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1. How do you value a company?

This question, or variations of it, should be answered by talking about 2 primary valuation methodologies:
Intrinsic value (discounted cash flow valuation)
Relative valuation (comparables/multiples valuation)
Intrinsic value (DCF) - This approach is the more academically respected approach. The DCF says that
the value of a productive asset equals the present value of its cash flows. The answer should run along
the line of “project free cash flows for 5-20 years, depending on the availability and reliability of
information, and then calculate a terminal value. Discount both the free cash flow projections and
terminal value by an appropriate cost of capital (weighted average cost of capital for unlevered DCF and
cost of equity for levered DCF). In an unlevered DCF (the more common approach) this will yield the
company’s enterprise value (aka firm and transaction value), from which we need to subtract net debt to
arrive at equity value. Divide equity value by diluted shares outstanding to arrive at equity value per
share.
Relative valuation (Multiples) - The second approach involves determining a comparable peer group –
companies that are in the same industry with similar operational, growth, risk, and return on capital
characteristics. Truly identical companies of course do not exist, but you should attempt to find as close
to comparable companies as possible. Calculate appropriate industry multiples. Apply the median of
these multiples on the relevant operating metric of the target company to arrive at a valuation. Common
multiples are EV/Rev, EV/EBITDA, P/E, P/Book, although some industries place more emphasis on
some multiples vs. others, while other industries use different valuation multiples altogether. It is not a
bad idea to research an industry or two (the easiest way is to read an industry report by a sell-side
analyst) before the interview to anticipate a follow-up question like “tell me about a particular industry
you are interested in and the valuation multiples commonly used.”
2. What is the appropriate discount rate to use in an unlevered DCF analysis?
Since the free cash flows in an unlevered DCF analysis are pre-debt (i.e. a helpful way to think about this is
to think of unlevered cash flows as the company’s cash flows as if it had no debt – so no interest
expense, and no tax benefit from that interest expense), the cost of the cash flows relate to both the
lenders and the equity providers of capital. Thus, the discount rate is the weighted average cost of
capital to all providers of capital (both debt and equity).
The cost of debt is readily observable in the market as the yield on debt with equivalent risk, while the cost
of equity is more difficult to estimate.
Cost of equity is typically estimated using the capital asset pricing model (CAPM), which links the
expected return of equity to its sensitivity to the overall market (see WSP’s DCF module for a detailed
analysis of calculating the cost of equity).
3. What is typically higher – the cost of debt or the cost of equity?
The cost of equity is higher than the cost of debt because the cost associated with borrowing debt (interest
expense) is tax deductible, creating a tax shield. Additionally, the cost of equity is typically higher
because unlike lenders, equity investors are not guaranteed fixed payments, and are last in line at
liquidation.
4. How do you calculate the cost of equity?
There are several competing models for estimating the cost of equity, however, the capital asset pricing
model (CAPM) is predominantly used on the street. The CAPM links the expected return of a security
to its sensitivity the overall market basket (often proxied using the S&P 500). The formula is:
Cost of equity (re) = Risk free rate (rf) + β x Market risk premium (rm-rf )
Risk free rate: The risk free rate should theoretically reflect yield to maturity of a default-free government
bonds of equivalent maturity to the duration of each cash flows being discounted. In practice, lack of
liquidity in long term bonds have made the current yield on 10-year U.S. Treasury bonds as the
preferred proxy for the risk-free rate for US companies.
Market risk premium: The market risk premium (rm-rf) represents the excess returns of investing in
stocks over the risk free rate. Practitioners often use the historical excess returns method, and compare
historical spreads between S&P 500 returns and the yield on 10 year treasury bonds.
Beta (β): Beta provides a method to estimate the degree of an asset’s systematic (non-diversifiable) risk.
Beta equals the covariance between expected returns on the asset and on the stock market, divided by
the variance of expected returns on the stock market. A company whose equity has a beta of 1.0 is “as
risky” as the overall stock market and should therefore be expected to provide returns to investors that
rise and fall as fast as the stock market. A company with an equity beta of 2.0 should see returns on its
equity rise twice as fast or drop twice as fast as the overall market.
5. How would you calculate beta for a company?
Calculating raw betas from historical returns and even projected betas is an imprecise measurement of
future beta because of estimation errors (i.e. standard errors create a large potential range for beta). As
a result, it is recommended that we use an industry beta. Of course, since the betas of comparable
companies are distorted because of different rates of leverage, we should unlever the betas of these
comparable companies as such:
β Unlevered = β(Levered) / [1+ (Debt/Equity) (1-T)]
Then, once an average unlevered beta is calculated, relever this beta at the target company’s capital
structure:
β Levered = β(Unlevered) x [1+(Debt/Equity) (1-T)]
6. How do you calculate unlevered free cash flows for DCF analysis?
Free cash flows = Operating profit (EBIT) * (1 –tax rate) + depreciation & amortization – changes in net
working capital – capital expenditures
7. What is the appropriate numerator for a revenue multiple?
The answer is enterprise value. The question tests whether you understand the difference between equity
value and enterprise value and their relevance to multiples. Equity value = Enterprise value – Net Debt
(where net debt = gross debt and debt equivalents – excess cash). For more on this equation see WSP’s
article at www.wallstreetprep.com/blog/.
EBIT, EBITDA, unlevered cash flow, and revenue multiples all have enterprise value as the numerator
because the denominator is an unlevered (pre-debt) measure of profitability. Conversely, EPS, after-tax
cash flows, and book value of equity all have equity value as the numerator because the denominator is
levered – or post-debt.
8. How would you value a company with negative historical cash flows?
Given that negative profitability will make most multiples analyses meaningless, a DCF valuation approach
is appropriate here.
9. When should you value a company using a revenue multiple vs. EBITDA?
Companies with negative profits and EBITDA will have meaningless EBITDA multiples. As a result,
Revenue multiples are more insightful.
10. Two companies are identical in earnings, growth prospects, leverage, returns on capital, and
risk. Company A is trading at a 15 P/E multiple, while the other trades at 10 P/E. Which would
you prefer as an investment?
10 P/E: A rational investor would rather pay less per unit of ownership.

