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).

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Comments (45)

Oct 23, 2007 - 2:49pm

Pretty impressive list.

One comment to your statement regarding "what makes a good LBO target" - the "not highly levered" attribute is irrelevant when looking at a potential target. From a buyside perspective, a company’s current capital structure has no impact on the company's valuation since you'll be acquiring the entire enterprise (this is why deal multiples are generally expressed in terms of EBITDA multiples).

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Oct 23, 2007 - 5:12pm

Thanks a lot for posting this!

One thing - could someone explain the all-stock acquisition accretive/dilutive questions a little more? I'm not sure if I completely understand whats going on there.

Oct 23, 2007 - 7:19pm

This is excellent stuff!

********"Babies don't cost money, they MAKE money." - Jerri Blank********

********"Babies don't cost money, they MAKE money." - Jerri Blank********
Oct 23, 2007 - 7:51pm

These were all asked of me for IB associate positions:

Q: How do you value the beta of a privately held company?
A: Look at comparable publicly held companies, unlever the betas to account for capital structure, take the average of these unlevered betas, relever this average to your private company's capital structure.

Q: If you lever up a company, and if bankruptcy is not a concern, tell me how each component in the WACC formula is affected.
A: WACC - decreases because rd is cheaper than re
D/V - increases
E/V - decreases

Q: Tell me about a recent article in the WSJ that you found fascinating.
A: Have memorized cold a recent transaction. Ex: ABN Amro acquistion.

Oct 23, 2007 - 8:09pm

1.Ebay declares an impairment write-down of $1.3B from the Skype deal. You check the latest B/S, but goodwill was written down by just half that amount- $650M. Why the discrepancy?..where did all that money go?

  1. Your client is seeking distressed assets. He has $1M on his B/S under cash and R/E on his B/S. You find him an estate on Park ave. which nobody wants. It has a fair value of $10M, but the buyer is willing to give your client an exclusive offer for ONLY $1M! Your client jumps on the opportunity and buys. How does he reflect this on his proforma B/S?

  2. Credit markets are frozen, so you're seeking investors to provide alternative capital to help your equity sponsor finance a buyout. Here's the remaining piece of the pie:
    a. $1M Preferred stock, (worth 10M equity @exit), pays a 5% dividend.
    b. $1M Convertible notes, (worth 10M equity @exit), pays a 5% coupon.

Which is more profitable to the investor?
Which is the more expensive to the issuer?
..and why?

Oct 25, 2007 - 3:33pm

1.Ebay declares an impairment write-down of $1.3B from the Skype deal. You check the latest B/S, but goodwill was written down by just half that amount- $650M. Why the discrepancy?..where did all that money go?

  1. Your client is seeking distressed assets. He has $1M on his B/S under cash and R/E on his B/S. You find him an estate on Park ave. which nobody wants. It has a fair value of $10M, but the buyer is willing to give your client an exclusive offer for ONLY $1M! Your client jumps on the opportunity and buys. How does he reflect this on his proforma B/S?
Best Response
Oct 25, 2007 - 7:52pm

1. The purchase price was contingent on the target meeting performance goals. This contigency was structured using earn out instruments tied to either future EBITDA, or the ability to reach product development milestones. Look up the DEFM 14A for exact arrangement. When deal financing gets tough to come by, earnouts become very helpful in reaching a consensus during negotiations. You'll see more of these in this slow credit market.

In EBAY's case, I believe FASB 141/142, requires that the expected purchase price be reflected at full cost (like a majority equity stake), including contigencies such as earnouts, since they are held in Escrow accounts pending a payout. So since the target couldn't reach the goal, the purchase price was actually revised downwards, that's why goodwill was written down by a much smaller amount based on the revised (lower) purchase price. It all balances out, on both sides of B/S.

  1. Write up the distressed assets to FMV, but since the PP is way lower than BV of acquired assets, in the US, you must deduct the negative goodwill created on a pro-rata basis from all non-current assets. If your fixed assets are down to zero, and you still have -ve goodwill, recognize a non-cash extraordinary gain (GAAP) on I/S, so on B/S negative goodwill disappears..magic! -> But this will almost never happen, at least not in Manhattan, but is very common in the distressed business...which is poised to pick up in the near future.
Oct 27, 2007 - 2:14pm

For the LBO Target question. This fits under the "undervalued" answer, but I received a question similar to this. An additional answer is that companies that have fully depreciated fixed assets with high market value are attractive take-over targets because the acquiring firm pays next to nothing for these assets.

