Interview Technical question help

I recently had an interview with a BB and was asked some tough technical questions for a Summer Analyst position. I was not sure if I got them right so I wanted feedback from you guys who probably know about these topics at the back of your hand.

1) If a company lost a lawsuit and the SEC has imposed a $100 million fine, payable $20 million each year, How would it impact the 3 financial statements:
a) on Dec 31st
b) on Jan 1st

2) Buy pen for $8 with debt and sell it for $10….what is the Impact on financial statements immediately

3) How does 40% cash vs 60% cash affect the merger model ?

Thanks !

 
Best Response

I'll take a crack at it:

(1) Initially (and ignoring taxes), you would record an extraordinary expense on the income statement, reducing net income (I am not 100% sure with lawsuits, but it seems like you would recognize the whole expense in that first period when the expense is incurred). The offset is the increase of the liability as a reserve to pay. Then, as you pay out, you decrease cash by $20mm each year. You also decrease the liability by $20mm each year. If you factor in taxes, then your cash out is only $12mm and you're net income has $8mm more ($8mm less in taxes, assuming a 40% tax rate)...

(2) Upon the sale of the pen, you have a gain of $2 on the income statement. You're cash flows are $10 from the sale. Assets decrease by $8. So, retained earnings go up by 2 and assets up by 2. If you pay down the debt, then decrease debt by 8 and cash by 8.

(3) I assume one of those percentages is stock....you'd have to take into account interest lost on cash, shares outstanding, and ownership, which will affect accretion / dilution.

 
  1. At time 0, assuming you pay 20mm upfront: IS: Unusual Loss of 100 (there is no tax benefit when you lose lawsuits) CF: I believe cash from operations (but am not sure) would decrease by 20 BS: Cash decreases by 20, liabilities payable increases by 80, RE decreases by 100
 

Your answer is generally correct, but just for some clarification for people who might not get.

You buy pen for 8 using debt so assets up 8, debt up 8...That is it for now.

You decide to sell the pen for 10.

Income statement revenue up 10, cost of goods sold up 8. Net Income positive 2

CF statement. Cash from operations up 10. cash from financing activities down 8 because you paid off the debt. cash flow up 2.

Balance sheet. Assets down 8 (sold pen), debt down 8 (paid off debt). Cash is up 2 (from statement of cash flows. Retained earnings is up 2 (from income statement), Balance sheet balances. Always end with the balance sheet because when it balances you know you did it right.

.

"Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
 
Gekko21:
Your answer is generally correct, but just for some clarification for people who might not get.

You buy pen for 8 using debt so assets up 8, debt up 8...That is it for now.

You decide to sell the pen for 10.

Income statement revenue up 10, cost of goods sold up 8. Net Income positive 2

CF statement. Cash from operations up 10. cash from financing activities down 8 because you paid off the debt. cash flow up 2.

Balance sheet. Assets down 8 (sold pen), debt down 8 (paid off debt). Cash is up 2 (from statement of cash flows. Retained earnings is up 2 (from income statement), Balance sheet balances. Always end with the balance sheet because when it balances you know you did it right.

.

Good points - i was thinking of it as a depreciate assets / capital asset on PP&E and not the actual product they are selling...

 
  1. When you buy the pen: IS: Nothing CF: Cash from operations decreases by 8, cash from financing increases by 8, no net change BS: Inventory increases by 8, notes payable increases by 8

When you sell the pen (assuming you don't pay down debt) IS: Revenue of 10, CoGS of 8, 2 pretax income, 0.8 tax expense, 1.2 NI CF: 1.2 NI, plus 8 change in working capital, so cash from operations/net change in cash increases by 9.2 BS: Cash increases by 9.2, inventory decreases by 8, RE goes up 1.2

 
avireddy:
Thanks guys that certainly makes logical sense. At least I know the concept behind the answer now. Anyone wants to take a crack at the final question I had

"3) How does 40% cash vs 60% cash affect the merger model ? "

I would think that having more cash in a merger transaction will make the deal more accretive because the forgone interest on cash is cheaper than the cost of other forms of financing.

just my 2cents.

 

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