 6: Mergers & Acquisitions - Question 011
Mergers &
Acquisitions
pg. 235
Give me some examples of cost synergies.
Next Question:
Walk me through an
M&A deal on...
Walk me through an
M&A deal on...
Why would you not
do an M&A deal...
Why would you do an
M&A deal if it’s...
Examples of cost synergies include:
•
Increasing operational efficiency to improve margins
•
Layoffs of redundant staff
•
Economies of scale: spread cost over larger number of units
•
Vertical integration of supply chain = removing markups on products
•
Access to competitive operational advantages: tech, infrastructure,
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
skilled employees
•
Tax benefi ts: location of company has lower tax rate
•
Net operating losses: benefi t for unprofi table companies
Mereger’s
& Acquisitions
Leveraged
Buyouts
246
Section 6: Mergers & Acquisitions - Question 012
Mergers &
Acquisitions
pg. 235
Walk me through an M&A deal on the buy-side.
Next Question:
Walk me through an
M&A deal on...
Why would you not
do an M&A deal...
Why would you do an
M&A deal if it’s...
What are the ways you
can finance an M&A...
First Round
•
Identify potential target firms
•
Reach out to gauge interest with teaser; sign CA(1) and receive
CIM(2) and financial statements
•
Send letter of intent (LOI) with preliminary offer
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Second Round
•
Access to data room
•
Perform detailed analysis and modeling and present to internal
team
•
Site visit, management meetings, due diligence questions
•
Send updated offer with SPA(3)
Third Round
•
Usually exclusive, meaning buyer can purchase third party due
diligence (DD) with minimal risk
•
Third party DD includes: accounting, legal, tax, quality of earnings,
environmental, management, background checks, consulting /
market research, etc.
•
Close transaction, wire transfer cash
Mereger’s
& Acquisitions
Leveraged
Buyouts
247
Section 6: Mergers & Acquisitions - Question 013
Mergers &
Acquisitions
pg. 235
Walk me through an M&A deal on the sell-side.
Next Question:
Why would you not
do an M&A deal...
Why would you do an
M&A deal if it’s...
What are the ways you
can finance an M&A...
Rank these financing
methods from...
First Round
•
Identify potential buyers
•
Reach out to gauge interest; send teaser, CA(1), and CIM(2)
•
Receive preliminary offers; select companies to advance to next
round
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Second Round
•
Give access to data room
•
Answer questions from buyers, provide additional material and
analysis when requested
•
Site visit, management meetings
•
Receive updated offers with SPAs(3); select company to advance to
third (exclusive) round
Third Round
•
Usually exclusive
•
Work with third party vendors such as accounting, tax, quality
of earnings, environmental, management, background checks,
consulting / market research, etc. to satisfy final due diligence
requirements
•
Close transaction, receive cash
•
Close transaction, wire transfer cash
Mereger’s
& Acquisitions
Leveraged
Buyouts
248
Section 6: Mergers & Acquisitions - Question 014
Mergers &
Acquisitions
pg. 235
Why would you not do an M&A deal if it’s
accretive?
Next Question:
Why would you do an
M&A deal if it’s...
What are the ways you
can finance an M&A...
Rank these financing
methods from...
Even if an M&A deal could be accretive, there may be other strategic
When would you use
stock to buy a...
risks that won’t be captured by an Excel model. For example, there could
be the risk of reputational damage if the target doesn’t have a similar
credibility or brand as the acquiror. Key executive members may move
or become disgruntled if they feel the scope of their responsibility has
changed, or they may be simply unhappy with the new culture and team.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Integrating the two companies’ operations may take much longer and be
much more expensive than expected.
Mereger’s
& Acquisitions
Leveraged
Buyouts
249
Section 6: Mergers & Acquisitions - Question 015
Mergers &
Acquisitions
pg. 235
Why would you not do an M&A deal if it’s
accretive?
Next Question:
What are the ways you
can finance an M&A...
Rank these financing
methods from...
When would you use
stock to buy a...
Many companies do M&A deals to expand into a new market or product.
When would you use
debt to buy...
They are often willing to pay a premium for company to gain access to its
expertise, relationships, and infrastructure, which is often a prerequisite
for entering a new market. They may be willing to reduce earnings in the
short-term while raising growth prospects in the long term.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
Leveraged
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250
Section 6: Mergers & Acquisitions - Question 016
Mergers &
Acquisitions
pg. 235
What are the ways you can finance an M&A
deal?
Next Question:
Rank these financing
methods from...
When would you use
stock to buy a...
When would you use
debt to buy...
•
Cash on balance sheet
•
Stock (share issuance)
•
Debt
What is the cost of
cash in an M&A...
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
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251
Section 6: Mergers & Acquisitions - Question 017
Mergers &
Acquisitions
pg. 235
Rank these financing methods from cheapest to
most expensive.
Next Question:
When would you use
stock to buy a...
When would you use
debt to buy...
What is the cost of
cash in an M&A...
Cash on balance sheet: No need to access capital markets for financing,
Why would an acquirer
not use cash?
the only cost is the opportunity cost of the cash.
Debt: Interest expense is after-tax, so there is a tax shield here. Also,
debt holders have higher priority on assets in case of a bankruptcy, so
they have less risk.
Leveraged
Buyouts
pg. 282
Other
Questions
Stock: Issuing new shares will dilute net income. Equity is the most
pg. 330
expensive because equity holders take on the most risk with the lowest
claim on assets in case of a bankruptcy, so they expect the highest
return.
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252
Section 6: Mergers & Acquisitions - Question 018
Mergers &
Acquisitions
pg. 235
When would you use stock to buy a company?
Next Question:
When would you use
debt to buy...
What is the cost of
cash in an M&A...
Why would an acquirer
not use cash?
You would use stock to buy a company if your stock price is trading
A company with a
higher P/E acquires...
quite high relative to the target. This could be because of temporary
cyclical trends or circumstances. You would also use stock if there is no
further cash or debt capacity and equity is the only option.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
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& Acquisitions
Leveraged
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253
Section 6: Mergers & Acquisitions - Question 019
Mergers &
Acquisitions
pg. 235
When would you use debt to buy a company?
Next Question:
What is the cost of
cash in an M&A...
Why would an acquirer
not use cash?
A company with a
higher P/E acquires...
You would use debt: if you don’t have enough free cash on the balance
Why is goodwill
created in an...
sheet, have the debt capacity, and would prefer a cheaper source of
financing than equity.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
Leveraged
Buyouts
254
Section 6: Mergers & Acquisitions - Question 020
Mergers &
Acquisitions
pg. 235
What is the cost of cash in an M&A transaction?
Next Question:
Why would an acquirer
not use cash?
A company with a
higher P/E acquires...
Why is goodwill
created in an...
The cost of cash is the opportunity cost of the cash, which is usually the
What would you
sensitize in a merger...
after-tax interest rate that could have been earned (typically 1-2%).
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
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& Acquisitions
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255
Section 6: Mergers & Acquisitions - Question 021
Mergers &
Acquisitions
pg. 235
Why would an acquirer not use cash?
Next Question:
A company with a
higher P/E acquires...
Why is goodwill
created in an...
What would you
sensitize in a merger...
The acquirer may not have enough cash, or they have set aside cash
Walk me through how
you would calculate...
on the balance sheet for another purpose such as market expansion,
meeting a contingent liability, or even to execute a different acquisition.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
Leveraged
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256
Section 6: Mergers & Acquisitions - Question 022
Mergers &
Acquisitions
pg. 235
A company with a higher P/E acquires a
company with a lower P/E in an all-stock
deal. Is this accretive or dilutive?
Next Question:
Why is goodwill
created in an...
What would you
sensitize in a merger...
Walk me through how
you would calculate...
This is accretive. A higher P/E means that you are paying more for
Walk me through
how you would...
every dollar of earnings, since the numerator is stock price and the
denominator is earnings. A lower P/E means you are paying less for
every dollar of earnings.
Leveraged
Buyouts
pg. 282
Therefore, the higher P/E company is more expensive, and the lower P/E
Other
Questions
pg. 330
company is cheaper, so this is like a more expensive company acquiring
a less expensive company. By acquiring earnings at a multiple that is
cheaper than its own, it will increase its earnings.
Note that this is only true if it’s an all-stock deal. If there is debt / cash
in the purchase as well, you would have to build an accretion / dilution
model to figure out if it’s accretive or dilutive.
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& Acquisitions
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257
Section 6: Mergers & Acquisitions - Question 023
Mergers &
Acquisitions
pg. 235
Why is goodwill created in an
acquisition?
Next Question:
What would you
sensitize in a merger...
Walk me through how
you would calculate...
Walk me through
how you would...
When an acquiror pays more than the book value for a company, the
How do you value
NOLs in an M&A deal?
excess amount over the book value is called goodwill.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
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258
Section 6: Mergers & Acquisitions - Question 024
Mergers &
Acquisitions
pg. 235
What would you sensitize in a merger model?
Next Question:
Walk me through how
you would calculate...
Walk me through
how you would...
How do you value
NOLs in an M&A deal?
You can sensitize key model assumptions like price paid, premium paid,
Why do deferred tax
liabilities get created...
debt used in the acquisition, etc. You can also sensitize synergies as
there is often a large variance in what that can be. Finally, you can
sensitize key operating metrics for the target company like revenue
growth, EBITDA margin, and capex.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Mereger’s
& Acquisitions
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259
Section 6: Mergers & Acquisitions - Question 025
Mergers &
Acquisitions
pg. 235
Walk me through how you would calculate
revenue synergies.
Next Question:
Walk me through
how you would...
How do you value
NOLs in an M&A deal?
Why do deferred tax
liabilities get created...
First, we should understand the revenue model. For example, it could
How do you adjust
the balance sheet...
be a quantity x price model, subscribers x ARPU model, etc.
