Answering your technical questions

Boiz, I need practice answering technical questions 

so if you have a burning technical question you don't know the answer to and you are about to post a new thread on WSO, just ask me here and I'll reply 

the offer runs for the next few weeks 

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Comments (144)

Mar 30, 2021 - 9:39pm

Here's one I got at a SA 2022 super day last week and still have no fucking clue how to work through:

When valuing the cash flows arising from a Section 338 election (i.e. decreased tax liability due to increased depreciation expense from step-up in basis of assets), what discount rate would you use and why?

  • Associate 1 in IB - Ind
Mar 30, 2021 - 10:13pm

I'm basing my answer on your clarification that this section 338 simply lets buyers treat targets as asset purchases when performing purchase price allocation 

In short I'd use a rate between risk-free rate and cost of debt. Tax benefit from such step-up will be virtually "risk free" and based on Corp Fin 101, discount rates which we use to discount cash flows should reflect the risk inherent in respective cash flows

Case solved, next question

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  • Intern in IB - Ind
Mar 31, 2021 - 1:10am

Not OP but you start at EV and subtract net debt. Is it wrong to say it the other way around though? Is it wrong to say add net debt to equity value? I ask because some of the guides frame it that second way, but I was under the impression that additional debt doesn't actually change enterprise value but rather lowers equity value. 

Most Helpful
  • Associate 1 in IB - Ind
Mar 31, 2021 - 5:15am

Enterprise value is the value of the core business or as some also say core operations to all investors. On the balance sheet it would be the equivalent of operational assets net of the operational liabilities or net operational assets

Equity value is the value of a company but only to equity investors. As such it recognises other investor groups and other claimants to company assets and excludes them from the enterprise value (eg debt holders, pension obligations, minority investors, restructuring and other liabilities, preferred stock holders)

EV = Equity Value + Debt + Minority investments + Preferred stock + Unfunded pension obligations + Other liabilities such as restructuring etc - Cash & equivalents - Short-term investments - Equity investments

  • Associate 2 in IB-M&A
Mar 31, 2021 - 9:03pm

In an M&A deal, through Section 382 limitations, the use of the target's NOLs are restricted to prevent buyers from acquiring companies for their NOLs. Section 382 decides how much of the NOLs can be utilized based on the difference between book value and acquisition value (with some adjustments, can't remember the full formula). Don't know fully how NUBIG's work, but they provide a way to increase that NOL utilization...but this added benefit only lasts for 5 years. So Section 382 + NUBIG = total NOL allowance. I'm pretty rusty from that point on, but that's the basic idea.

  • Associate 2 in IB-M&A
Apr 5, 2021 - 2:00am

Just read up on this. The whole point is to increase how much of a target's NOLs a buyer is allowed to use.

NUBIG (net unrealized built-in gains) is the difference between a company's market cap and their net asset value based on IRS accounting.

For 5 years, a buyer can use more of a target company's NOLs than what Section 382 provides for. That extra amount of NOLs that you can use is based on some fraction of NUBIG. That extra amount that you actually use each year is called RBIG (realized built-in gains). 

Section 382 + RBIG = how much of a target's NOLs a buyer can use

  • Intern in IB - Ind
Mar 31, 2021 - 1:12am

Someone I know was asked: "What would you estimate the beta of a slot machine to be?"

He told me he said that it would be 0 because slot machines are not connected to the market and that they have a certain payout ratio for the casino

  • Associate 1 in IB - Ind
Mar 31, 2021 - 5:38am

Pls note that I never played in a casino so although a slot machine rings a bell, I wouldn't necessarily remember how it looks or works.
 

Having said that I am not sure I'd agree 100%. Theoretically speaking if we assume that the way markets are changing, that's a reflection of a state of the economy then I'd expect slot machines to make more money when economy is doing well and markets are growing just because there will be more people coming to play. So perhaps not exactly beta of 0 but close to 0. 
 

Even if the payout ratio stays the same, you'd still make more money.

Lets say buying one slot machine costs $100. You make $1,000 of it in a week and you pay-out 10%. That's 800% return. 
 

Let's assume the economy heats up (markets make crazy gains) so people have more money to spend so you make $2,000 but the pay-out of 10% stays the same. You now make 1,700% return. You see where this is going if economy breaks down (so markets go down)..

Again that's based on my limited understanding how casinos and pay-outs in that industry work

  • Analyst 3+ in IB - Ind
Mar 31, 2021 - 8:37pm

This is one of those questions with a simple answer but the finance nerd interviewees made this question have a different answer.