Nov 2, 2007 - 7:31pm

Assume depreciation were to be increased by $10 mm at a 40% tax rate.

IS: Pre-tax income is $10 mm lower, so taxes paid are $4 mm lower and net income ends up $6 mm lower (- 10 + 4)

BS: PP&E is $10 mm lower, cash is $4m higher and retained earnings are $6 mm lower

CFS: Cash flows from operating activities is increased by $4 mm (net income was $6 mm lower, but offset by higher D&A of $10 mm)

Nov 3, 2007 - 8:33am

^ My mistake, both answers are exactly correct.

Another thing to think about is the actual cause of increased depreciation. A better answer would add that an incr. in depr. was likely due to the purchase of some fixed asset, so the fixed asset account reflects this increase, and depending on how the asset was financed (debt, equity, or cash account), the cash, equity or liability accounts would be affected as well.

Depr. increases are always sparked by increasing the fixed asset account by acquiring fixed assets.

That leads to the last point. CF from investing acitivities (capex) would be -ve the cost of the acquired asset..so this actually hurts cash flows only in the period of the acquisition.

Remember as per GAAP, capital expenses are immediately capitalized, but are expensed over the useful life of the asset on I/S via D&A, so capex really has no effect on reported EPS, but effects CFs.

The poster below is correct aswell.

Nov 12, 2007 - 9:30am

I had the depreciation question, I asked was there a purchase of fixed assets or was there a change in policy or what? they said no change in assets, just $100 more dep. Obviously depends what they ask, you may want to clear that up, cause then you have a lot more effects. If it's an increase in assets you are looking at the half year rule, whereby only 50% of your dep is deductable in the current year. Doubt they get that specific, but just in case I personally asked. The first answer is fine, that's what I said, and the guy said it was the best answer he had all day, most ppl mess up the cash portion for w/e reason, your also assuming revenue high enough that the dep doesn't take you into negative, in which case you would have a change in future tax asset or liability. You could also see a change in the two if you are not depreciating at the rate allowed by the government agency (I'm from Canada so it's CCA, don't know the US name), so you have to adjust the future tax a/l.

Nov 3, 2007 - 1:58am

correct me if I'm wrong, but I think the whole point of this question is to see if you remember the tax shield (as smuguy did)

How can your net income decrease by 10M? It should reduce by 10M*(1-T) which is 6M and that 6M should feed into r/e.

Depreciation is a non-cash expense as you said, but I think the 4M cash increase smuguy spoke of is because of 4M tax savings

I'm not sure, maybe I'm wrong, but I think smuguy's answer is what an interviewer wants to hear

Nov 3, 2007 - 10:48am

Wow thanks for the quick response.

One more:

If your have two companies, both with the same EBIT, but one has a higher interest coverage ratio, does this mean that the higher one has more financial flexibility in terms of debt? One has a credit rating of A, and the other of BBB.

My professor took the Interest Expense and divided by WACC (the first company having a lower wacc due to better credit), and showed that the company with the higher interest coverage ratio had LESS financial flexibility.

This goes against my general understanding of the interest coverage ratio, and I may have misunderstood him in class, but can someone clear this up?

Nov 12, 2007 - 2:00am

Having recently gone through the interview process - this is an EXCELLENT list.

While no list can be totally comprehensive, I'd be surprised if you got thrown for a loop on any technical question if you have mastered this list.

- Capt K - "Prestige is like a powerful magnet that warps even your beliefs about what you enjoy. If you want to make ambitious people waste their time on errands, bait the hook with prestige." - Paul Graham
Nov 12, 2007 - 2:01am
  • Double post redacted -
- Capt K - "Prestige is like a powerful magnet that warps even your beliefs about what you enjoy. If you want to make ambitious people waste their time on errands, bait the hook with prestige." - Paul Graham
Jan 25, 2008 - 12:54am

I would say... "Generally, you would use the WACC method which is... (explain the equation) then to find the discount rate for equity you would use the famous CAPM (explain that). Then you take your discount rate and plug it back into your FCF summation to find the enterprise value of the company."

Mar 11, 2011 - 5:16pm

my threads.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
Apr 3, 2011 - 12:34pm

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