Leveraged
Buyouts
If the revenues synergies come from increasing one of these variables in
the revenue model, such as increase in subscribers as a result of crossselling, then we should estimate how many more subscribers we would
pg. 282
Other
Questions
pg. 330
get as a result of cross-selling. We can analyze the historical data to
see how effective cross-selling has been in the past.
If the revenue synergies come from a new revenue source, such as an
adjacent (similar) product that has been enabled as a result of this
acquisition, then we should estimate the quantity and price of this new
product. This can be done either through a top-down method, such as
analyzing market size and market share.
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& Acquisitions
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260
Section 6: Mergers & Acquisitions - Question 026
Mergers &
Acquisitions
pg. 235
Walk me through how you would calculate cost
synergies.
Next Question:
How do you value
NOLs in an M&A deal?
Why do deferred tax
liabilities get created...
How do you adjust
the balance sheet...
Cost synergies often involve reducing or eliminating a specific cost.
What adjustments do
you have to make...
For example, the combined company will not need two headquarters,
so eliminating a headquarters is one source of cost savings. This might
involve saving costs on salaries and rent.
Leveraged
Buyouts
pg. 282
Other
Questions
Cost synergies can also come from having more bargaining power.
pg. 330
Being a larger company allows you to get better deals on your goods
and supplies, therefore reducing your cost of goods sold.
Finally, cost synergies can come from economies of scale. Being a
larger company allows you to spread fixed costs such as PP&E over a
larger variable cost base. In other words, a smaller % of your revenue
needs to be allocated to fixed costs as you get bigger, which will
improve your EBITDA margins.
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& Acquisitions
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261
Section 6: Mergers & Acquisitions - Question 027
Mergers &
Acquisitions
pg. 235
How do you value NOLs in an M&A deal?
Next Question:
Why do deferred tax
liabilities get created...
How do you adjust
the balance sheet...
What adjustments do
you have to make...
An NOL (net operating loss) happens if a company loses money one
What are the most
important terms of...
year. In most jurisdictions, the company can spread this loss around to
reduce their taxable income in future years and therefore reduce their
taxes.
Leveraged
Buyouts
pg. 282
Other
Questions
NOLs can be valued by finding the net present value (NPV) of the tax
pg. 330
savings. For example, if a company lost $100M and is allowed to spread
this loss over the next 5 years, then we would take each annual savings
of $20M and discount it to the present period to find the NPV of the
NOLs.
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& Acquisitions
Leveraged
Buyouts
262
Section 6: Mergers & Acquisitions - Question 028
Mergers &
Acquisitions
pg. 235
Why do deferred tax liabilities get created in an
M&A deal?
Next Question:
How do you adjust
the balance sheet...
What adjustments do
you have to make...
What are the most
important terms of...
In many jurisdictions, the acquiror is allowed to mark up the assets
What are earnouts
and why are they...
of the target from their accounting book value to fair market value.
Fair market value is the price an asset would sell for on the open market
today. On the other hand, book value is the original price paid. For certain
assets, such as real estate, the asset may have increased in value.
Since so many assets are being marked up and having their values
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
increase, this also means we will have a higher depreciation expense on
our financial accounting books, and therefore our taxable income will also
be lower on our financial accounting books.
However, the government will follow different accounting rules when
determining a company’s taxable income. Most countries will use a
double declining balance method; in the US, they will use MACRS to
depreciate assets, and in Canada, they use CCA. The key point here is
that the government accounting books will not mark up the assets to fair
market value, preferring instead to use the original book value the assets
were purchased at.
Because of the lower asset values, the depreciation expense will
also be lower. Lower expenses results in higher taxable income, which
leads to higher taxes. As a result, the tax expense on the government’s
accounting books will be higher than the financial accounting books
given the different depreciation method used. Since more tax is owed to
the government than would appear on the financial accounting books,
we have to create a liability which represents this tax owed to the
government. This is called a deferred tax liability.
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& Acquisitions
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Buyouts
263
Section 6: Mergers & Acquisitions - Question 029
Mergers &
Acquisitions
pg. 235
How do you adjust the balance sheet in an M&A
deal?
Next Question:
What adjustments do
you have to make...
What are the most
important terms of...
What are earnouts
and why are they...
First, we can account for the acquisition. We should debit any existing
What is the due
diligence process...
shareholder’s equity out of the target’s balance sheet. Then we should
credit shareholder’s equity by the new acquisition amount, and we
should also credit any new debt that was raised for this acquisition.
Finally, we should debit or credit any difference to goodwill. Goodwill
represents the amount we pay for the company that is in excess of its
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
book value.
Secondly, we can make other adjustments to cash. If the target company
has a cash balance, we should credit the cash balance to make it zero,
and debit goodwill by the same amount.
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& Acquisitions
Leveraged
Buyouts
264
Section 6: Mergers & Acquisitions - Question 030
Mergers &
Acquisitions
pg. 235
What adjustments do you have to make to the
income statement in an M&A deal?
Next Question:
What are the most
important terms of...
What are earnouts
and why are they...
What is the due
diligence process...
You have to adjust for any additional interest expense for any new debt
What is the most
important due...
you’ve taken on. You also have to adjust net income for any transaction
and financing fees from the acquisition. Additionally, you have to adjust
for any synergies or additional corporate costs. Finally, you have to adjust
the share count if any new shares were issued to finance the purchase.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Keep in mind these adjustments are often made pre-tax, and then a
tax rate is applied to see the after-tax effect.
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& Acquisitions
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Buyouts
265
Section 6: Mergers & Acquisitions - Question 031
Mergers &
Acquisitions
pg. 235
What are the most important terms of an M&A
agreement?
Next Question:
What are earnouts
and why are they...
What is the due
diligence process...
What is the most
important due...
The most important terms are the price agreed upon, the type of
What are the key
areas of risk...
consideration paid, and the effective date of the transaction.
Leveraged
Buyouts
Other important terms include how the cash and working capital
will be accounted for when determining the price of purchase. The
representations and warranties section is often very important as
pg. 282
Other
Questions
pg. 330
it indicates what will happen if financial / company information is
wrong and if there will be an indemnity or not. An indemnity will cause
somebody to pay not only for direct damages, but also indirect damages,
and can drastically widen the potential liability.
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Leveraged
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266
Section 6: Mergers & Acquisitions - Question 032
Mergers &
Acquisitions
pg. 235
What are earnouts and why are they important?
Next Question:
What is the due
diligence process...
What is the most
important due...
What are the key
areas of risk...
An earnout is a payment to management for achieving a certain goal.
How do you account
for transaction fees...
For example, an earnout could stipulate that management needs to
achieve 10% growth in gross profi t in the next year in order to receive an
earnout payment. This is important because it incentives management to
grow the business, it aligns interests, and it also motivates management
to stay with the company.
Mereger’s
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Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Leveraged
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267
Section 6: Mergers & Acquisitions - Question 033
Mergers &
Acquisitions
pg. 235
What is the due diligence process for an M&A
deal?
Next Question:
What is the most
important due...
What are the key
areas of risk...
How do you account
for transaction fees...
The due diligence process for an M&A deal typically involves
What is the difference
between a stock...
questioning and confirming all key aspects of the business, especially
the growth trajectory of the business and industry. PE firms will often
hire 3rd parties to help out with different aspects of due diligence.
Leveraged
Buyouts
pg. 282
Other
Questions
Some of the most important due diligence is done on the industry, and
pg. 330
this can include competitor analysis, pricing analysis, volume analysis,
and speaking with industry experts.
Due diligence will also be done on the company’s financials, accounting
statements, EBITDA and earnings, customers, products, strategy,
distribution chain, etc.
There are many other common due diligence items that are more
“check-the-box” and perfunctory in nature, which are often 100%
outsourced to third parties. These include: IT, lender due diligence,
facility due diligence, site visit, environmental due diligence, market
sizing, compensation of management, ownership, legal, tax and
insurance.
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268
Section 6: Mergers & Acquisitions - Question 034
Mergers &
Acquisitions
pg. 235
What is the most important due diligence item
in an M&A deal?
Next Question:
What are the key
areas of risk...
How do you account
for transaction fees...
What is the difference
between a stock...
The most important piece to question is the revenue model. It’s
Company E has an
EBITDA of $300M...
important to due diligence where the company expects growth since
that will drive returns. This can be tested by asking about and diving
into the company’s strategy, products, and customers. We can also
analyze this by looking at the industry, and diving deep into competitor
analysis, pricing analysis, volume analysis, and speaking with industry
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
experts.
Also, if the investment thesis is based on any cost-cutting measures, it
will be important to do due diligence on those as well.
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Buyouts
269
Section 6: Mergers & Acquisitions - Question 035
Mergers &
Acquisitions
pg. 235
What are the key areas of risk in an M&A
transaction?
Next Question:
How do you account
for transaction fees...
What is the difference
between a stock...
Company E has an
EBITDA of $300M...
Usually the biggest risks are that the synergies do not materialize
Company A has a P/E
of 10x and Company...
as projected, and that integrating the two companies is much more
expensive, difficult, and lengthy than previously imagined.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
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Leveraged
Buyouts
270
Section 6: Mergers & Acquisitions - Question 036
Mergers &
Acquisitions
pg. 235
What are the key areas of risk in an M&A
transaction?
Next Question:
What is the difference
between a stock...
Company E has an
EBITDA of $300M...
Company A has a P/E
of 10x and Company...
Transaction fees are usually based off of a percentage of the total
Buyer has $100 share
price, 3M S/O...
transaction value, usually around 2%. This is paid as a one-time fee
and is displayed in the income statement after operating income.
Leveraged
Buyouts
pg. 282
Financing fees are usually based off of a percentage of the total amount
of debt, usually around 2%. However, this is amortized through a 5 year
Other
Questions
pg. 330
period, so the expense will be distributed over 5 years on the income
statement.