Q: Why would two companies merge? What major factors drive mergers and acquisitions?

There are four reasons for mergers and acquisitions:


a. Company merge with another company to enter new markets. They will either
gain access into new product markets, or broaden the spectrum of their product
line. For example, Cisco was famous for its speed of acquiring small/medium
companies during its booming period. A series of acquisition enabled it to build
the full-range network architecture for its customers.
b. Companies merge to enter new geographical markets. With China joining WTO,
we’ll expect that there may be some M&A in the future 5 years, which will help
global companies enter the market.
c. Some mergers focus on enhancing the brand recognition.
d. Some merge to consolidate operations to lower costs by achieving the economies
of scale; Consolidation to gain market share
e. Defensive merger: Buy their way in to prevent them from entering
f. Buy technology/RnD
g. Go further into value chain

Several ways to Merge:


a. Purchase: the amount of payment out of book value is carried as good will on the
purchasing company
b. Consolidation: new company is formed to acquire the assets of the combining
companies.

Q: 2. What are some common anti-takeover tactics?

a. Repurchase the outstanding stocks.


b. Poison Pill: The targeted firm may issue a new series of preferred stock that gives
shareholders the right to redeem it at a premium price after take over.
Two variations: a flip-in poison pill allows all existing holders of target company
shares except the acquirer to buy additional shares at a bargain price; a flip-over
poison pill allows holders of common stock to buy the acquirer’s shares at a
bargain price in the event of an unwelcome merger. A third type of poison pill is
known as people pill, is the threat that in the event of a successful takeover, the
entire management team will resign at once.
c. The major share holders can ally so as to gain the share percentage out of the
control point, say 51%.
d. White Knight: Find another company to buy

Q: 3. What is an LBO? Why leverage up a firm?

