Interview Questions (Was just asked for an Analyst Role)
Okay here it is (just got off a phone interview and was asked these questions for an Analyst role):
1. If a company has no access to any sort of capital and does not have a cash flow, how would you advise it to get cash?
2. If account receivable increases by 100, is that a source of cash or use of cash, and why?
3. If a company's EBITDA is $50 mln, and comps are 7X Ebitda, and the company is split between two types of debt tranches, secured senior and subordinated notes, how much, as an investor, are you willing to pay for both of those types of bonds?
Please answer, need help!! Really curious as to what the correct answers would be? Thanks everyone!
I cant answer 1 or 3 with certainity but I can help you with #2. Refer to this chart when determining if an increase or decrease on the balance sheet is a source of use of cash.
Assets Decrease Increase
Liabilities Increase Decrease (S/E)
As for your question, when A/R increases by $100 it will be a use of cash.
If AR increases it'd be a source of cash... it's increasing the amount of cash that can later be collected, you aren't using cash.
Sorry that chart looks funny and confusing when I posted it:
Assets Increase = Use of Cash Assets Decrease = Source of Cash
Liabilities Increase = Source of Cash Liabilities Decrease = Use of Cash
If your A/R increases by 100, that means you made a sale but never got the cash for it. In other words you have less cash than your income statement would suggest.
Got it, thanks. Shame on me as overworked_overpaid pointed out. I am ashamed haha.
Obtain some type of debt financing that is secured by assets or sell of assets/inventory
If A/R goes up, its a USE OF CASH because you're tying up cash that you could have otherwise immediately had (like you let your friend borrow money and tell him that he can pay you back in a few days; you don't physically have the cash that is yours - its "tied up")
Need more info. And I don't really get what this question is even asking
1) monetize assets (can license in addition to sell). See Kodak etc. 2) Use of cash in this period. 3) If those are credit comps, $350bn is debt capacity, which I guess is what the question is asking, but unclear.
Just beating a dead horse: 1) Sell assets, equity raise, debt raise, JV assets, license assets. (just trying to see how creative you are) Hell, tell them you want to sell the company's building and lease it back, take the cash upfront and have a string of costs, positive NPV.
2) Agree with most, and shame on those that get it wrong, increasing AR is a use of cash.
3) I'd talk this through before saying 'need more info', might get some pointers from the interviewer. Along the lines of "If comps are 7x, and EBITDA is $50 mm, then market cap should be $350... and in the absence of additional data... may I assume that the company's interest covereage ratio and solvency are non-issues?" etc. They'll typically give you more data this way.
You can't do an equity raise, or debt raise as this is implying that they don't have access to capital, i.e. they can't go to the capital markets, but they can license, jv, or sell assets.
On number 3, the Enterprise Value would be $350... Agree about asking about leverage constraints / covenants thereafter...
What do you mean by " company's interest covereage ratio and solvency are non-issues"?
Thanks guys, I get number one and two, but three is still bothering me. Why the f would he ask me that question for a 1st year Analyst role ahah. I know I know to see how creative I can be, and that's fine, but during the interview I really drew a blank since it was a curveball, and I began to overthink it.
So, if enterprise value is $350 mm, why does this is about the bond prices? The question asks how much will an investor pay for each type of debt, I think he also told me that the company has 200m in debt and is split between the two debt tranches aforementioned, but does this make sense? Can you have $200 mm in debt and $50 mm in EBITDA, I guess you can right since EBITDA is irrelevant to cap structure? Someone, please advise? Am I think about this the right way?
Also, what does the interest coverage ratio and solvency, like leverage constraints and/or convenants have anything to do with this? Thanks.
If he said comps are 7x EBITDA he's probably talking about a measure of leverage, i.e. you have $350 mm of debt in the capital structure (which seems high). Still, there's a big jump from there to how much you'd pay for individual tranches of the debt so it seems like something is missing.
who did you interview with? curious to know who is asking these questions for an analyst role.