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& Acquisitions
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Buyouts
271
Section 6: Mergers & Acquisitions - Question 037
Mergers &
Acquisitions
pg. 235
What is the difference between a stock
purchase and an asset purchase?
Next Question:
Company E has an
EBITDA of $300M...
Company A has a net
income of $240...
Buyer has $100 share
price, 3M S/O...
A stock deal is when an acquirer purchases all equity ownership of a
You have 200 pro
forma shares after...
firm to purchase the entire company. This is by far the most common
kind of deal.
Leveraged
Buyouts
pg. 282
An asset deal is when the acquirer purchases the majority of the
target’s assets and does. The target firm uses the cash proceeds from
Other
Questions
pg. 330
sale to pay off shareholders to prepare for acquisition. All asset deals
are friendly and they do not necessarily involve the entire company.
Most importantly, an asset deal does not assume the target’s liabilities
which can be useful if the target has contingent liabilities such as
lawsuits or has a bad brand reputation.
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& Acquisitions
Leveraged
Buyouts
272
Section 6: Mergers & Acquisitions - Question 038
Mergers &
Acquisitions
pg. 235
Company E has an EBITDA of $300M and Company F has
an EBITDA of $150M. Let’s say that Company E acquires
Company F and realizes $50M in revenue synergies from
additional unit sales and $100M from cost synergies.
What is the pro forma EBITDA? Assume that the pro forma
company has a gross margin of 60%.
Next Question:
Company A has a net
income of $240...
Company A has a P/E
of 10x and...
Buyer has $100 share
price, 3M S/O...
If there are revenue synergies of $50M in additional unit sales,
You have 200 pro
forma shares after...
this also suggests that these extra units sold will incur an
additional cost. Since we know that the gross margin is 60%,
we can assume that cost of goods sold can be calculated as
$50M x 60% = $30M. Therefore, we are earning $50M - $30M =
$20M of additional EBITDA from these unit sales.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Cost synergies are $100M, which could be derived from
improving the efficiency of the business through scale or
increased barganing power with suppliers. They can be taken
as is.
Therefore, pro forma EBITDA can be calculated as Company
E EBITDA + Company F EBITDA + additional EBITDA from
revenue synergies + cost synergies = $300M + $150M + $20M +
$100M = $570M.
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& Acquisitions
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273
Section 6: Mergers & Acquisitions - Question 039
Mergers &
Acquisitions
pg. 235
Company A has a net income of $240, share price of
$3 and has 160 shares outstanding. Company B has a
net income of $300, share price of $4 and has 15 shares
outstanding. If Company A purchases Company B in an
all stock deal at a 25% premium, what is the % change in
accretion or dilution?
Next Question:
Company A has a
P/E of 10x and...
Buyer has $100 share
price, 3M S/O...
You have 200 pro
forma shares after...
If a company with
a P/E of 10...
Equity Value of Company B
$4 share price
x 15 shares outstanding
Leveraged
Buyouts
$60 equity value
x 1.25
pg. 282
# of shares issued to buy company B
Other
Questions
$75 equity value
pg. 330
÷ $3 share price
25 shares issued
Total # of Shares Outstanding
160 common shares outstanding
+ 25 shares issued
185 total shares outstanding
Combined Net Income and EPS
$240 net income of Company A
+ $300 net income of Company B
$540 combined net income
÷ 185 total shares outstanding
$2.92 EPS
Original EPS
$240
÷ 160
$1.5 EPS
Accretion
$3.0
- $1.5
$1.5 accretion
$2.92
÷ $1.5
1.95
- 1.0
0.95, or 95% accretion
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& Acquisitions
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Buyouts
274
Section 6: Mergers & Acquisitions - Question 040
Mergers &
Acquisitions
pg. 235
Company A has a P/E of 10x and Company B has a
P/E of 12x. Company A’s cost of debt is 10%, its cost of
cash interest is 1% and its tax rate is 40%. If Company
A purchases Company B using 25% stock, 50% debt
and 25% cash, is the deal accretive or dilutive?
Next Question:
Buyer has $100 share
price, 3M S/O...
You have 200 pro
forma shares after...
If a company with
a P/E of 10...
What is industry
consolidation and...
Cost of Equity for Company A
1
Leveraged
Buyouts
÷ 10 P/E of Company A
pg. 282
10%
Weighted Average Cost of Capital (WACC)
Other
Questions
pg. 330
(% Equity)(Cost of Equity) + (% Debt)(Cost of Debt)(1-Tax Rate) + (% Cash)
(Cost of Cash)(1-Tax Rate)
= (25%)(10%) + (50%)(10%)(1-40%)+(25%)(1%)(1-40%)
= 2.5%+(5%)(60%)+(0.25%)(60%)
= 2.5%+3%+0.15%
= 5.5%+0.15%
= 5.65%
Cost of Equity for Company B
1
÷ 12 P/E of Company B
8.33%
Since WACC of 5.65% < Cost of Equity for Company B of 8.33%, we are
buying a higher return with a lower cost of capital; therefore the deal is
accretive.
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& Acquisitions
Leveraged
Buyouts
275
Section 6: Mergers & Acquisitions - Question 041
Mergers &
Acquisitions
pg. 235
Buyer has $100 share price, 3M S/O, $20M net income, 40%
tax rate. Target has $18 share price, 500,000 S/O, $5M net
income, 40% tax rate. Buyer purchases target with 25%
debt and 75% equity at $20/share. Debt has interest rate of
8%. There are $900,000 in pre-tax synergies. What is the $
value and % of accretion/dilution?
Next Question:
You have 200 pro
forma shares after...
If a company with
a P/E of 10 acquires...
What is industry
consolidation and...
Purchase Price of Target
$20 share purchase price
x
500k shares outstanding
$10,000k purchase price
Total # of Shares Outstanding
3,000k shares outstanding,
opening balance
+
75k shares issued
3,075k total shares outstanding
Interest Expense
$10,000k purchase price
x
25% of acquisition financed
by debt
$2,500k debt
x
8% interest rate
$400 pre-tax interest expense
x
60% 1- tax rate
Synergies
x
$20,000k net income of buyer
$10,000k purchase price
+
75k shares issued
pg. 330
Total Net Income and EPS
-
100 share price of buyer
Other
Questions
60% 1- tax rate
# of Shares Issued
÷
pg. 282
$540,000 after-tax synergies
+ $5,000k net income of seller
$7,500k equity value
Leveraged
Buyouts
$900,000 pre-tax synergies
$120 after-tax interest
expense
x
75% of acquisition financed
by debt
If a large company
acquires a smaller...
$120k interest expense
$540k after-tax synergies
$25,420k total net income
÷ 3,075k total shares
outstanding
$8.27 EPS
Accretion / Dilution
$20,000K
÷ 3,000k shares outstanding,
opening balance
$6.67 EPS
$6.78 new EPS
- $6.67 old EPS
$0.11 accretion
÷ $6.67 old EPS
1.65% accretion
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& Acquisitions
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276
Section 6: Mergers & Acquisitions - Question 042
Mergers &
Acquisitions
pg. 235
You have 200 pro forma shares after an
acquisition. You currently have 0.50 cents
per share dilution. 40% tax rate. What pretax synergies do you need to break even?
Next Question:
If a company with a
P/E of 10 acquires...
What is industry
consolidation and...
If a large company
acquires a smaller...
If a large company
acquires a smaller...
200 pro forma shares
x
0.50 per share dilution
Leveraged
Buyouts
$100 dilution
pg. 282
÷ 60% 1 - tax rate
Other
Questions
$167 of pre-tax synergies to breakeven
pg. 330
Company A’s P/E is 10x, Company B’s P/E is 8x. If your cost of financing
was 12%, would the transaction be accretive or dilutive?
1/8=12.5%
Therefore accretive.
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& Acquisitions
Leveraged
Buyouts
277
Section 6: Mergers & Acquisitions - Question 043
Mergers &
Acquisitions
pg. 235
If a company with a P/E of 10 acquires a
company with a P/E of 12 with 50% debt and
50% equity, is it accretive or dilutive? The
cost of debt is 10% and the tax rate is 40%.
Next Question:
What is industry
consolidation and...
If a large company
acquires a smaller...
If a large company
acquires a smaller...
Cost of equity:
1/10=10%
Leveraged
Buyouts
(50%)(10%)(1-40%)+(50%)(10%)
pg. 282
= (5%)(60%)+(5%)
Other
Questions
= 3%+5%
pg. 330
= 8%
Cost of equity of the target:
1/12=8.33%
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& Acquisitions
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Buyouts
278
Section 6: Mergers & Acquisitions - Question 044
Mergers &
Acquisitions
pg. 235
What is industry consolidation and why
does it happen?
Next Question:
If a large company
acquires a smaller...
If a large company
acquires a smaller...
Industry consolidation is when smaller and more fragmented
companies are being acquired by larger companies in the same
industry. This often happens as part of a larger trend. As more and
more small companies are acquired, there will be fewer and fewer left,
leading to a scarcity effect where demand continues to rise as supply of
targets decreases.
Mereger’s
& Acquisitions
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
Leveraged
Buyouts
279
Section 6: Mergers & Acquisitions - Question 045
Mergers &
Acquisitions
pg. 235
If a large company acquires a smaller
target company, in what situation would
the P/E of the smaller target company be
lower than the acquiror?
Next Question:
If a large company
acquires a smaller...
The P/E of the smaller target company would be lower than a large
acquiror if it is viewed as less safe and secure, and if it doesn’t earn a
return high enough to compensate for this increased risk.
This is because as companies get larger, they become more established
and have a lower risk of going out of business during temporary
downturns. As a result, when it comes to larger companies, investors
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
may pay more per dollar of earnings because they value this increased
safety.