LBO, leveraged buyout, is to takeover a company with borrowed funds. Most often,
the target company’s assets serve as security for the loans taken out by the acquiring
firm, which repays the loan out of cash flow of the acquired company. Management
may use this technique to retain control by converting a company from public to
private. A group of investors may also borrow funds from banks, using their own
assets as collateral, to take over another firm. In almost all leveraged buyouts, public
shareholders receive a premium over the current market value for their shares. When

a company that has gone private in a leveraged buyout offers shares to the public
again, it is called reverse leverage buyout.

A major reason for leverage buyout is because a target company is somehow


undervalued. Thus to gain control of the company, build up the management team,
turnover the performance and sell the company when it has gained a higher value will
provide investors with huge premium.

LBOs are typically accomplished by either financial groups (e.g., KKR) or company
management, whereas M&A deals are led by companies in the industry.

Always LBO a company with a strong cash flow in order to pay off interest on debt.
If miss payment banks might repossess.

Q: 4. Why might a company choose to issue debt vs. equity?

• Positive Equity:
i. Does not require dividend payments
ii. If highly leveraged can raise $
iii. Weak cash flow
iv. Currency for acquisition
• Negative Equity:
i. Dilution
ii. More expensive
• Interest on debt is tax deductible, saving on tax increases firm's value.
• When a company has sufficient earning to utilize the tax shield over the life of
the debt, the company will choose to issue debt
• When a company 's debt level is still relatively low. Since the amount of debt
increases to certain level, the increasing probability of bankruptcy begins to
overweight the tax advantage, firm value falls with further increase in leverage.
• Companies with predominantly tangible assets are more likely to issue more debt
than companies with predominantly intangible assets, because of the lower
bankruptcy cost.
• EPS -Earning per share is a good measure when choosing between debt or equity
financing. Although debt financing saves tax, newly created interest expense
reduces net income. For equity financing, although there is no interest expense,
there is possible dividend expense. More importantly, due to the increase in total
number of shares outstanding, equity financing has dilution effect on earning.
• Market Signaling Effect -Historical studies indicate that the announcement of
equity issuing tends to drive down the stock price. Under the assumption of that
managers in the company has more information than the investors, when the
manager expects to have higher earning in the future, issuing debt is a better
choice due to coverage ratio, tax benefit and financial flexibility. Conversely, if
the manager expects the earning will go down, issuing equity is a better choice
since the low coverage ratio and inability to take the advantage of tax benefit.

Q: 5. What could a company do with excess cash on the balance sheet?

• Invest in capital expenditure, research and development


• Invest in the stock and bond market
• Buy back shares
• Look for acquisition targets

Q: 6. How would you calculate a firm's WACC? What would you use it for?

Weighted Average Cost of Capital (WACC)

WACC = Debt/(Debt+Equity) * Return on Debt * (1-tax rate)+ Equity/(Debt+Equity)*Return on Equity


Return on Debt = Yields implied by the trading price of a company's outstanding debt
Return on Equity = Risk Free Rate+ (Market Premium-Risk Free Rate) * Beta
Capital Structure = Debt/(Debt+Equity) : since companies' capital structure often
change over time, it is usually not based on company's current structure, but rather
some target capital structure, often derived from examination of industry average.

WACC is used:
-to discount a company's unlevered free cash flow and terminal value to derive the
value of the company
-in capital budgeting to find the net present value of a particular project

Q: 7. What is the Beta and where would you go to find a firm's Beta? How and why would
you unlever a beta?

Beta measures the systematic risk of an equity portfolio. It describes the sensitivity of
the portfolio to broad market movements. For example, a portfolio which has a beta
of 0.5 will tend to participate in broad market moves, but only half as much as the
market overall.

Various brokerage houses, such as Merrill Lynch and so on, publish beta books where
the results of such regressions are published for a large number of stocks. Bloomberg
also supplies information on betas.

Q: 8. What is the CAPM?