Gotcha -- how would you calculate how much you would pay for the two type of tranches typically, if you were given the leverage ratio, so 350 mm of debt, and each debt tranch was 175 mm...what else would you need to derive the estimation of price per bond or price for the aggregate debt issue(s)?
And a VP at a MM firm asked me.
Number 3 is retarded to ask in a freaking SA interview. What the hell is wrong with these firms?
It's not SA, it's for FT. There are only 18 guys in this firm, many are ex-BB MDs and most are from target schools -- fairly prestigious firm on the street.
1) yah the company can sell assets, but that doesn't necessarily improve cash flow moving forward. one thing it can do is to improve working capital management, such as decrease inventory days, decrease accounts receivable days, increase accounts payable days, etc. if they have less working capital tied up, they'll be able to put that cash to use somewhere else more productively.
3) i think you should just know that the subordinated notes would trade less than the senior secured, due to the liquidation preferences, convenants, etc.
Can you explain your answer to number 3 a bit more, I get the liquidation preference part but doesnt both sub and senior secured have convenants (they are diff ones but still have convenants right)? OR is senior secured convenants more lenient?
for example if each piece of debt is face value 200 million, I would pay full 200 million for the senior secured and 150 for the subordinated note
Makes sense, however real quick -- what do you mean by, "or face value whichever is greater"?
Face value aka notional amount vs market value.
If someone says that they issued 300mm bonds what they are saying is that the notional value of those bonds is 300mm and that market value at issuance is 300mm once the bonds begin to trade the market value could go higher or lower.
That 3rd question is either horseshit or it is meant for you to start asking more questions to show that you know what you are talking about because there is no way to talk about price of that debt without maturity, coupon, yield etc. Another possibility that was raised above, is that you should ask how much of each tranche does the company have. Assuming they are equal, you would buy all of the senior secured up to 350mm and/or all the senior secured and part of the subordinate with the maximum subordinate debt price being (350mm-senior secured debt)/subordinate debt which would give you a dollar price. An example is below
Company value =80mm Senior debt = 50mm Sub debt = 50mm
The senior debt gets paid off in full, but there is only 30mm left to pay off the sub debt which means that you would not pay more than 60 cents on the dollar for the sub debt.
Here are the answers I'd give.
If the question was clearly saying zero access to any cash from someone else giving it to you then you're stuck with selling parts of your business and the IP angle.
Quick note: Current asset increase = Cash use, Current asset decrease = cash source; Current liability increase = cash source; Current liability decrease = cash use.
This is an oddly worded question which means this was a real interview as all these things end up being more conversational in nature. Also within thread yes you can raise debt to $200M on $50M in cash flow depending on what company you are dealing with. $200M debt balance on $50M in cash flow is not that bad, because even if you have a 10% rate on your debt, your $50M in cash flow more than covers the $20M interest payment... But this is a long drawn out conversation comparing industries etc.
Anyway first question would be "7x ebitda on interest coverage, valuation for firm eg. Enterprise value?".. I see your additional comment that says $200M in debt so that could have meant a debt to EBITDA metric as well. So without further info here's what you could use as a proxy next time.
Debt tranches in a quick LBO (which you will need to build from scratch when you interview for PE in the future because this sounds like an M&A group interview).
That is a quick way to "back of the envelope" think of an LBO. Here's a quick guide to the debt tranches.
Revolver has the lowest rate and will be what people talk about in terms of "corp debt rate" for a mega firm think LIBOR. Extremely safe companies can get sub LIBOR. This company is small so just assume a revolver would be 4%, if asked for a mega cap assume closer to 2% (of course give line of thinking before throwing numbers out)
Senior debt think roughly 50% above revolver rate so would use 6% as a proxy.
Sub Debt gets to ~66% above senior debt so you can use 10% as a proxy.
Back to the question... and note these are ways to think about answering it and in no way shape or form are they "correct" answers as pieces are missing and you'd have to talk through any heavily technical question like this.