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& Acquisitions
Leveraged
Buyouts
280
Section 6: Mergers & Acquisitions - Question 046
Mergers &
Acquisitions
pg. 235
If a large company acquires a smaller
target company, in what situation would
the P/E of the smaller target company be
higher than the acquiror?
Next Question:
The smaller target company would have a higher P/E multiple if it earns
a substantially higher return that more than offsets the increased risk of
being a smaller company.
Leveraged
Buyouts
pg. 282
Other
Questions
pg. 330
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& Acquisitions
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Buyouts
281
Section Seven
Leveraged
Buyouts
282
Section 7: Leveraged Buyouts - Question 001
Leveraged
Buyouts
pg. 282
What makes a good LBO
candidate?
Next Question:
Why do an LBO?
What factors influence
how much debt...
What are the types of
debt in LBO?
The most important characteristic of a good LBO candidate is stable
Which types of debt
have a fixed interest...
cash flows, since the PE owner will have to service the debt and stay
within covenants in order for the investment to be successful. This
means recurring revenue is very valuable, meaning that the revenue is
Other
Questions
pg. 330
“sticky” and it’s hard for customers to switch to other providers. Having
stable margins is crucial as well.
Good LBO candidates should also not have too many other cash
outflows, and have relatively light capex. PE firms usually avoid
manufacturing companies for this reason, since they require a lot of
capex to build new factories and buy new equipment.
Ideally, the company should also be strongly positioned as a leader
in its industry or niche, and have high growth potential and multiple
growth avenues to grow revenue and EBITDA.
If there are opportunities to improve the company, this would also be
also attractive.
Having a large tangible asset base is useful as well for providing
collateral and potentially securing more debt on better terms.
Finally, other important positives include a very experienced
management team and a favorable acquisition price. For example, a
favourable price may be driven by mispricing in the public markets due
to the short-term focus of public stocks.
Leveraged
Buyouts
Other
Questions
283
Section 7: Leveraged Buyouts - Question 002
Leveraged
Buyouts
pg. 282
Why do an LBO?
Next Question:
What factors influence
how much debt...
What are the types of
debt in LBO?
Which types of debt
have a fixed interest...
The main advantage of doing an LBO is by increasing the rate
What are three drivers
of IRR in an LBO?
of equity or internal rate of return. Using a capital structure that
incorporates debt allows for the acquirer to use large amounts of debt
to leverage the seller’s assets and can also lead to some tax benefi ts. It
Other
Questions
pg. 330
allows private equity firms to buy companies that may be in distressed
situations for a fair price and to hopefully continue their operations in a
more efficient manner to increase the internal rate of return.
Leveraged
Buyouts
Other
Questions
284
Section 7: Leveraged Buyouts - Question 003
Leveraged
Buyouts
pg. 282
What factors influence how much
debt you can raise in an LBO?
Next Question:
What are the types of
debt in LBO?
Which types of debt
have a fixed interest...
What are three drivers
of IRR in an LBO?
The factors that influence how much debt you can raise for an LBO
Give me 5 ways you
can increase IRR.
include the asset base of the target company (quantity and how much
is liquid). Furthermore, you can analyze the interest rate environment,
as well as the sentiment of debt investors towards the company. If
Other
Questions
pg. 330
the target is tech with volatile cash flow, then likely to raise less debt
because investors will think it’s too risky. If anything, interest rate/
expense will be higher on debt financing.
Leveraged
Buyouts
Other
Questions
285
Section 7: Leveraged Buyouts - Question 004
Leveraged
Buyouts
pg. 282
What are the types of debt in an
LBO?
Next Question:
Which types of debt
have a fixed interest...
What are three drivers
of IRR in an LBO?
Give me 5 ways you
can increase IRR.
The three types of debt include bank debt (senior secured), senior term
Walk me through an
LBO model.
loans and lastly mezzanine debt.
Other
Questions
pg. 330
Leveraged
Buyouts
Other
Questions
286
Section 7: Leveraged Buyouts - Question 005
Leveraged
Buyouts
pg. 282
Which types of debt have a fixed
interest rate and which have a
floating interest rate?
Next Question:
What are three drivers
of IRR in an LBO?
Give me 5 ways you
can increase IRR.
Walk me through an
LBO model.
A loan can have a fi xed interest rate or floating interest rate. If the
What is the circular
reference in an...
loan has a fixed interest rate, the interest rate remains constant for the
duration of the loan. If the loan has a floating interest rate, also called a
variable interest rate, then the interest rate fluctuates over the duration
Other
Questions
pg. 330
of the loan.
Leveraged
Buyouts
Other
Questions
287
Section 7: Leveraged Buyouts - Question 006
Leveraged
Buyouts
pg. 282
What are three drivers of IRR in an
LBO?
Next Question:
Give me 5 ways you
can increase IRR.
Walk me through an
LBO model.
What is the circular
reference in an...
Why would an
acquirer use an LBO...
Some of the key drivers include:
•
Cumulative Cash flow available for financing
•
EBITDA growth
•
EBITDA exit multiple
•
Remaining Debt balance
Leveraged
Buyouts
Other
Questions
pg. 330
Other
Questions
288
Section 7: Leveraged Buyouts - Question 007
Leveraged
Buyouts
pg. 282
Give me 5 ways you can increase
IRR.
Next Question:
Walk me through an
LBO model.
What is the circular
reference in an...
Why would an
acquirer use an LBO...
Does a DCF or an LBO
model return a...
Five ways to increase IRR can include:
1.
Revenue growth
2.
EBITDA margin expansion
3.
Increasing % of debt in payment consideration = minimizes
Other
Questions
pg. 330
required equity injection
4.
Paying down debt throughout holding period = lesser remaining
debt balance, which gets subtracted from proceeds at end
5.
Multiple expansion = exit EBITDA multiple
Leveraged
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Other
Questions
289
Section 7: Leveraged Buyouts - Question 008
Leveraged
Buyouts
pg. 282
Walk me through an LBO model.
Next Question:
What is the circular
reference in an...
Why would an
acquirer use an LBO...
Does a DCF or an LBO
model return a...
When answering this question, there are six key steps to follow:
1. Make Transaction Assumptions
•
EBITDA Entry/Exit Multiple
•
Holding period
•
Financing structure (types of debt)
What is the due
diligence you need...
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2. Create Sources and Uses Tables
•
Calculate initial required equity (difference between sources of debt and
uses)
•
Sources: debt, equity and management rollover to be raised to purchase
the company and pay transaction and legal fees associated with the deal
•
Uses: the various channels in which raised capital is allocated to
complete the transaction
•
•
•
Purchase price of company, fees to investment banks, fees to legal
counsel)
Table is used to determine required sponsor equity contribution
Sponsor equity = total uses - debt raised - other sources like
management rollover
3. Project Cash Flows Available For Financing Throughout Holding Period
•
Cash fl ow from operations + cash fl ow from investing = cash fl ow
available for financing
•
Extended version: (Revenue - COGS - Operating Expenses - INTEREST
FROM DEBT) * (1 - Tax Rate) + D&A - Change in NWC - Capital
Expenditures
•
Subtract any debt to be paid off throughout the holding period (depends
on terms)
•
Cash available for financing can either be a) held, b) used to be down
debt, or c) reinvested into the business to create value
4. Build debt schedule, link the interest expense and the repayment / borrowing
to the 3 financial statements
5. Determine IRR
•
IRR = (Proceeds at End / Sponsor Equity) ^ (1 / Holding Period in Years) - 1
•
Proceeds at End = (Final Year Projected EBITDA * EBITDA Exit Multiple) Remaining Debt Balance + Remaining Cumulative Cash Flow Available for
Financing
6. Perform a Sensitivity Analysis
•
Finding IRR under multiple scenarios
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290
Section 7: Leveraged Buyouts - Question 009
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pg. 282
What is the circular reference in an
LBO model?
Next Question:
Why would an
acquirer use an LBO...
Does a DCF or an LBO
model return a...
What is the due
diligence you need...
A LBO/Cash Flow model will always be circular. The interest that you
How is the balance
sheet adjusted in...
pay affects the cash flow available to retire debt and that cash flow
available to retire debt, eventually affects the interest that you pay.
That linkage in excel cells is usually called the circular reference.
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Questions
291
Section 7: Leveraged Buyouts - Question 010
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pg. 282
Why would an acquirer use an LBO
model rather than a DCF?
Next Question:
Does a DCF or an LBO
model return a...
What is the due
diligence you need...
How is the balance
sheet adjusted in...
The fundamentals of an LBO analysis and a DCF analysis are the same
Do you need all three
statements to make...
as an LBO attempts to model cash flows from different parties and
then calculate a rate of return to each party while a DCF models cash
flows and calculates a rate of return based on risk. An LBO makes more
Other
Questions
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sense when the capital structure is changing which is expected to
happen under an acquisition.
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292
Section 7: Leveraged Buyouts - Question 011
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pg. 282
Does a DCF or an LBO model return
a higher value?
Next Question:
What is the due
diligence you need...
How is the balance
sheet adjusted in...
Do you need all three
statements to make...
A DCF gives a higher return. LBO valuation is typically considered
Pitch me an LBO.
“floor valuation” because PE firms almost ALWAYS pay less for
companies compared to strategic acquirers. LBO valuation means
setting a specific IRR first, then backsolving to find a required purchase
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price (Enterprise value). So, the return from the very beginning is
already limited and predetermined.
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293
Section 7: Leveraged Buyouts - Question 012
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What is the due diligence you need
to do in an LBO?
Next Question:
How is the balance
sheet adjusted in...
Do you need all three
statements to make...
Pitch me an LBO.
Before a buyer can even talk to a seller, the buyer must examine their
Other than IRR, how
else can you...
entire universe of deal opportunities and decide which they want
to invest in the future; this process is called sourcing. The buyer is
examining the landscape of companies and examining if they have
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the core traits they want in the business and weighing the investment
risk and benefi ts as well. The second step includes screening. The
goal of screening is to reach a short-list of high-value opportunities
and ultimately agree on a single target price to pursue that deal close.