If you're at a very technical bank like a top EB, I feel like you have to go with the market cyclicality approach. If you're at any other bank including BBs and MMs, the answer is the simple 0. 

Source: I've been asked this question several times in interviews and the answer varies based on how technical the bank is. As you know, EBs love to go deep into this stuff. Oh and if this were Qatalyst, they'd expect you to go above and beyond what even the Associate answered cuz they're that technical lol. 

  • Prospect in IB - Gen
Mar 31, 2021 - 2:22am

Good broad one for you - "If a company generated $100 every year, how much are you willing to pay for it? is there a formula or is it conceptual?"

  • Intern in IB - Ind
Mar 31, 2021 - 2:41am

That sounds like a simple bond question? I would say something about it depending on the discount rate you use, but you make it sound like an investment with very low risk, which would imply a low discount rate, which would imply a high price 

Mar 31, 2021 - 3:52am

Conceptually, the value you pay for any asset is the present value of it's future cash flows. In other words, the present value of all discounted future cash flows. 
Mechanically, if there is a series of cash flows that aren't growing, then the present value is CF/(Discount rate). 

For your question, the present value would be 100/(Discount rate). You'll probably learn this in your Intro Finance class or in a couple guides. 

"Markets can stay irrational longer than you can stay solvent."

Apr 4, 2021 - 1:45am

i don't totally get your comment about cash flows that aren't growing. isn't CF/(Discount Rate) the present value of a perpetuity? and a perpetuity, well, grows in perpetuity?

edit: now thinking about this in terms of just a single cash flow on a timeline so i sort of get what you're saying (maybe?) but still confused with your formula

  • Associate 1 in IB - Ind
Mar 31, 2021 - 5:23am

If I understood the question correctly, this is more of a conceptual thing. The answer will really depend on your risk tolerance and investment goals.

I'm personally a risk-averse investor so I know that my opportunity cost of capital is ~5% as this is the most that "safe" investments such as real estate or investment grade debt will return. However I also know that where I live the minimum I can do is ~3.5-4% return on investments in real estate. 
 

So I'd be willing to pay between $2,000 and $2,800 assuming no growth. Otherwise I'll invest somewhere else.

Mar 31, 2021 - 11:14pm

It should depend on the riskiness of the counterparty as well, of course. What kind of "company" is this coming from and where is this $100 outflow in priority? How material is $100 to this company? + considerations about its business model, customers, competition, regulation ... this is why VC investors have a higher discount rate than PE investors, it's not just because the investors are more/less risk averse, it's to do with what they are investing in.

Be excellent to each other, and party on, dudes.
  • Intern in IB - Ind
Apr 4, 2021 - 1:28am

My guess is to just do a simple DCF. Assuming the company has 0 debt, use CAPM as the discount rate. I would also assume that beta is 1 if hypothetically the $100 is guaranteed every year with no systematic risk associated with it. 

  • Analyst 1 in IB - Gen
Apr 5, 2021 - 3:56pm

how is this a good or broad? there's nothing more to it than the PV of Perpetuity.

  • Prospect in IB - Gen
Apr 5, 2021 - 5:08pm

Alright Mr. Genius sir, how do you calculate PV of perpetuity in this context? It is meant to be a simple question to make people over think (which clearly it is doing given the prior comments)

  • Prospect in IB - Ind
Mar 31, 2021 - 8:00am

In the case of M&A, why would asset write-up creates a DTL, not DTA. Asset write-up means more depreciation on book account than tax account and hence paying more tax in actuals than book. shouldn't be it DTA?

  • Prospect in IB - Ind
Mar 31, 2021 - 9:05am

Okay. Then in normal case of calculating DTL, we use [MACRS dep ( Tax account ) - St line Dep ( Book )]*Tax rate , by this logic, We have paid less tax in cash than book, hence an asset should be created (DTA), but in reality we create a DTL here as well. Sorry little confused here.

  • Associate 2 in IB-M&A
Apr 8, 2021 - 2:44pm

In M&A, you have to separate book (GAAP) and tax (IRS) accounting statements. Otherwise you'll mix things up and come up with wrong answers.

GAAP: always adjust assets to FMV. In fact, you can't calculate goodwill without adjusting assets to FMV. Must always be done.

IRS: only adjust assets to FMV if it's an asset deal, which would mean no DTA/DTLs. But in a stock deal, you don't write up assets to FMV on IRS statements, so you end up with DTA/DTLs. 

So if you write-up an asset by $100 and depreciate straight-line over 5 years, you'll owe more on IRS taxes than GAAP taxes, so you make a DTL (=$100*21%). Then each year you record GAAP D&A, you lower DTL (=$100*21%/5) until eventually it reaches 0.