"With $50M in annual cash flow if the comps are trading at roughly 7x EBITDA this means our max interest payment is roughly $7M (this is assuming his 7x is a coverage number (50/7 = 7.14 round to 7). Now we would have to calculate the rates on debt, I would assume ~6% on senior debt as a revolver would likely be closer to 4%, and the sub debt is another 400bps incremental so 10% on this rate. To make the math easier if we assume 75% senior debt and 25% sub debt we get to a net interest rate of 7%, so the max a debt investor would be paying up to loan out is $100M ($25M into sub debt and $75M into senior debt)."
If he gave you the current debt load at $200M and you only have the 7x interest coverage ratio then you can also give a back envelope solutions.
You say "$200M in debt with a 7x coverage ratio implies that the total interest rate on the debt is roughly 3.5%. Splitting this out if we assume the company runs at 75% senior debt and 25% sub debt you get $50M paid for the sub debt and $150M for the senior debt. Since sub debt gets a higher rate and assuming roughly 66% higher this would mean that sub debt investors get a rate of 5% and Senior holders get a 3% rate (0.753= 2.25% + 0.25%5= 1.25% nets you 3.5%).
[Note that 3% and 5% rates seem real off based on the limited info from the question.]
Good luck brotha!
Dude, thanks so much for all your help...most of it makes sense, however I have a few questions:
Can you please explain this part, "With $50M in annual cash flow if the comps are trading at roughly 7x EBITDA this means our max interest payment is roughly $7M (this is assuming his 7x is a coverage number (50/7 = 7.14 round to 7)."? How do you derive the max interest payment? I know you wrote out the math for it (appreciate that), but intuitively how does that work?
Can you please also explain this part, "$200M in debt with a 7x coverage ratio implies that the total interest rate on the debt is roughly 3.5%."? Of course, I understand you just did 7/200, but how does that work intuitively?
He is assuming that 7x is your coverage ratio which is how many times a company could pay its interest expense--a measure of how leveraged a company is. If you have 50mm and the coverage ratio is 7 then the total yearly interest payment is around $7mm. You derive the max interest payment using the amount of cash and the coverage ratio. If we had a coverage ratio of 6x and 60 million cash, the interest payment would be 10mm. We have enough cash to pay our interest payment 6 times.
If your total interest expense is 7mm on 200mm of debt the average interest rate on the debt (coupon) is 3.5%. What is an interest expense?
Notional Value of bonds x coupon = interest expense
200mm x ? = 7mm
? = 3.5%
If you had different bonds with different coupons you would sum the totals to get total interest expense
Given that, I understand using Net Working Capital as a net amount to adjust EBIT or NI to Free Cash Flow, but what I don't get is why we call AR/Accrued Expenses/etc. "uses" or "sources" of cash when they do NOT affect the cash account (outside of tax consequences). I've heard it explained that there's some "opportunity cost" of using AR instead of having a cash sale, but you can't really control how you customer pays so...yeah. Same with accrued expenses, I just don't get it. How is a noncash transaction considered a source or use of cash? Anyone who cares to explain this to me will be my friend forever (and will benefit the thread too ;) )
So if you know the comps trade at 7x interest. That means he is saying for the industry "7 times interest coverage is the norm".. This is an assumption that you would mention as you went through the math.
If you have $7M in interest payment and the max you can "lever up" is to 7x leverage thats $7M*7x leverage = $49M in EBITDA or roughly $50M as you saw by the rounding.
Knowing that you can get your interest payments all the way up to 7x leverage... That means the question is how much debt can you get on your books to get $7M in interest payments. I used numbers that would be "appropriate" based on today's rates and how you would build out a 1 page LBO in an interview.
If the company was insanely good, and got interest rates of say "1%" then well you can actually take out $700M in debt. This is because the 1% on debt is only a $7M in annual interest payment.
Same concept on your second question.
If he gave you the amount of debt and told you "7x coverage" and you assume you go to the "comps" ie the normal that means the $200M in debt cannot have an interest payment in excess of 3.5% because then your multiple exceeds 7x.