Once the buyer chooses a company, the firm will sign a Non-Disclosure
Agreement (NDA) with the company of their choice to access more
confidential data. A signed NDA signals many rounds of due diligence
lasting anywhere from a few weeks to a few months, and will review
the seller’s confidential information memorandum (“CIM”). The due
diligence process for an LBO deal typically involves questioning and
confirming all key aspects of the business, especially the growth
trajectory of the business and industry. PE firms will often hire 3rd
parties to help out with different aspects of due diligence.
Some of the most important due diligence is done on the industry, and
this can include competitor analysis, pricing analysis, volume analysis,
and speaking with industry experts. Due diligence will also be done
on the company’s financials, accounting statements, EBITDA and
earnings, customers, products, strategy, distribution chain, etc.
There are many other common due diligence items that are more
“check-the-box” and perfunctory in nature, which are often 100%
outsourced to third parties. These include: IT, lender due diligence,
facility due diligence, site visit, environmental due diligence, market
sizing, compensation of management, ownership, legal, tax and
insurance.
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Section 7: Leveraged Buyouts - Question 013
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How is the balance sheet adjusted
in an LBO?
Next Question:
Do you need all three
statements to make...
Pitch me an LBO.
Other than IRR, how
else can you...
First, we can account for the acquisition. We should debit any existing
What are the key
differences between...
shareholder’s equity out of the target’s balance sheet. Then we should
credit shareholder’s equity by the new acquisition amount, and we
should also credit any new debt that was raised for this acquisition.
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Finally, we should debit or credit any difference to goodwill. Goodwill
represents the amount we pay for the company that is in excess of its
book value.
Secondly, we can make other adjustments to cash. If the target
company has a cash balance, we should credit the cash balance to
make it zero, and debit goodwill by the same amount.
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295
Section 7: Leveraged Buyouts - Question 014
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Do you need all three statements
to make an LBO model?
Next Question:
Pitch me an LBO.
Other than IRR, how
else can you...
What are the key
differences between...
No, you do not need all 3 statements to make an LBO model. You only
What kind of
covenant does an...
have to calculate cash flow available for financing activities, which
shows you the cash surplus with which you can pay back debt. If it’s
a cash deficit, then you will have to borrow more from the revolver to
Other
Questions
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calculate that debt.
Cash flow available for financing activities can be calculated as cash
flow from operations + cash flow from investing.
Alternatively, this is usually equivalent to net income + D&A - increase
in net working capital - capex. You may also have to add back other
non-cash items like PIK interest, and subtract any cash flows used for
add-on acquisitions.
Effectively, we really need just the income statement and a few other
line items.
The reason we usually use all 3 statements is because the balance
sheet acts as an useful check to show if your model is right or wrong.
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Section 7: Leveraged Buyouts - Question 015
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Pitch me an LBO.
Next Question:
Other than IRR, how
else can you...
What are the key
differences between...
What kind of
covenant does an...
An LBO pitch is very similar to a stock pitch, in which it entails talking
Which industries are
attractive for LBOs?
about your thought process and what you believe makes a good
company. You can speak about stable cash flows, being a market
leader, high-quality revenue and other characteristics that will make
Other
Questions
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it a valuable holding for the future. Present these points and also touch
on the debt structure you would use and why. It may also be valuable to
speak about any risks you see and how you plan to mitigate for them.
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297
Section 7: Leveraged Buyouts - Question 016
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Other than IRR, how else can you
measure the return in an LBO?
Next Question:
What are the key
differences between...
What kind of
covenant does an...
Which industries are
attractive for LBOs?
Two other measurements include MoM (Money on Money Multiple) and
Why does an LBO
produce a tax shield?
MOIC (Multiple on Invested Capital).
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Questions
298
Section 7: Leveraged Buyouts - Question 017
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What are the key differences
between high-yield and bank
debt?
Next Question:
What kind of
covenant does an...
Which industries are
attractive for LBOs?
Why does an LBO
produce a tax shield?
Higher-yield debt refers to below investment grade (BB+ and below),
Would you rather
finance an acquisition...
corporate bonds pay a higher yield than investment grade or bank
debt due to being higher risk. Leverage loans have a limited interest
rate feature because they have a floating rate feature. Bank debt is also
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Questions
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usually secured by highly liquid assets.
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Questions
299
Section 7: Leveraged Buyouts - Question 018
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pg. 282
What kind of covenant does an LBO have?
Next Question:
Which industries are
attractive for LBOs?
Why does an LBO
produce a tax shield?
Would you rather
finance an acquisition...
A covenant is a term used on loan documents like an LBO or any other
What are other ways
you can drive...
kind of bond issuance and it dictates ant terms in a corporate takeover
or acquisition or bond repayment. The covenant is just any specified
agreement usually on a Debt/EBITDA ratio. This is crucial as when
Other
Questions
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calculating the amount of debt available to be borrowed to finance a
transaction, covenants will determine the amount of money that can
be borrowed or issued. Breaking a covenant is often referred to as a
default.
Other common covenants include:
•
Debt/EBITDA
•
Debt to Assets
•
Debt to Equity
•
EBIT/Interest
•
Loan to Value
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300
Section 7: Leveraged Buyouts - Question 019
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pg. 282
Which industries are attractive for LBOs?
Next Question:
Why does an LBO
produce a tax shield?
Would you rather
finance an acquisition...
What are other ways
you can drive...
Usually, industries with stable cash flows and a tangible asset
What is a dividend
recapitalization...
base are good for LBOs. For example, consumers, B2B services, and
industrials are common industries for PE. Software companies with
recurring revenue who serve businesses could also be attractive;
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despite lacking a tangible asset base, they often have very sticky
customers.
Private equity firms may also specialize in industries such as
infrastructure and natural resources. Natural resources is not a natural
fi t for LBOs, but can still be attractive to smart investors who rely on
their expertise and connections and less so on debt availability.
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301
Section 7: Leveraged Buyouts - Question 020
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pg. 282
Why does an LBO produce a tax shield?
Next Question:
Would you rather
finance an acquisition...
What are other ways
you can drive...
What is a dividend
recapitalization...
This is because interest expense is tax deductible. Any new debt raised
What is IRR?
to buy the company will result in more interest expense, which will
reduce tax expense.
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302
Section 7: Leveraged Buyouts - Question 021
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Would you rather finance an acquisition of
70% debt and 30% equity, or 90% debt and
10% equity?
Next Question:
What are other ways
you can drive...
What is a dividend
recapitalization...
What is IRR?
Generally speaking, you would rather finance an acquisition of 70%
What is Multiple of
Capital?
debt and 30% equity. 90% debt and 10% equity could potentially
increase your returns since you would not need as much initial equity.
Other
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However, it would also drastically increase interest expense and
increase the chance that the company cannot meet these interest
payments, therefore increasing the chances of bankruptcy. Equity
holders usually receive very little or nothing at all in a bankruptcy.
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303
Section 7: Leveraged Buyouts - Question 022
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pg. 282
What are other ways you can drive return
before selling the company?
Next Question:
What is a dividend
recapitalization...
What is IRR?
What is Multiple of
Capital?
You can do a dividend recapitalization to drive additional return before
What IRR do financial
sponsors aim for?
the sale of the company.
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Questions
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304
Section 7: Leveraged Buyouts - Question 023
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pg. 282
What is a dividend recapitalization and why
do PE firms use them?
Next Question:
What is IRR?
What is Multiple of
Capital?
What IRR do financial
sponsors aim for?
A dividend recapitalization is when a company borrows money to
What Multiple of
Capital range do...
pay their investors a special dividend. This often happens when
the company has paid down lots of debt from the original LBO, and
investors want to enhance their return. By borrowing money and then
Other
Questions
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paying investors a dividend, the liabilities in the balance sheet will go
up and shareholder’s equity will go down.
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305
Section 7: Leveraged Buyouts - Question 024
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pg. 282
What is IRR?
Next Question:
What is Multiple of
Capital?
What IRR do financial
sponsors aim for?
What Multiple of
Capital range do...
IRR stands for internal rate of return, and PE firms use this metric to
Explain how a
revolving credit...
judge the return of an investment.
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IRR can be calculated using the CAGR (compounded annual growth
rate) formula, which is equal to (ending equity at time of sale / initial
equity invested) ^ (1 / number of years) - 1. However, we can only use
this formula if there are no cash flows in between the initial investment
and the sale of the company. For example, dividend recapitalizations or
additional calls for equity investment would make this formula invalid.
IRR can also be defined as the discount rate that makes the NPV (net
present value) of the firm equal to zero.
In industry, IRR is usually calculated with an Excel formula which
starts with =IRR(*select series of annual cash flows*).
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306
Section 7: Leveraged Buyouts - Question 025
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What is Multiple of Capital?
Next Question:
What IRR do financial
sponsors aim for?
What Multiple of
Capital range do...
Explain how a
revolving credit...
Multiple of capital is calculated by dividing the ending equity with the
What’s the difference
between a positive...
initial equity invested. It shows you how many times the equity in the
investment has grown. For example, if a company delivers 2x return, that
means the ending equity received after the sale was twice the equity
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Questions
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initially invested.
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307
Section 7: Leveraged Buyouts - Question 026
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pg. 282
What IRR do financial sponsors aim for?
Next Question:
What Multiple of
Capital range do...
Explain how a
revolving credit...
What’s the difference
between a positive...
Financial sponsors aim for 20% or higher typically speaking.
What’s the difference
between a...
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308
Section 7: Leveraged Buyouts - Question 027
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pg. 282
What Multiple of Capital range do financial
sponsors aim for?
Next Question:
Explain how a
revolving credit...
What’s the difference
between a positive...
What’s the difference
between a...
