Hard Interview Question (MM)
Was asked this in an interview (CB): You have a widget factory and a mine, to which would you extend financing to?
How would you answer this?
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He wants you to ask him about the nature of the cash flows. So the answer is widget factory.
Or he wants you to say something about the certainty of asset base. Again, widget factory has a more certain asset base that is likely more readily liquidated.
going to go with mine before reading comments
edit: awh shieet
widget factory aint worth shit, a mine is worth what the mine is probably worth
Widget factory, a mine’s financial performance is entirely based upon one input (the price of its mined commodity). Asset value falls precipitously as the business’s cash flows do, which is a bad combination if you’re a lender
I'd ask what type of financing?
Widget factory would probably make more sense to receive debt financing since it most likely has more hard assets and stable cash flows.
Mine typically would be equity seeing as there is significant downside with not many assets to fall back onto and literally no cashflows unless it hits something and if it does you want all the upside provided by providing equity financing.
There is no right answer to this question. The interviewer wants to see your thought process and how you evaluate businesses.
There are many aspects you can approach this, but I would first ask what type of financing we're talking about. Project financing? Equity? Maybe even royalties?
Then I'd evaluate the competitiveness of each business. Widget factory, at first glance, might be more attractive for debt financing - the farther you get from upstream industries (e.g. oil & gas, mining), generally, the more differentiated the products. But maybe the widget factory produces shitty widgets no one really wants anymore. Or perhaps the factory is extremely reliant on a few customers / suppliers.
In contrast, while mines are victims to the vicissitudes of the commodity markets, they can be attractive too. If the mine produces a commodity that is scarce and projected to have high demand in future, it could be interesting. Or if the properties of the mine allow for lower cost operations (e.g. better infrastructure, better geology, located close to export terminal, etc.) And if the mine is owned by a large producer, like Rio Tinto or BHP, could be worth talking about economies of scale or operational expertise.
And lastly, would talk about the returns for each financing. If the interest rate charged is the same for both, yeah the widget factory is probably more attractive. But given the general lack of investor interest in the mining space, you might be able to extend financing to the mine with more attractive terms (higher rates, stricter covenants, etc.)
"Neither, i have no money to lend"
it depends...if the mine procudes rare earth metals, and the price of those are skyrocketing with no end in sight, then the mine would be a better investment.
If the widget factory makes buggy whips...and they are going out of style, then that might not be a great investment (although, maybe the factory can be retooled to produce something else that has more value...where as a mine con only produce what its got in the ground).
So, you need more information, as a lender, before making this determination.
I would assume this interview question is a prompt to get you to think about all the other questions that you should be asking as a lender, in your role as a risk manager and a steward of capital...which is kindof what finance is all about.
I would avoid saying investment in a lending interview. Commercial Banks finance companies, they don't invest in companies. The return on a loan for a CB is 1-2%, therefore, we try to understand all risks and mitigate them when possible - and price the loan according the risk.
damn good call on the upside part, you genius
Thanks for this
Got asked this during interviews (can't exactly remember who- Moelis or PJT). As has been mentioned, it's more of a case question that's probing your thought process.
Anyway,
Everything that has been said here is important but no one has said the key point the interviewer is looking for: a mine has a finite life.
This affects a few things.
First, obviously you need reliable estimates that it will outlive the tenor of the note (you would ask this to the interviewer). Second, how you value of the underlying asset changes too, because you can't use Gordon growth for terminal value, so you need to talk through a well reasoned valuation.
You can infer a few more things, but the interviewer told me that finite life was the big difference.
I mean...no it's not inferred that the factory also has a finite life. It's a pretty large difference (especially when you get the "would you invest" theoretical instead of "would you finance".) The crux of accounting and valuation is based on firms being a going concern, and the mine is not necessarily a going concern, while the factory most certainly is.
I just bring it up because it is the key point my interviewer was making and I think it is the point of the question.
I've given my share of technical interviews for associates an analysts when I worked in banking. I have to say that this is a pretty dumb interview question, if the crux of the interview depends on someone first having to somehow figure out that mines have a finite life....unless you were interviewing for an natural resources group (in which case, this would be fair game because these are the companies you would be working with). The interviewer would have been better off just telling the interviewee upfront that the mine has a finite life so that the interviewee can work through the implications of that difference, which seems far more important and relevant as far as testing a candidate's understanding of finance.
I don't want to echo the points that have already been said about cash flow, asset values, the need for more information, and the like. I would throw in asking some basic questions about the output of both options. Are the widgets a standardized item, or is it like the iPhone where a new model is released every few years and the previous model is then sold at a reduced price? How commoditized and price sensitive are the goods being mined? What are the economic conditions we're assuming going into this, particularly over the X-Year time horizon of the potential lending agreement?
There are two things I want to add which I don't believe were covered though. The first is what are the minimum breakevens for both options. While this is less important for the widget factory, as there are only two real factors that drive being able to break even, this becomes an issue for the mines. Since output prices fluctuate greatly, knowing what the minimum breakeven price will be can provide you a good sense of what the repayment risks could be. Using oil as an example, Permian Shale, depending on the field, has a breakeven between $32 and $47 USD/BBL. As long as oil stays above 50/BBL, the Permian Base continues to be viable. If it drops below that, then not every oil field will be viable. At Sub-$32 USD/BBL, the entire Permian Base will be losing money. The same concept should apply for mining. This poses a potential risk depending on the price of the goods being produced and needs to be factored into the discussion. At the same time, you also need to tie out that future cash flows for the mine can fluctuate based on pricing more than the widget factory.
The second thing I will add, and it shows that you're thinking in a broader sense, is asking about the value of each relationship. Is this a new business or a pre-existing relationship? Do either opportunity have a real shot at growing into a long term relationship? How much can be levered by relationships across the firm (ex. this is a new business for lending, but one of the choices has a relationship with Sales and Trading or IBD already)? What are the economic conditions faced by both companies? How does that impact their ability to grow in the future? What other services can you provide directly or refer to across the firm? Things like that show you grasp the bigger picture. By being cognizant of the relationship, you are showing that you understand the nuances of the relationship aspect of finance and banking as well as the financial aspects of this deal.
What sort of security does the financing have? If it has security in the underlying assets, then the widget factory can stop producing cash flow but your loan money good if collateralized by the actual factory. You would probably not want to make an unsecured loan to a mine.
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