Hope that clears it up now.
(also going to toot my own horn for a second since I caught "heat - eg monkey shit" on my "EV/Sales" question in a thread I started when that is exactly what you were asked in a different way)
If you don't mind, can i take a stab in the dark and say M&A division with high deal flow and low turnover? This is the future my friend, breed candidates within and promote within to decrease cost, increase revenue and lower risk of "new hires" who don't perform. We put up a full guide of the main ~50 technical ?'s u'll be answered on the site but not going to troll and place a link have at it.
Hey everyone, really appreciate all your help. I will SB, when I get a chance. WSP, I understand most of what you said. Can you just explain a bit more, but how you use EBITDA/Interest Payments ratio (that's what you mean by 7X coverage, correct? But that would NOT be 7X EBITDA then, correct, cause then you're stating ebitda is in the denominator of the ratio, and i think the only important ratio that has EBITDA in the denominator is debt/ebitda, right?) to get to 3.5% for the second question? Or, do you just use the 7 mm in interest payments and just do something like 7mm/200mm, so interest payments/debt = interest rate percentage, which totally makes sense of course, but would you in any way utilize the coverage ratio? THANKS SO MUCH!
You have it together.
The ebitda/coverage ratio got the "Max dollar amount outlay"
As you see in the first part it was really $7.14M but just rounded to $7M.
Interest coverage means = EBITDA/Interest Payment (all in dollars)
7x coverage = $50M/ something Solve: multiply both sides by "something" 7x * something = $50M $50M/7 = $7.14.
Now you have the max interest payment for all debt loads.
$7.14M/total debt = rate on debt
Given two tranches of debt, assume a 75%/25% (for "interview purposes") and put the rates 2 or 4 percent apart.
This is bc the math is easier (75% 25%) you just cut 1% or 50bps off the high end. At 50/50 you take the midpoint, at 25/75 you add 50 or 100bps to the mid-point.
You can move the numbers around and then the interviewer believesyou are fast at math, when really you're just setting yourself up to be "perceived" as fast. Which is all that matters anyway.
Ps: don't subscribe to threads so just ping if there is a question people are not answering, also dont be surprised to see more of these over the next year or so. Not the "debt question" but the backward multiple ones.
I'm not 100% of this, but I'm fairly confident.
Make these assumptions: 1. Multiples are EXTREMELY reliable (i.e. efficient market) 2. No taxes, no bankruptcy costs 3. They mean that the firm is funded solely through debt
Ahem ahem... Modigliani-Miller (wiki it).
EV = $50mX7 = $350m (this is the firm value, including value of equity and debt) EV = Debt + Equity Equity = 0 Debt = EV = $350 million
Under the above assumptions, investors should be indifferent between funding the company with debt, and funding it with equity. Accordingly, the value of the two tranches, together, is $350 million. Ask yourself, why would it be worth any less? If you KNOW the firm is worth $350 million, and you're indifferent between debt and equity, then you would price the debt at $350 million.
Refinements 1. Obviously there are taxes. Interest is tax deductible, so there is a tax shield effect which should increase the value of the firm (and debt). Note that this fully depends on the average D/EV ratio of your comps. If all of your comps have a D/EV=1, then the tax shield effect is already priced-in. If the average D/EV$350 million.
Sorry for the limited info. Have a couple questions if that's okay:
In number 3, why would using sub notes mean that someone is worried about bankcruptcy costs?
For number 1, if Debt/EV is less than 1, doesnt this mean debt is lower in value, and is
^^ I see where you're going but the OP says in the comments
"Interviewer said company has $200M in debt"
So the question is just obscure and it sounds like this was a walk through question where op didn't remember all the deets.
Oh haha that's a pretty crucial piece of info... wish I didn't waste my time.
There is a lot more missing here...