CAPM divides the risk of holding risky assets into systematic and specific risk. To
the extent that any asset is affected by general market moves, that asset entails
systematic risk. Specific risk is the risk which is unique to an individual asset. It
represents the component of an asset's volatility which is uncorrelated with general
market moves. According to CAPM, the marketplace compensates investors for
taking systematic risk, but not for taking specific risk.

CAPM considers a simplified world where: There are no taxes or transaction costs.
All investors have identical investment horizons. All investors have identical perceptions
regarding the expected returns, volatilities and correlations of available risky investments.

Q: 9. What is the calculation for EPS? Does that include preferred stock? Does preferred
stock trade at a discount or premium to common stock and why? (similar question for
convertible bonds)

Net Earnings-Per-Share (EPS) is the portion of a company's net earnings allocated to


each share of stock. It is calculated by dividing net earnings by common shares
outstanding adjusted for the assumed conversion of all potentially dilutive securities.
So it does not include preferred stock.

Securities having a dilutive effect may include convertible debentures, warrants,


options and convertible preferred stock.

Q: 10. Company A wants to buy Company B for $400m, the max they think it is worth,
Company B wants $430m. Company A could use stock v. cash for the additional $30m.
Under what circumstances might Company A agree to the additional $30m?

It seems to me that this question could get various answers under different scenarios.
With my lack of knowledge in accounting and finance, the alternatives as follow.

Alt1.
If Company A and B agree to convert deal from cash deal to stock deal and Company
A and B has different perspective on the value of Company A: Company A expects
that the post-merger value of Company A would be lower than Company B did.

Alt2.
Company A finds out more synergies in the deal

Alt3.
Company A faces unexpected increase in profit and expects that Company B would
record in loss. So the merger would bring more than 30 million tax benefit to
Company A. For example, Company A has 400 million earning before tax and
Company B has 200 million loss in earning before tax then Company would get 70
million tax benefit with assumption that tax rate is 35%.

Another perspective
If Company A and B agree to convert deal from cash deal to stock deal and
shareholders of Company B expects to get capital gains by selling Company B, the
Company B shareholders’ marginal tax rate would change from 39.6% (ordinary
income marginal tax rate) to 20%(capital gain tax rate for the selling stock at the
market). So there is a room for further negotiation.

I am not sure any of alt, so I welcome your comments.

Q: 11. Say you have two high yield bonds with identical coupons and maturities, one from a
supermarket and one from a high tech company. Which one do you buy and why?

Price of bond is decided by the discount rate for each bond. It would be reasonable to
expect that high tech companies would have more spread to treasury than
supermarkets. There fore, the value of high tech bond would be lower than
supermarket bond. If there is no arbitrage opportunity in the market and the investors
are risk averse, the investors choose super market bond.

Q: 12. How do you calculate the firm value for the firm below?

Shares outstanding 100,000


Stock price $20
Debt $500,000
Cash and equivalents $500,000

There are four valuation techniques that are commonly used. Here I used market valuation.
Shares outstanding X Stock Price = 100,000 X $20 = $2,000,000

Q: 13. What major factors affect the yield on a corporate bond?

The short answer:


1) interest rates on comparable US Treasury bonds, and
2) the company’s credit risk.

A more elaborate answer would include a discussion of the fact that corporate bond
yields trade at a premium, or spread, over the interest rate on comparable US Treasury bonds.
How large this spread is depends on the company’s credit risk: the riskier the company, the
higher the interest rate the company must pay to convince investors to lend it money, and
therefore, the wider the spread over US Treasuries.

Q: 14. What did our firm's stock close at yesterday?

Find by looking in the newspaper (e.g., WSJ Money & Investing section) or online
(e.g., http://finance.yahoo.com/).

Q: 15. What is the DJIA at today? NASDAQ? S&P500? What is the long bond at? Fed
funds rate?

Definitions: The “long bond” is the 30-year US Treasury bond. The “Fed funds rate”
is the interest rate charged by banks with excess reserves at a Federal Reserve district
bank to banks needing overnight loans to meet reserve requirements.

For these numbers, you can check the newspaper (WSJ) or any number or financial websites.