Financial sponsors aim for 1.5x multiple of capital or higher typically
Why do you need to
complete a pro forma...
speaking.
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309
Section 7: Leveraged Buyouts - Question 028
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Explain how a revolving credit facility
works?
Next Question:
What’s the difference
between a positive...
What’s the difference
between a...
Why do you need to
complete a pro forma...
A revolving credit facility is like a credit card or line of credit. It can
How does an asset
write-up or...
be drawn anytime as long as the maximum limit is not reached. It’s
commonly used to cover cash shortfalls, net working capital needs, and
acquisitions.
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For example, if the maximum limit is $100M and if the company is short
of cash by $50M one year, they can draw $50M from the revolver. Going
forward, they can either pay the interest expense regularly, or eventually
pay back the revolver balance to reduce their interest expense.
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310
Section 7: Leveraged Buyouts - Question 029
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What’s the difference between a positive
and negative covenant?
Next Question:
What’s the difference
between a...
Why do you need to
complete a pro forma...
How does an asset
write-up or...
A positive covenant is when the company agrees to do something for
How do we calculate
IRR for debt...
the duration of the loan. This can range from maintaining adequate
insurance plans to plant and equipment repairs and upgrades. If they do
not do what they agreed to during the duration of the loan, the company
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Questions
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will be in default.
A negative covenant prevents the company from doing certain things,
such as acquisitions or raising new debt.
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Questions
311
Section 7: Leveraged Buyouts - Question 030
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What’s the difference between a
maintenance and incurrence covenant?
Next Question:
Why do you need to
complete a pro forma...
How does an asset
write-up or...
How do we calculate
IRR for debt...
Maintenance covenants requires the borrower to maintain a certain ratio
Why would a sponsor
use debt in an LBO...
or metric at all times. This is required by the lenders because they want
to make sure the company is in good shape to pay interest and pay back
the principal.
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Common maintenance covenants include:
•
Senior Debt Leverage Ratio: Senior debt to EBITDA
•
Leverage Ratio: Total debt to EBITDA
•
Fixed Charge Coverage Ratio: (EBITDA – Capex) / (Interest Expense
+ Mandatory Amortization of Debt)
Incurrence covenants are usually related to debt, expansion, or
acquisitions, since any of these actions could materially affect a
company’s ability to meet interest payments. For example, lenders may
dictate that the company is to take no new debt unless the borrower’s
debt to EBITDA ratio is less than 5.0x.
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312
Section 7: Leveraged Buyouts - Question 031
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pg. 282
Why do you need to complete a pro forma
income statement to get IRR?
Next Question:
How does an asset
write-up or...
How do we calculate
IRR for debt...
Why would a sponsor
use debt in an LBO...
We need to project the income statement in order ot arrive at a
How can a PE firm
incentivize...
projected net income for the holding period of the company.
In additon to net income, we must also add back depreciation
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& amortization, deduct capex and deduct any increase in net
working capital to arrive at cash flows available for financing.
This determines whether we have a cosh surplus, which we can
use to pay back debt, or a cash deficit, which we can finance by
borrowing from the revolver.
We can also add cash flows from operation and cash flows from
investing to arrive at cash flows available for financing.
At the very minimum, we have to project the income statement
along with a few other items in order to determine how much the
company’s EBITDA grows and how much debt we can pay down,
which will ultimately drive the IRR of an LBO.
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313
Section 7: Leveraged Buyouts - Question 032
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pg. 282
How does an asset write-up or writedown
affect an LBO model?
Next Question:
How do we calculate
IRR for debt...
Why would a sponsor
use debt in an LBO...
How can a PE firm
incentivize...
Asset write-up = higher depreciation = lower taxes = pay less tax on
For what kinds of debt
do sponsors...
financial books
However, government will use a different to depreciate, owe tax to the
Other
Questions
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government
Deferred tax liability gets created on financial books
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Questions
314
Section 7: Leveraged Buyouts - Question 033
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How do we calculate IRR for debt investors
in an LBO?
Next Question:
Why would a sponsor
use debt in an LBO...
How can a PE firm
incentivize...
For what kinds of debt
do sponsors...
Calculating IRR for debt investors in an LBO is akin to finding the yield
Why would a financial
sponsor use PIK...
they are earning. This can be done using the =IRR formula in Excel or
using a financial calculator.
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For example, we can look at a $100M mezzanine debt with a term of 5
years In Year 0, debt investors would have a negative cash flow equal
to the amount they are lending. In Years 1-5, debt investors would be
receiving interest payments, so we can include those as cash inflows.
In Year 5, when the company is sold, the principal will be repaid, so
there will be another inflow equal to the amount of the principal. Finally,
we can use the =IRR(*select series of annual cash flows*) formula to
calculate the IRR.
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315
Section 7: Leveraged Buyouts - Question 034
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pg. 282
Why would a sponsor use debt in an LBO
even though it has enough cash on hand to
buy 100% of the company?
Next Question:
How can a PE firm
incentivize...
For what kinds of debt
do sponsors...
Why would a financial
sponsor use PIK...
A financial sponsor would use debt in an LBO because it reduces the
How do you calculate
the amount you...
initial equity invested, which gives them a higher return.
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316
Section 7: Leveraged Buyouts - Question 035
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How can a PE firm incentivize management
to stay and perform?
Next Question:
For what kinds of debt
do sponsors...
Why would a financial
sponsor use PIK...
How do you calculate
the amount you...
A PE firm can incentivize management to stay by getting management
How do you calculate
the cash flows...
to put up some equity for the acquisition, such that management owns
5-10% of the company.
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Another common method to incentivize management is with options.
Options give management a percentage of the upside. For example, if
management is given 7.5% of the upside and the value of the company
increases, then management will get 7.5% of that value increase when
the company is sold.
Finally, earn-outs can be used as well. An earnout is a payment to
management for achieving a certain goal. For example, an earnout could
stipulate that management needs to achieve 10% growth in gross profi t
in the next year in order to receive an earnout payment. This is important
because it incentives management to grow the business, it aligns
interests, and it also motivates management to stay with the company.
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317
Section 7: Leveraged Buyouts - Question 036
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For what kinds of debt do sponsors use PIK
interest?
Next Question:
Why would a financial
sponsor use PIK...
How do you calculate
the amount you...
How do you calculate
the cash flows...
PIK stands for payment-in-kind. PIK interest is a non-cash interest
What are the key
factors you have to...
expense. Instead of deducting cash, we simply increase the debt by
the amount of the interest expense. It’s like a credit card balance which
accumulates interest rather than being paid.
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Typically, we see PIK interest used only in mezzanine debt and
subordinated notes. This is because there are more junior types of debt;
“junior” refers to a lower claim on assets compared to “senior” debt.
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318
Section 7: Leveraged Buyouts - Question 037
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Why would a financial sponsor use PIK
interest?
Next Question:
How do you calculate
the amount you...
How do you calculate
the cash flows...
What are the key
factors you have to...
Although junior debt has a lower claim on assets, it also has a higher
When do PE firms use
investment banks?
interest rate. However, this higher interest expense means there is
more stress on cash flows, and the portfolio company may not have
enough cash to execute market expansions, do add-on acquisitions,
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Questions
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or meet working capital needs. As a result, the portfolio company may
prefer PIK interest, since PIK interest does not need to be paid in cash,
but is simply accumulated on top of the debt balance.
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319
Section 7: Leveraged Buyouts - Question 038
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How do you calculate the amount you need
to borrow on your revolver per year?
Next Question:
How do you calculate
the cash flows...
What are the key
factors you have to...
When do PE firms use
investment banks?
This is usually based on a Debt / LTM EBITDA multiple. The amount can
Why do PE firms use
an LBO model instead...
vary, but typically total debt cannot exceed 6 or 7x LTM EBITDA.
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Banks will use past precedents in similar industries to find the
appropriate multiple. If they don’t have any, they can look at comparable
public companies and see what their median debt multiple is, and apply
that to the target company.
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Section 7: Leveraged Buyouts - Question 039
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pg. 282
How do you calculate the cash flows
available for debt repayments?
Next Question:
What are the key
factors you have to...
When do PE firms use
investment banks?
Why do PE firms use
an LBO model instead...
In order to calculate the cash flows available for debt repayments, we
What are some key
debt metrics...
will need to find cash flow available for financing less any mandatory
amortization. Cash flow available for financing = cash flow from
operations + cash flow from investing. After subtracting mandatory
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amortization / repayments on debt, we arrive at the cash flow that can
be used for debt repayments.
Leveraged
Buyouts
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Questions
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Section 7: Leveraged Buyouts - Question 040
Leveraged
Buyouts
pg. 282
What are the key factors you have to
consider when deciding your exit strategy?
Next Question:
When do PE firms use
investment banks?
Why do PE firms use
an LBO model instead...
What are some key
debt metrics...
We need to consider what type of exit strategy, the type of buyers, and
What is the simplest
LBO model you...
the sector outlook.
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Type of exit strategy: we could do an IPO, sell to a strategic acquiror, or
sell to a private equity company (aka financial sponsor).
Type of buyers: Will the buyers be strategic, financial sponsors, or both?
Which sectors are they in?
Sector outlook: What size is the end market? How large will the market
be by the time we sell the company? What are the industry growth rates,
and which key trends are happening which could affect the company’s
positioning?
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Section 7: Leveraged Buyouts - Question 041
Leveraged
Buyouts
pg. 282
When do PE firms use investment banks?
Next Question:
Why do PE firms use
an LBO model instead...
What is the simplest LBO model you...
What are some key
debt metrics...
What is the simplest
LBO model you...
PE firms usually use investment banks when they sell one of their
What are some error
checks you could do...
portfolio companies. This is because selling a company requires an
extensive network of buyers which investment banks have access to.
Additionally, there are also a lot of processes which investment banks
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have nearly automated, and they are able to do the behind-the-scenes
work much more efficiently than a private equity firm. Additionally,
investment banks have access to large analyst teams from different
groups, while private equity firms are usually too lean to run a sales
process.