It's definitely a DTL when you write up an asset because you're going to pay more in IRS taxes than GAAP taxes. But as each year goes by, the DTL goes down until it gets to 0.

  • Associate 1 in IB - Ind
Mar 31, 2021 - 7:07pm

I'll be honest i don't know because I'd normally look up these types of things in publications such as Dugff & Phelps.

Having said that I have never dealt with truly distressed firms before and if I had to, I don't know the extent to which I'd want to add additional % on top of CAPM because

(i) this risk will be reflected when re-levering beta because levered beta = unelevered beta * [1 + D/E (1-t) ] 

(ii) if I had to deal with a distressed company, there would probably be enough info for me to adjust cash flows, ie I would probably have an idea which customers won't pay or which suppliers will want the money sooner 

  • Intern in IB - Ind
Mar 31, 2021 - 8:46pm

I would say that it's very low, but not zero. I would also assume that it would be lower in chapter 7 than 11 because chapel 11 can result in restructuring which could work out in the future, and chapter 7 may result in the equity holders getting some piece of the liquidation, but they are on last lien, which is why I'd say it's lower in 7 than in 11, but not zero in either.

  • Analyst 3+ in IB - Ind
Mar 31, 2021 - 8:45pm

Ok, Mr. Associate. Here's 2 questions an Associate got asked for a fit interview. 

Situation: Your senior analyst has never done financial modeling and has no experience with data analysis including Index Match or even Vlookup. However, this analyst has been assigned the model for two urgent live deals. How would you work with and advise this analyst so you all can get through these deals together and have the analyst develop a strong foundation financial modeling foundation?

Situation #2: A top bucket analyst has recently been very unresponsive, lazy and unmotivated for the past few weeks. Workstreams are falling behind and you as the associate are getting blamed. How would you navigate this situation such that the senior analyst does not get any backlash and you both come out with the best outcome?

  • Intern in IB - Ind
Mar 31, 2021 - 8:49pm

How is it possible that a senior analyst has never done modeling? Internal lateral?

  • Analyst 3+ in IB - Ind
Mar 31, 2021 - 11:42pm

Believe it or not, I've met a fair share of 3rd year analysts who have never used a pivot table or only know the lookup equations rather than Index Match. Also, definitely a good amount of analysts that have just gotten unlucky or were bottom bucket such that the other analyst would always be assigned the model and they would get stuck with the CIM

  • Associate 1 in IB - Ind
Mar 31, 2021 - 9:06pm

In all honesty, if I had these two questions in an interview in this form, I would not know how to respond. Most probably I would not bother even trying to come up with a good enough answer because I know that situation #1 is almost unrealistic. In real life there is zero chance you'd pull through if senior analyst who is staffed with you not on one but in two deals doesn't know how to model at all. Hey, that's only my personal opinion

situation #2 - again I am yet to see a human being who in real life wouldn't throw this analyst under the bus. I would obviously try to speak with the analyst first but given workload in IB is high and there isn't usually a lot of free time, people wouldn't waste more time and neither would I. 
 

Both situations would show to me that senior management and the staffer are incompetent and i wouldn't want to work in such a team 

  • Analyst 3+ in IB - Ind
Mar 31, 2021 - 11:53pm

Both situations happened in our group in recent months due to so many analysts leaving but instead of it being a senior analyst, it's a 1st or 2nd year. 

As for the second situation, I'm sure you know this but didn't say it: a top bucket analyst suddenly acting this way is most likely about to put in their 2 weeks' notice or are preparing for upcoming interviews. When I was an analyst, I had a bunch of senior analysts and associates act this way suddenly with me as in they would be completely unreachable some days. After talking with them when they're leaving, I always end up being right as the weeks or months that they tell me they were interviewing, I noticed they were unreachable. 

I got another one: Teach me how to use Index Match as if I were a 5-year-old. Can assume I know the basics of Excel including how to create nested formulas, but note I don't know how to use the lookup formulas. 

  • Analyst 1 in IB - Gen
Apr 5, 2021 - 4:07pm

Is this a trap question? Index Match or Pivot tables are some of the least useful tools when you have to create a model. Sure IM can help sometimes but you'd be complicating things for no reason. The guy that mentioned Pivot Tables; what kind of models are you running? In my mind it's be a nice to have last priority feature. It's DCF or an LBO guys not a dashboard. Vlookups are 1 google away. There are far more, different, structural issues one would have to face than vlookup

but maybe my xp is basic and you get massive data dumps from a client to work with.. dunno 

  • Analyst 3+ in IB - Ind
Mar 31, 2021 - 11:40pm

How do you know so much finance on a technical level? I'm an A2A and knew more about finance when I was interviewing and preparing for these technical questions than now. So much of the industry is non-finance based (PPT, admin, etc.) and even the financial modeling is very basic or is mainly data analysis so on a purely technical basis, I haven't really learned much of anything in finance. 

