POPULAR ACCOUNTING/FINANCE QUESTIONS
since plenty of people are interviewing, either for ib, pe or hf, figured it would be useful to start a thread where ppl could contribute their accounting/finance/modeling questions and answers. i didn't have any in particular, but figured i would start off with a response from another thread that i saw; if i come up with any during my work/personal review for interviews, i'll make sure to post them:
Q. What has a cheaper cost of capital, Equity or Debt? A. Debt has the cheapest cost of capital. There are two reasons. First, using debt allows corporations to deduct interest payments which lowers the cost. Second, debt holders would be paid off before equity holders in the event of a liquidation, so the risk of not being paid back is less for debt holders than equity holders. r2. Subordinated Debt (Mezzanine Debt) 3. Preferred Stock 4. Equity
Q. How do I determine the Cost of Debt and Equity? A. Debt- Does the company have any debt outstanding? If so, use the Yield to Maturity (YTM) on the bonds as the cost of debt. If there are no bonds outstanding, look at comparable companies' YTMs. Preferred stock can be found the same way. Equity - use the Capital Asset Pricing Model (CAPM). If you don't know the Beta, use a comparable company beta.
Q. How do I determine the Weighted Average Cost of Capital (WACC)? A. To determine the WACC, find the what percentage debt and equity are of the total capital structure and multiply these numbers by your cost of debt (1-t) and your cost of equity. For example: Capital structure= 100, Debt= 50, Equity=50, Cost of Debt= 8%, Cost of Equity=12%. The WACC is= .58%(1-T)+ .512
Q. If my capital structure is optimized, what also should be optimized? A. Return on Equity. Basically you have the optimal amount of equity to produce your net income.
Q. Define cash earnings per share. A. Cash Earnings=NI+Depreciation and Amortization+Deferred Taxes.
Q. A company is listed as an ADR on an American exchange. The ration of shares on the home exchange to ADR shares is 6 for 1. If the ADR earnings per share is $6 what is the EPS for a share listed on the home exchange? A. $1, treat as if a 6 for 1 stock split occurred.
Q. Suppose you have a company where EBITDA has been rising for the past several years and that company suddenly declares bankruptcy, name some reasons for why that could have happened? A. Companies declare bankruptcy because they have no cash (liquidity crunch); the best answer would be to walk down the cash flow statement and describe how each of the sections could contribute to a bankruptcy filing:
- Working capital crunch (receivables could be rising; could be getting pushed on payables; might be required to build significant inventory)
- Capex requirements could be large (ie telecom)
- Might not be able to refinance a maturing issue
- Litigation (ie Philip Morris posting tobacco bond) Report abuse Amber Adams on 8/31/2006 9:14:28 AM wrote: Some more questions - lets get a big discussion going here.....
Q. You are looking at acquiring a company, but that company has a negative book value of equity. Is this a big deal? A. You would want to see why the BV of equity is negative, and there could be several reasons: - Could be from negative net income over the past several years - this might a problem from an operational perspective - Might be due to a write-down of assets - would want to understand this but might not be as bad a recurring negative net income - Firm might have levered up to issue a large dividend - will leverage be an issue going forward?
Q. Which will place a higher value on the company, equity comparables or M &A comparables and why? A. M &A comparables will be higher due to a control premium that must be paid and synergies expected to be derived from the deal
Q. Briefly walk through a discounted cash flow analysis. (including WACC) A. First, you want to calculate free cash flow for a certain period of time (generally five or ten years). To calculate free cash flow, start with after-tax EBIT and then add back D &A, subtract Capex and add/subtract and decrease/increase in working capital. Next, you want to determine the appropriate discount rate for the cashflows, the WACC. The cost of debt is determined using the current yields on the company's existing debt issues (where bonds are trading) and tax affecting them. The cost of equity is generally determined by CAPM (ie risk-free rate plus company's beta multiplied by the equity risk premium). WACC=D/(D+E)(1-T)Kd + E/(D+E)*Ke Next, you would calculate a terminal value for the firm either using a multiple of EBITDA or a perpetuity growth rate on the firm's free cash flow. - Multiple Method - Multiply the final year's EBITDA by an appropriate EBITDA multiple for the firm (based on comparables) - Perpetuity Growth Method - multiply the final year's free cash flow by (1+growth rate) and divide that by (r-g) You would next calculate the PV of the terminal value Next, you would determine the PV of the free cash flows for the given period (dividing the cashflows by WACC) Finally, you would add the PV of the terminal value to the PV of the free cash flow to determine the value of the firm
Q. If a company is considering an all-stock acquisition, what is the easiest way to determine (roughly) whether or not the acquisition will be accretive or dilutive? A. The quick way is to look at P/E multiples. If the acquirer's P/E is higher than the target's, the acquisition will likely be accretive and vice versa. For instance, if the acquirer's P/E is 20, and the target's is 10, then you are able to pay less per dollar of earnings for the target.
Q. If you are going to graph a company's cost of capital, with the cost on the Y-axis and with the company's leverage level across the X-axis (from 0% leverage to 100% leverage), what would the graph look like? A. It would look approximately like a smile; the cost of capital would initially decline as you add leverage, however as the firm becomes increasingly levered, the cost of capital would increase due to bankruptcy risk
Q. Why would two companies merge / What major factors drive M &A? A. synergies (revenue - cross-selling; expenses - cost cutting); could exploit economies of scale, common distribution channels, elimination of a competitor, etc., defensive (do not want someone else to acquire them)
Q. Why might a firm choose debt over equity financing? A. Assuming the firm has the ability to take on additional leverage without damaging its creditworthiness, the firm might choose this in order not to dilute ownership; also, up to a reasonable level, debt can be seen as having a lower cost than equity.
Q. How do you unlever at beta? A:: BL = Bu * [1+(1-T)*D/E] (Hamada formula) T = tax rate; D/E = debt/equity ratio
Q. How do you calculate the enterprise value of a firm? A. Enterprise Value = Equity Value (i.e. shares outstanding under Treasury method * price) + debt - cash + preferred stock + minority interest
Q. How do you value a company that is not CF positive, has no public comps, nor any acquisition comps? A. Look at distribution, production methods of other companies and see if you can find any operational similarities. (i.e. find value drivers and see if there are companies that could be comps)
Q. Give me an example of a coverage ratio? A. EBITDA/interest expense: shows ability of the firm to generate sufficient cash flow to cover fixed charges; (EBITDA-Capex)/interest expense: shows ability to cover interest expense after spending for capex
Q. What types of companies make good LBO targets? A. Has predictable, stable CF; mature, steady industry; well-established products; limited capex and product development expenses; undervalued or out of favor; owned by a motivated seller; not highly levered
Q. Conglomerate X has a significant amount of debt maturing next year. With debt markets still tight, what options does the company have? A. If the company does not have excess cash, it could sell some of its assets (but would lose cashflow from that unit) or issue equity (these are the two primary answers)
Q. How would you value the naming rights of a stadium? A. You could look at comparables (adjusting for market differences, football, concerts, demographics, TV rights, size of stadium) to get the intrinsic value; you would then think about market specific details and willingness to pay of potential buyers (key points understand valuation is based on intrinsic value and willingness to pay).