Q: 16. Where is the market going? Bond, equity and forex? Where do you think interest
rates will be in the next 12 months?

The current bond market is very attractive to most investors because of the bear
stock market and low interest rates on bank savings. This trend will continue until the
clear turn around in stock market or rising in saving interest rates.
On the foreign currency exchange side, the J.P.Morgan Index climbed up by 0.3 this
Friday.

Actually in a recession(or “downturn”, modestly saying). Although there is no


much space for federal reserve to squeeze, the interest rate would be cut again to help
stimulate the economy. I think the interest rate might keep so low for a quite long while
like one year until the economy eventually bound up.

Q: 17. What happened on the markets in the past three months?

Almost all industries except pharmaceutical and healthcare still keep good profit,
others can’t meet the expectation of market. Gross market demand is inadequate.
Another factor is the lack of confidence in market, though it has been recovered a lot.

Q: 18. Do you read the Wall Street Journal everyday? What's on the front page today?

Yes. Pick one story off the front page every day to remember.

Q: 19. Do you follow an industry, a stock?

Be prepared to talk in detail about an industry or stock.

Q: 20. What do you personally invest in?

Education! Namely books!

Q: 21. What is LIBOR?

Benchmark rate for borrowing used by banks. London Interbank Offered Rate: Rate
that the most creditworthy international banks dealing in EURODOLLARS charge
each other for large loans. The LIBOR rate is usually the base for other large
Eurodollar loans to less creditworthy corporate and government borrowers. For
instance, a Third World country may have to pay one point over LIBOR when it
borrows money

Q: 22. What indicators are considered by Greenspan when deciding on interest rate changes?

When deciding on interest rate changes, we can look at inflation rate (i.e. CPI -
consumer price index, PPI -producer price index), unemployment rate, economic
growth rate, and financial market performance

Q: 23. Why is everyone worried about inflation?

Given everything else the same, inflation means the money you hold in hand worth
less and the nominal prices of commodities go up. If salary increases at similar speed
as inflation rate and inflation is expected, it won’t bring too much impact.

When inflation is expected, it will result in two kinds of cost.


1) Menu cost: it incurs because all the commodities need to re-price, the society has
to pay extra money to make price adjustment;
2) Shoe leather cost: when experiencing inflation, people would increase consumption
and go shopping more frequently because the cost of holding money increases. In this
way, the increased trading frequency and trading time bring extra cost to the society.

On the other hand, when inflation is unexpected, it will result in two negative effects.
1) Redistribution of wealth: employers and banks would benefit from unexpected
inflation since the salary and interest rate can not adjust immediately.
2) Decreased resources allocation efficiency: inflation would increase uncertainty, which
might decrease companies’ willingness to invest or result in wrong decision making.

Q: 24. Draw the forward rate curve over the treasury curve and explain which apex occurs
first since the Treasury curve is now inverted?
This is basically a question specifically for fixed income interview. This question is,
in essence, a question about current rates v.s. future rates. The answer would depend
on your opinion of the forward rate (i.e. Will the Fed be cutting or raising interest
rates in the future?). If you answer is to cut rates, then bond prices would be expected
to go up, thereby reducing the yield for the forward rates. If your answer is to raise
rates, then bond prices would be expect to go down, thereby increasing the yield for
the forward rates.

Q: 25. What does the current shape of the yield curve imply about the market's expectation
for economic growth?

Yield curve is the term structure of interest rates. When the economy is good, the
yield curve is increasing upward. However, the yield curve is inverted when the
economy is bad. The current shape of the yield curve is inverted, which means that
the market’s expectation for economic growth is not favorable

Q: 26. If I gave you $1 for 10 years or $1000 today which one will you choose?

I am risk averse and like to invest the money in risk-free treasure bond. In addition I
have no urgent need of money to expense. So, I will to do the bellow calculation to
make the decision.

I expect that over the next 10 years the risk free rate will be 6%, and I purchase bonds
at the end of every year. The PV of my investment is 2686, which is more than 1000.
As such I will choose $1 every day for 10 years.