Smoor00: I remember in undergrad one of my profs saying that every year they had a group of MBAs that just finished reading M&M's theories that came up with the very original idea of running a company on 100% debt. Just can't do all debt, but on the upside, at least you're thinking like an MBA.
I feel a little trolled by OP adding details late in the case. It's like a guy that keeps going back to tell you details in a joke.
Am I the only one who thinks everyone is overthinking #3? To me: "how much would you pay" translates to "quote me some realistic pricing."
For a company levered 3.5x through the senior secured, with only $50MM of ebitda, you would pay like 500bps in this market for the secured tranche. Levered 7x through the sub notes, you'd probably have to pay like 10% (plus or minus a few hundred bps, depending on what kind of assets we're dealing with & the type of business model).
That is, I'd pay par at 5% and 10%(ish).
You are talking about what the coupon on the debt would be not the price.
Sub notes is not a necessary bankruptcy risk, could be a ton of reasons to issue sub/mezz debt, when you get into PE it's quite common depending on situation of course. Sub debt is one of the "last in line"
All those notes are is "order of liquidity preference"
If a company takes out mass debt, and you are the mezz/sub-debt. You're last in line, that is the layer where debt investors are worried abt bankruptcy risk.
Revolver -> senior -> sub/mezz is your order of higher interest rates and therefore higher risk of bankruptcy insolvency. No need to overthink
Also the comments above generally validates the rough numbers link to libor everyone is coming in at 5-10% without any info because you just base it on the leverage, comps and size of company in a quick lbo for an interview.
Note if someone asked "why is sub-debt higher" then that would show a complete misunderstanding of bonds and would be a ding for sure.
Oreos: So we agree that MBAs are Douchbags, done (its okay, I have friends that are MBAs so I can say that).
Cries: I'm a little confused by your statement "if D/EVEV = D+E, so D must be EV, so D/EV will always be
[quote=overpaid_overworked]Oreos: So we agree that MBAs are Douchbags, done (its okay, I have friends that are MBAs so I can say that).
Cries: I'm a little confused by your statement "if D/EVEV = D+E, so D must be EV, so D/EV will always be EV, i think he meant it would be 1, if D=EV, but then you would have to subtract cash so it should be less than one, right?...
i posed a similar question if you can advise perhaps, "For number 1 (in his post), if Debt/EV is less than 1, doesn't this mean debt is lower in value, and is
[quote=overpaid_overworked]Oreos: So we agree that MBAs are Douchbags, done (its okay, I have friends that are MBAs so I can say that).
Cries: I'm a little confused by your statement "if D/EVEV = D+E, so D must be EV, so D/EV will always be
^^ agree with much of above. Only disagreement is based on question looks like he was asked to do so, in that case you should definitely at least walk through a possible interest rate.
@ddp My answer doesn't apply since the actual value of debt was revealed to be $200m.
Just to clarify, I was saying that if the D/EV of your COMPS was EV/EBITDA multiple since your target firm enjoys a relatively larger tax shield, as compared to its comps (because your target's D/EV=1).
So, you would add a premium to EBITDA, because of a higher tax shield present in your target firm, since the debt (d/EV=1, wholly debt financed) of your target would be higher than your comps (
Still don't understand why it would increase your debt and FV though, if tax shield is up?
The way the first question is worded, I found myself chuckling and instinctively wanting to say "uhh...I'd recommend they sell a product or service above cost."
Obviously, this isn't the answer they'd be looking for, but based on how it's worded, I couldn't help but say that.
Was this for a restructuring group? I got asked these same qs during my RX interviews
What is the equity worth?
2 is a use of cash because when a receivable goes up, that is cash that is owed but is not being paid. This can be showed through the use of the Operating Activities part of the statement of Cash Flows. When an asset increases, you subtract because that is cash being used, not an inflow of cash.
So since your A/R is increasing, that means that the people who owe you money are not paying you in CASH, your account is increasing. Therefore increasing the amount of cash OWED, not being paid. When an asset increases, you always subtract from OP activities for Cash flows.
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