Am I alone in thinking this way?

  • Analyst 3+ in IB - Ind
Apr 4, 2021 - 2:26am

Wow, yeah you are definitely interested in finance. I make up for my lack of financial knowledge by just working really hard. Have met hundreds of bankers in my lifetime and know very few who could talk so in depth about finance and answer such questions in the way you have. I seriously mean it. You need to give yourself more credit, man. 

Apr 1, 2021 - 10:34am

Varies from bank to bank. Honestly, modeling as a cash expense probably saves you the most brain damage and is the best approach from an 80/20 perspective.

If you're doing a true, "'fairness opinion", level valuation, then you go with a qatalyst approach of modeling the actual dilution (i.e. treating as non-cash and translating the expense to a share amount)

Apr 1, 2021 - 2:52am

Just a freshman trying to take a shot at some of these questions:

2. Wouldn't increasing price and decreasing Opex be the same?

3.

A) I think EBITDA increases by $6, because assuming the variable COGS also grows at 10%, Gross profit is up $6.

B) EBITDA increases $5, because no other expense increases? If its just price increasing, you wouldn't see any change in COGS right?

C) EBITDA increases $8? SG&A is fixed, I assume?

4. Wouldn't the multiple stay the same, because tax is factored after EBIT?

  • Analyst 1 in IB - Gen
Apr 1, 2021 - 11:15am

Could be wrong but I'll take a crack at the lower tax rate question. Despite the fact that EV/EBITDA excludes taxation impact, in reality it is likely that EV/EBITDA will increase as a result of decreased tax expense, which leads to higher cash flow to the firm. Thinking about it from a PublicCo perspective, if say Biden announces some corporate tax decrease today, market is likely to reward that company by bidding up the stock price, hence increasing the Market Cap component of the Enterprise Value formula.

  • Associate 1 in IB - Ind
Apr 3, 2021 - 1:57pm

(1) If there is nothing else in the EV-Eqv Value bridge, it seems that the intrinsic value is in line with the market price

(2) Assuming no other changes (or all else equal), I would prefer a 10% increase in sales volume

(3) ok, this is just simple accounting

(4) Should go up

(5) (i) If the two companies are completely identical, I will invest in company that generates $2 EPS. It will give me back 10% yield; (ii) many reasons with P/E multiples.. debt levels, accounting distortions to name a few

  • Intern in IB - Ind
Apr 5, 2021 - 9:03am

Had this one in a recent interview :

How do you get from Unlevered Free Cashflow to Levered Free Cashflow?

  • Intern in IB - Ind
Apr 5, 2021 - 9:21am

What about the tax effects on interest?

Why do you add back debt raised?

The analyst interviewing me tried to tell me that mandatory debt repayment shouldn't be subtracted from LFCF .....

Apr 5, 2021 - 12:29pm

just need to know the formula...

EV = FCF / (r - g)

where 

 -  r = discount rate = WACC

 - growth rate (g)

also, you need to remember that FCF = operating profit - reinvestment

so EV becomes => [operating profit x (1 - rr) ] / [r - (rr x ROIC)]

where

 - Reinvestment rate (rr) = reinvestment/operating profit
 - Return on invested capital (ROIC) = return/(profit x rr)

 - growth rate (g) = return / operating profit ( or rr x ROIC)

you just need to know the value drivers of the EV or the formula lol. then just plug and chug... :)

Apr 6, 2021 - 4:02am

ahah no worries - I understand it is a NAV (company per company). What I am not sure is if you add a certain discount to the total NAV or a premium and why. thanks! 

Apr 6, 2021 - 4:22am

Thank you! If PE is equity/net income, is it the one which is the more levered that would have a lower NI hence a higher PE? Not sure about that as logically I would say the opposite

  • Analyst 3+ in IB - Ind
Apr 5, 2021 - 5:14pm

This is a good one that over the next few years, will become a common question.

"Explain the Great Financial Recession and the Great Pandemic Recession and point out the differences in each. Additionally, explain your view on how the economy and financial market will shape out following the GPR."

Hmm...this is actually starting to sound more like an essay question on a Finance 101 exam.

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