Q: 27. Now if I gave you $1 everyday for life and $1000, which one would you choose?

Based on the above analysis, the PV of $1 everyday for life is much more than
$1000( suppose that my life expectance is the average of US residents at 75), so I will
still select the daily payment

Q: 28. Give me 4 ways to calculate terminal value.

Terminal value (TV) refers to the interest’ s value at the end of a given projection period.

Method1.
The TV can be calculated by; using either a market-derived pricing multiple or a growth
model. The most commonly used is the Gorden Growth Model shown below:
TV=(NCF*(1+g))/(k-g)

Where:
NCF=normalized net cash flow in the terminal year
G=expected annual long-term growth rates in NCF
K=the cost of capital

Method2.
Multiple of EBIT or EBITDA in the final year. Often, the current pricing
multiple for guideline companies is used.

Method3.
P/E ratio of the net income of the terminal year. Assuming the company
will be worth some multiple of its future earnings in the continuing period. The
difficulty of this approach is to estimate an appropriate P/E ratio.
Method4.
The liquidation value. Suppose the company will be liquidated at the
terminal year, all assets will be sold at book value.

Q: 29. What is EBITDA?

EBITDA refers to earnings before interest, tax, depreciation and appreciation.


EBITDA is a buzzword in banking industry. It is widely used in business valuation
and analysis. For example, interest coverage ratio (EBITDA/interest expense)
represents a company’s ability to pay interest to its creditors. Debt service ratio
(EBITDA/Outstanding balance of long term loan) measures a company’s ability to
honor its long-term debt.

Often used as proxy for cash flow, especially in telecom because amortization and
depreciation distorts net earnings figures.

Q: 30. Walk me through the major line items of a Cash Flow Statement.

Operation Cash Flow


Direct method: Cash In – Cash Out
Indirect Method: NetIncome + NonCash Loss – NonCash Gain

Investment Cash Flow


Cash In – Cash Out on Long Term Asset

Financing Cash Flow


Cash In (borrow) – Cash Out (pay off debt/dividend)

Q: 31. Walk me through the major line items of a Cash Flow Statement.

Operating Activities:
Sales
Dividends received from subsidiaries
Interests
Cash paid to supplies
Salaries
Income taxes

Investing Activities:
Sale of Equipment
Purchase of land

Financing Activities:
Repurchase of bonds
Dividend paid

Q: 32. If you have closed the books of accounts and now you discover that $10 of depreciation
expense was left out, how would you go about changing the Income Statement and Balance
Sheet?

In general, the correction of an error that is discovered in the financial statements of a


period after they are issued should be accounted as a prior-period adjustment. The nature
of the error and the effect of its correction should be disclosed in the period in which the
error is discovered and corrected.

However, depreciation expense is normally calculated based on estimation. The $10


(assuming it is not significant) can be accounted for in the year in which it is discovered
and should be disclosed in the footnote.

Tax shield would increase.

Q: 33. If you have an accounting background, be prepared to describe how the disposal of a
fixed asset in exchange for cash would be reflected on a GAAP/IAS statement of cash flows.

In general, disposal of fixed assets is under “net cash flow from investing activities”. The
proceeds from the sale are recorded in the Statement of Cash Flows. The gain/loss is
recognized in Income Statement, and the removal of book value of the assets and
accumulated depreciation thereof are booked on Balance Sheet.

Q: 34. What is the difference between a balance sheet and an income statement?
• A balance sheet describes a firm’s financial status at a specific time (end of fiscal year or
quarter).
• An income statement represents a firm’s operating resulting over a period of time (a
fiscal year or quarter).
• From another angle, a balance sheet tells a business’s economic resources that creditors
and shareholders can claim. An income statement summarizes a business’s profitability
(revenue minus expenses) within a time period.

Q: 35. What is goodwill? How does it affect net income?

Goodwill is an asset account that represents the intangible assets a firm has. For example,
the public image / reputation of a firm such as Coca-cola and Nike, and the possible
financial value that the image / reputation may add, is considered as goodwill. Goodwill
can be generated internally or through acquisition.