Sometimes PE firms may also hire an investment bank for larger
acquisitions, but this is not always necessary because PE firms will
have many ex-bankers on their team who have deal experience and can
handle an acquisition process.
Leveraged
Buyouts
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Questions
323
Section 7: Leveraged Buyouts - Question 042
Leveraged
Buyouts
pg. 282
Why do PE firms use an LBO model instead
of a DCF model?
Next Question:
What are some key
debt metrics...
What is the simplest
LBO model you...
What are some error
checks you could do...
PE firms need to forecast their cash flows available for financing, which
Paper LBO: Revenue
grows 8%...
shows how much debt they need to borrow or repay. This way, they can
build a debt schedule and figure out how much debt they need to pay
back, which allows them to find their ending equity at the time of sale,
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and ultimately their IRR.
Only an LBO has that functionality to calculate IRR. A DCF will not
have a debt schedule, has less detailed cash flow calculations, and only
gives you the intrinsic value of the company (eg for valuing stocks) but
not the value in a leveraged buyout.
Leveraged
Buyouts
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Section 7: Leveraged Buyouts - Question 043
Leveraged
Buyouts
pg. 282
What are some key debt metrics, and why
are they important?
Next Question:
What is the simplest
LBO model you...
What are some error
checks you could do...
Paper LBO: Revenue
grows 8%...
The leverage multiple, debt / EBITDA, is a common metric comparing
If you buy a company
at 10x EV...
debt and EBITDA. EBITDA is a proxy for cashflow that can be used to
pay back the debt. It also remains neutral in terms of capital structure,
tax jurisdiction, and accounting policies.
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The interest coverage ratio is another key debt metric, and is calculated
as EBITDA / Interest Expense. Since EBITDA is a good proxy for
cashflow, this shows how many times we can pay interest. For example,
if EBITDA is two times interest expense, that means we have a bit of
cushion even if the interest rate rises, or the EBITDA declines. Lenders
are focused on this metric to see how much “cushion” the borrower
has.
A more precise version of the interest coverage ratio is: (EBITDA Capex) / (Interest Expense + Mandatory Repayments of Debt).
Leveraged
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Section 7: Leveraged Buyouts - Question 044
Leveraged
Buyouts
pg. 282
What is the simplest LBO model you could
make?
Next Question:
What are some error
checks you could do...
Paper LBO: Revenue
grows 8%...
If you buy a company
at 10x EV...
A simplified LBO model would not include a balance sheet or a full cash
flow statement, although we still need the income statement. We would
calculate levered free cash flow (LFCF) using the following formula:
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LFCF = Net Income + D&A - capex - increase in net working capital +
borrowings - mandatory debt repayments
This cash flow would then determine whether we need to borrow more
debt or pay back debt, and IRR can be calculated in the usual way by
arriving at EV by applying the exit multiple to the final year EBITDA, then
subtracting net debt and calculating IRR based on ending equity and
beginning equity invested.
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Section 7: Leveraged Buyouts - Question 045
Leveraged
Buyouts
pg. 282
What are some error checks you could do to
make sure your LBO model is correct?
Next Question:
Paper LBO: Revenue
grows 8%...
If you buy a company
at 10x EV...
You can make sure your balance sheet balances. You can also try to build
a bridge from EBITDA. You can also look at the cash flow statement as
well to make sure debt repayments / borrowings are linked properly to
the debt schedule. If you are doing cash flow sweep, which is when all
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cash flow is used to pay back debt, and you have positive cash flow, then
you should usually have change in cash of zero in most years until the
debt is paid down since all the cash will be used to pay back debt.
The most important check of all is to view it from the perspective of
the user. Pretend that you are the client or investor and look for the most
important high level metrics such as revenue growth, EBITDA margin,
etc. If anything looks strange or stands out, investigate it and get to the
root of the issue.
Leveraged
Buyouts
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Section 7: Leveraged Buyouts - Question 046
Leveraged
Buyouts
pg. 282
Paper LBO: Revenue grows 8% every year and EBITDA
margins are constant. Company is bought at 10x, sold at
10x. There’s a 10% interest rate and a 40% tax rate. D&A
is flat throughout at $15/year, and capex is equal to D&A.
There are no transaction fees or changes in net working
capital.
Next Question:
If you buy a company
at 10x EV...
Assume no debt is paid off until the end, cash is
accumulated until the final debt repayment at year 5
when the company is sold. Revenue in year 0 is $100, and
COGS is $50 while SG&A is $20. What’s the IRR?
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The IRR is 17%.
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Buyouts
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Section 7: Leveraged Buyouts - Question 047
Leveraged
Buyouts
pg. 282
If you buy a company at 10x EV / EBITDA and
sell it at 10x EV / EBITDA 5 years later, what is
the IRR if the EBITDA has doubled? Assume
no debt has been paid down.
Next Question:
The IRR is 15%.
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Buyouts
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Section 7: Leveraged Buyouts - Question 048
Leveraged
Buyouts
pg. 282
What’s the purpose of creating a
3-statement model for an LBO?
Next Question:
Pitch me an LBO.
Other than IRR, how
else can you...
What are the key
differences between...
Creating a 3-statement model significantly enhances the accuracy of
What kind of
covenant does an...
the model. It is very easy to make mistakes on calculating cash flow,
which then directly effects the amount of debt you have, which then
effects the interest expense. Therefore, mistakes in an LBO model tend
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to flow through in a circular fashion and can actually move the needle
quite a bit.
If the balance sheet balances, that is a very useful proof that the model
is working.
Further more, investors may wish to see the effect on the balance sheet
and how certain assets are moving. For example, it is useful to see
the changes in net working capital line items like accounts receivable,
inventory, prepaid expenses, accounts payable, etc.
It is also useful to see how long-term assets are changing over time,
such as PP&E, in order to get a sense of the value of the company’s
collateral in case the company defaults on its interest payments.
The company may also be doing add-on acquisitions, and it’s useful to
see how the value of these acquisitions are being allocated between
PP&E and goodwill.
Leveraged
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Section Eight
Other
Topics Covered
331
Section 8: Other Questions - Question 001
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How big is XYZ market? (e.g.
auto market in Toronto)
Next Question:
How many black cars
are there in Toronto?
How many eggs does
your school sell?
If you were shrunk to
the size of a pencil...
These questions are usually for consulting interviews but may be
thrown into a finance interview to test logic and high-level thinking.
The key to this question is to be articulate and to walk them through your
steps clearly. If the question is for example, how many vans there are in
Toronto, the following steps can possible be used to walk them through
the thought process:
The first step is to structure your approach. You can take any market
sizing task and break it down into key components. The first part can be
to get a rough estimate of the population in the Greater Toronto Area to
be in the ballpark of around
5 000 000 people. Vans are usually for families with children.
We can estimate that maybe 80% of the GTA population comes from
families.
When making your assumptions, try your best to be reasonable with
your assumptions and not to use any numbers that may throw off the
interviewers. Based off that, that leaves around 4 000 000 people left.
Families are on average the size of 4 people. That leaves us off with
about with about 1 000 000 families *in total. We can estimate that
about 75% of these families own a vehicle. That leaves us with about
750 000 families. We can estimate that of these families that own a car,
only 30% of them own vans as they are expensive and there are many
other options that families can purchase. That leaves us with about 225
000 vans in the Greater Toronto Area.
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Section 8: Other Questions - Question 002
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How many black cars are there
in Toronto?
Next Question:
How many eggs does
your school sell?
If you were shrunk to
the size of a pencil...
This is a brain teaser/logic question. The ideal way to answer this
question is to look out the window and see how many black cars you
see in comparison or as a percentage of total cars that you observe.
If you for example see 10 cars and 1 one of them was black, based off
this random sample, you can conclude that around 10% of cars in the city
are black. You can do a reasonable assumption that equates to 125 000
000 households. Based off that assumption, around 75% of households
own a car, so that would to about 812 500 vehicles in the Greater
Toronto Area.
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Section 8: Other Questions - Question 003
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How many eggs does your
school cafeteria sell in the
morning?
Next Question:
If you were shrunk to
the size of a pencil...
This is another example of a market sizing question.
As mentioned, make sure to be clear with your approach, reasonable
with your assumptions and to be diligent and clear in your response.
Let’s choose Queen’s University as the test case subject. Queen’s
University has around 5,000 undergraduate students. We can assume
that only about first-years would routinely go to the cafeteria to buy
breakfast. That leaves us with around 1 250 students. It is safe to
assume that only about 75% of students will grab breakfast that
morning leaving us with about 940 students. It is also safe to assume
that 10% of entrants may be guests, older students or parents or staff.
Which leaves us at a total count at about 950 people. If about 75% gets
eggs at about 2 eggs worth of meals per person, that leaves us at about
1460 eggs served each morning.
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Section 8: Other Questions - Question 004
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If you were shrunk to the size of
a pencil and put in a blender,
how would you get out?
Next Question:
This is a brain teaser as well as a chance for employers to see if you
have a sense of humour and creativity. A possible answer can be to just
wait until someone pours food and liquids in and you can just use that
volume to swim to the top of the blender and get out.
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Section 8: Private Equity
- Question 001
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Walk me through your resume / tell me
about yourself (1-3 min) - Part 1 of 2
Next Question:
You want to tell a story about how you became interested in investing
and learning how to improve businesses. Always start from the
beginning: where you came from or grew up, where you went to school,
and how the first “spark” led to your interest in financing, whether it be
from trading your own portfolio, joining an investment club, or taking a
finance class.
If you’re interviewing for a post-IB associate role, you want to really focus
on the deal experience you’ve had. In particular, you should walk through
a few key steps of the process and provide the context of the deal and
industry.
