Just had first round with Moelis today
Got the following question and had no idea wtf was going on:
A firm with 10x P/E buys out a firm with 20x P/E, what cost or debt is needed to cancel out the difference?
Mind went totally blank and f-d it. Can someone tell me the answer to this please?
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How did you already have an interview with Moelis?
There is not enough information.
A lot of the times questions like this are designed not with one correct answer but to see how you think about something.
The correct way to answer this is ask more details and follow up questions so you have enough details to answer the question. And for simple things, you add assumptions.
What sort of follow-up questions would you ask? Could you give some examples. Really appreciate it!
Are you being for real or are you just promoting this crappy looking site?
He literally was missing how much debt should be used in the question…
Here is how you do it:
Given the sellers yield is only 5% (the reciprocal of their P/E ratio, so 1/20), the post cost of debt needs to be 5%. In this case, you take 5% and divide it by 60% if you assume a 40% tax rate. Therefore, the pre-tax cost of debt should be around 8.33%.
Wrong you need to know much debt was used
Yeah obviously - but you preface the answer by saying that you are assuming its an all-debt deal
Actually you could not have been any more wrong, you don’t need to know level. I’ll let you go figure it out
This is what I would’ve said except I probably would’ve said “cost of debt should be 5% after taxes” Rationale: If the Sellers Earning Yield (1/PE) is greater than the WACA, then it’s accretive. Therefore, if it’s equal to the earning yield there’s no acct/dilution. So the WACA has to be 5%. Assuming it’s all debt (I have no idea how to do it otherwise), then the cost of debt after taxes would equal 5%.
this correct imo
i thought interviews come out next week. how’d you already have one?
Yeah you already explained your answer in the comments and it’s correct. Inverse PE for the company we’re acquiring so EPS or yield is 1/20 or .05. Without knowing the tax rate all we know is the after tax cost of debt should be 5% for an all debt deal to make there be no accretion or dilution.
Im having a hard time conceptually understanding this question - is this right?
Company A has a price of 100$ and EPS of 10$
Company B has a price of 100$ and EPS of 5$
Through the acquisition, pro forma company has EPS of 15$ (10+5), minus cost of debt of 5% (0.05 * 100$) would be 5$, so 15-5 brings the EPS back to 10$, so no accretion or dilution
Is this essentially what the answer is? or am in on wrong path
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