Goodwill generated internally through the development of a firm is usually not


recognized in the balance sheet. in an acquisition. Goodwill can also be generated when
an acquisition occurs.

Goodwill value = price paid in acquisition – fair market value of tangible assets.

Goodwill reduces net income reported in the income statement. Based on current GAAP,
goodwill must be amortized and recorded as amortization expenses, thus reduces a firm’s
net income.

Q: 36. What are deferred taxes? How do they arise?

An indeterminate-term liability that arises when the pretax income shown on the tax
return is less than what it would have been had the firm used the same accounting
principles and cost basis for assets and liability in tax returns as it used for financial
reporting. SFAS No. 109 requires that the firm debit income tax expense and credit
deferred income tax with the amount of the taxes delayed by using accounting principles
in tax returns different from those used in financial reports. If as a result of temporary
difference, cumulative taxable income exceeds cumulative reported income before taxes,
the deferred income tax account will have debit balance, which the firm will report as a
deferred charge.

Q: 37. What is working capital?

Current asset minus current liabilities; sometimes called “net working capital” or “net
current assets”.
Capital required to keep company operating

The important point to remember in doing problems is that the cash flows associated with
working capital are the changes in working capital. When working capital requirements
go up, there is a negative cash flow, i.e. you need to provide funds; when working capital
requirements go down there is a positive cash flow, i.e. funds freed up.

Q: 38. Who is in the bulge bracket?

According to the Vault: Goldman Sachs Co, Morgan Stanley, Credit Suisse First Boston,
Merrill Lynch, JP Morgan, Citigroup Corporate and Investment Banking (Saloman Smith
Barney).

Q: 39. Describe a typical day of an investment banking associate?

What you always hear is that there is no typical day in investment banking. Deals and
projects come in with no prior warning. So as an investment banking associate, she/he
has to continuously rebalance the priorities. The day is usually split between data
crunching, financial modeling, word processing, client presentations and meetings and
internal meetings/conference calls. Below is the Vault’s version of a typical day of an IB
associate in Goldman Sachs, which many of you may have come across already:

8:15 Arrive at 85 Broad Street. (Show Goldman ID card to get past the "surly" elevator guards).
8:25 Arrive on 17th Floor. Use "blue card" to get past floor lobby. ("Don't ever forget your blue card.
Goldman has tight security and you won't be able to get around the building all day.")
8:45 Pick up work from Word Processing, review it, make changes.
9:00 Check voice mail, return phone calls.
9:30 Eat breakfast; read The Wall Street Journal. ("But don't let a supervisor see you with your paper
sprawled across your desk.")
10:00 Prepare pitchbooks, discuss analysis with members of deal team.
12:00 Conference call with members of IPO team, including lawyers and client.
1:00 Eat lunch at desk. ("The Wall Street McDonald's delivers, but it's the most expensive McDonald's in
New York City; Goldman's cafeteria is cheaper, but you have to endure the shop talk.")
2:00 Work on restructuring case studies; make several document requests from company library.
3:00 Start to prepare analysis; order additional data from DRG (Data Resources Group).
5:00 Check in with vice presidents and heads of deal teams on status of work.
6:00 Go to gym for an abbreviated workout. ("Many Goldman employees belong to the New York Health
& Racquet Club across the street. The firm has also opened a new state-of-the-art fitness center at 10
Hanover.")
6:45 Dinner. ("Dinner is free in the IBD cafeteria, but avoid it. Wall Street has pretty limited food options,
so for a quick meal it's the Indian place across the street that's open 24 hours.")
8:00 Meet with VP again. ("You'll probably get more work thrown at you.")
9:45 Try to make FedEx cutoff. Drop off pitchbook to Document Processing on 20th Floor. ("You have to
call ahead and warn them if you have a last-minute job or you're screwed.")
10:00 Order in food again. ("It's unlikely that there will be any room left in your $20 meal allowance -but
we usually order in a group and add extra names to bypass the limit.")
10:30 Leave for home. ("Call for a car service. Enjoy your nightly 'meal on wheels' on the way home.")