If there was any interesting “drama” between the buyers / sellers /
owners, you’ll want to highlight that and how it affected the negotiation
of the deal. This will demonstrate that you truly understood the
background of the deal and you didn’t just blindly punch in numbers.
Since you don’t have enough time to dive too deep into your deal
experience, you should just summarize your role in the deal: make sure to
mention if you ran the LBO model, any industry research / due diligence
you did, and how this ultimately affected the valuation and closing of the
deal.
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Section 9: Private Equity
- Question 001
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Walk me through your resume / tell me
about yourself (1-3 min) - Part 2 of 2
Next Question:
If you’re interviewing for an entry level PE role without IB experience, you
want to really focus on how your work experience and extracurriculars
gave you the intellectual curiosity to understand business fundamentals
and think of creative ways to improve them, as well as how your
experience tangentially led to your passion for investing.
Finally - and this may seem odd - but it’s good to mention some hobbies
and interests of yours. This is because they are looking for good and
interesting personalities much more than IB, as teams tend to be smaller
and closer-knit.
The “story” is more important in PE interviews than in IB, because PE
firms aren’t just looking for smart and polished presenters. They’re
looking for truly passionate investors who are intellectually curious about
the fundamentals of the business. Many PE firms believe this is often
something you either have or don’t, so you need to catch their interest.
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Section 9: Private Equity
- Question 002
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Walk me through a deal you’ve worked on.
(1-2 min) - Part 1 of 2
Next Question:
First, you should provide the context of the deal and industry. Many folks
forget to do this. Explain the target business in an easy-to-understand
way, and also provide a quick overview of the acquiror and its strategic
rationale. It’s important to explain upfront why the deal is happening and
what the industry backdrop is. For example, is this part of a larger trend
of industry consolidation? Is this part of an existing roll up strategy by
the acquiror to dominate a market niche, or are they looking to acquire
expertise so they have a beachhead for further expansion into a new
market?
If there was any interesting “drama” between the buyers / sellers /
owners, you’ll want to highlight that and how it affected the negotiation
of the deal. This will demonstrate that you truly understood the
background of the deal and you didn’t just blindly punch in numbers.
After fully explaining the context of the deal and the industry backdrop,
you should explain your role in the deal step-by-step with adequate
technical detail. For example, if you created the model, you should go
over how the revenue model works and what drove the key assumptions
in revenue growth. You should also go over the capital structure
assumptions, such as how much debt was used, and if necessary,
highlight one or two other key assumptions that are critical to valuation,
such as COGS, SG&A, and capex.
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Section 9: Private Equity
- Question 002
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Walk me through a deal you’ve worked on.
(1-2 min)- Part 2 of 2
Next Question:
It’s also important to go over the industry research and due diligence you
performed. For example, if the acquiror is looking to expand the target
into new industries and sectors, what research did you do on these
potential growth opportunities? Did you value the market and analyze
competitors and even hire a consultant? What were the most critical
items to due diligence which would affect whether the deal went through
or not?
It’s important to provide a step-by-step quantitative and qualitative
breakdown so that the interviewer can realize that you actually
did significant work on the deal. This will also prove that you are
knowledgeable about the context and broader implications, and didn’t
simply have your head in the weeds. Otherwise, the interviewer may
be led to believe that you didn’t do the heavy lifting in the deal and only
participated in a more cursory manner.
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Section 9: Private Equity
- Question 003
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Why private equity? (1 min)
Next Question:
There are essentially two or three ways you can answer this question.
You can tell a story about how you became interested in private equity,
or you can list a number of reasons you’re interested in private equity,
and back them up with examples from work or even school. You can also
combine these two methods into one answer.
For example, if you want to tell a story, you can talk about how your
interest in finance was sparked by a passion for investing, perhaps
developed while taking finance courses or working with an investment
club. You can also speak to your investment banking work experience
and / or deal experience - or any other related experience - and elaborate
on how that generated an interest in understanding the strategic
rationale behind each deal and if it made sense from both the buyer’s
and seller’s perspective.
If you have any experience with strategy, such as consulting, you can
speak to how you really enjoyed finding the best strategy for different
firms, and how you became more interested in analyzing and viewing
growth from the owner’s perspective.
All this segueways nicely into your current interest in private equity.
Alternatively, or in addition to this, you can list a few concrete reasons
you’re interested in private equity, such as being passionate about
investing or company growth/strategy, and a desire to take a longer term
perspective by following portfolio companies closely rather than moving
onto the next deal like in investment banking.
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Section 9: Private Equity
- Question 004
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What are the 3 most common ways to
increase IRR in an LBO? (1 min)
Next Question:
The 3 most common ways to increase IRR are: growing EBITDA, paying
off debt, and increasing the exit multiple.
Growing EBITDA is the most common way to increase IRR. Most PE
firms plan to grow EBITDA either by increasing revenues, cutting costs,
or some combination of the two. Even if they sell the company at an exit
multiple that is equal to the entry multiple, the multiple will be applied to
a higher EBITDA, so the investment will have grown in value.
Paying off debt is the second most common way to increase IRR. PE
firms usually take a significant amount of leverage, anywhere between
4-6x Debt / LTM EBITDA. However, PE firms will usually pay off some
of this debt with the company’s cash flows. By paying off debt, they are
increasing their equity ownership of the company, similar to how paying
off a mortgage will result in greater equity ownership of a house. Even if
the company does not grow in value, the PE firm’s equity ownership will,
and so paying off debt increases IRR.
Increasing the exit multiple is the third most common way to increase
IRR. A PE firm can improve the attractiveness of a business by fixing
some of its internal issues, such as augmenting the management team,
changing a bloated cost structure, improving high employee turnover,
enhancing brand / reputation, or even resolving union / labour conflicts.
A PE firm can also improve the attractiveness of a business by improving
its future outlook by entering attractive markets, exiting unattractive
markets, cross-selling existing products, creating a larger platform
through add-on acquisitions, etc. These factors will cause outside buyers
to value the company more and pay a higher multiple for the company
than the original PE firm paid.
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Section 9: Private Equity
- Question 005
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Why this firm? (1 min) - Part 1 of 2
Next Question:
You want to combine your answer with more objective reasons about the
company as well as some subjective reasons about the team and people.
For example, in terms of objective answers, you could mention your
preference for their investment style and parameters (eg. buying growth
companies vs. large established companies, doing deals with partners
vs. by themselves, amount of leverage used) and sector focus, as well as
how involved they are with their portfolio companies and their growth
strategies. It’s a good idea to research some deals they’ve done to get a
sense of their typical transaction.
For example, for a PE firm that focuses on buying growth-oriented
companies, you could mention how you enjoy the idea of finding growth
companies in attractive niches and being more involved with their
growth strategy, as smaller companies can benefi t from the expertise
and economies of scale that PE firms have to offer. For a PE firm that
does a lot of add-on acquisitions and tries to roll up the industry, you can
mention how getting involved with portfolio companies and helping drive
their corporate development strategy is very satisfying, as is the ability
to buy add-on acquisitions at lower valuation multiples and roll them
up to a higher valuation multiple once it’s integrated with the rest of the
platform.
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Section 9: Private Equity
- Question 005
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Why this firm? (1 min) - Part 2 of 2
Next Question:
For a PE firm that focuses on larger companies, you can mention how
you like working with more sophisticated management teams and more
complex companies which are often involved in multiple markets. These
deals often completely change the landscape of the industry they’re
operating in. Because of the higher stakes, the analysis and due diligence
is often more comprehensive and done by more parties, and the debt
financing and financial modeling can be more complex as well. There
is the opportunity to learn best practices both from the very smart and
talented professionals on the team, but also from the portfolio companies
which are usually very professionally run.
Finally, you should mention any subjective reasons about the team, and
it helps tremendously if you’ve had a chance to talk to somebody in the
team. This gives you a chance to ask what they personally like about the
firm, the group, and the people. For example, perhaps the firm is very
dedicated to investing in the long term growth of junior professionals,
and there are lots of cases of folks progressing throughout the firm and
staying with the firm. Other positive reasons could be a tight-knit and
collegial environment, a strong focus on ethics and sustainable investing,
and leadership within the team that has demonstrated itself through a
combination of successful deals and dedicated mentoring.
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Section 9: Private Equity
- Question 006
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Do you invest in stocks? What are some
stocks you own? (1 min)
Next Question:
This question is a bit of a trap as they are seeing if you are actually a
passionate investor, or if you are just faking it. One easy way for the
interviewer to tell is to simply ask the interviewee if they actually buy
stocks or not.
Presumably, if you are interviewing for a PE firm and are passionate
about investing, you do invest in stocks. However, there are some valid
reasons why you might not, and it’s worth explaining if you say you don’t
invest in stocks. If you work at an investment bank, there are often quite
a number of restrictions on which stocks you can buy, and how long you
must hold them before you sell, so your preference might be to buy index
funds rather than hold individual stocks. Maybe you have had to focus
your cash flow on repaying student debt if you did not have the privilege
of a free ride in university, or perhaps you have been investing in real
estate / paying off a mortgage.
However, if you say you don’t invest in stocks and provide a legitimate
reason, it’s important to then follow up with stocks you would
hypothetically own if you could. Make sure to have a short rationale
prepared as to why you like those stocks; perhaps it’s part of a larger
industry trend and you think the company is undervalued, or the stock
has great growth potential that is not being fully priced in. It’s good
to know roughly how large the market cap is, what their LTM revenue
is, and what multiples they are trading at in terms of EV / EBITDA or
whatever multiple is relevant for that industry.
Similarly, if you do invest in stocks and begin listing your holdings, it’s
better to list stocks that you can provide a quick rationale as to why you
like them. The interviewer could ask you about any of those stocks at any
moment to test if you’ve truly done your due diligence. It’s not necessary
to list every single stock you own if you have a large portfolio; it’s more
important to list stocks that you can pitch effectively.
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