Q: 40. Which of the three methods of valuation is most robust? What are the inherent flaws in
the DCF method?

Methods of valuation:
1) DCF, including WACC and APV
2) Comparative methods, including comparable M&A deals and publicly traded
firms. No fundamental basis for this. Only tells where market is AT.
3) Liquidation method, using the sum of liquidation value of all of the firm’s asset.
Its usefulness depends heavily upon the quality of information it is based on.

The most robust method among these is obviously the DCF method, which takes into
account the synergies and the tax benefit of the capital structures. Essentially, DCF
analysis shows the maximum the acquirer should be willing to pay.

The inherent flaws:


WACC method assumes constant debt ratio, while APV method does not normally take
into account of the bankruptcy costs.

Q: 41. If you were doing comparative company analysis for a client, what are some ratios
would you look at and why?

Ratios include premium over market value and multiples of earning, sales, book value,
and cash flow etc. Comparisons can be made to either comparable M&A deals or
comparable publicly traded firms. The basic idea here is that in a competitive market,
similar firms should sell for similar amount. This requires identifying similar transactions
or firms first, and then using various ratios to see how much the target firm should be
worth.

Q: 42. What is minority interest?

Minority interest is a parent company’s claim to its subsidiary’s earnings, contingent


upon what percentage of the subsidiary is owned by the parent company.

When the minority interest is significant in absolute amount, parent company’s treatment
of minority interests can affect its interest coverage, which is an indicator of a company’s
financial healthiness.

For the parent company, the accurate method of minority interests treatment is:

1. Net earning should exclude earnings from subsidiaries.


2. Dividend charges should also exclude those of subsidiaries as well.
However, the real world treatment can vary from company to company.

Q: 43. What is a P/E (Price/Earnings) ratio and why do analysts use it?

P/E ratio = Price of stock / Earnings per share

P/E ratio, also known as multiple, is used in comparing the relative attractiveness of
stocks. It is an inverse of Earnings/Price ratio. It gives investors an idea of how much
they are paying for a company’s earning power. The higher the P/E, the more investors
are paying, and therefore the more earnings growth they are expecting.

P/E Expected Growth


High (>20) Fast
Low (<20) Slow

Q: 44. Beyond the answer that all of your classmates have given, explain "duration" and
"convexity".

Duration is often used by bond analysts to describe the average time to each payment. If
we call the total value of the bond V, the duration is calculated as follows:
Duration = (1*PV(C1))/V + (1*PV(C2))/V + (1*PV(C3))/V + ….
V = PV(C1) + PV(C2) + PV(C3) + …
In general, duration rises with maturity, falls with the frequency of coupon payments, and
falls as the yield rises (the higher yields reduces the present values o the cash flows.)

A bond’s volatility is directly related to its duration and volatility explains the likely
effect of a change in yield (interest rates) on the value of a bond. The greater the duration
of a bond, the greater its percentage volatility.
Volatility (%) = Duration / (1 + Yield)

Convexity is used to measure the volatility in larger yield changes. It is a mathematical


concept that measures sensitivity of the market price of an interest-bearing bond to
change in yield (interest levels).

That term derives from the price-yield curve for a normal bond, which is convex. In
other words, the price is always falling at a slower rate as the yield increases. The more
convexity a bond has, the merrier, because it means the bond’s price will fall more slowly
and rise more quickly o a given movement in general interest rate levels.

Q: 45. How would you determine the appropriate discount rate for a ".com" company?

Can try to use CAPM. The tricky part is to determine BETA. Regression is not
recommended because there are not enough historical data. One method is to find
comparable companies that have great volatility in stock movements. There should be
constant checks and rationalization of the BETA number obtained.

Q: 46. Given a noodles company with steady earnings, and a technology company that is
poised to take off and which can be sold at a higher exit price, which would you choose
for a LBO?

LBO = Leveraged buyout: takeover of a company, using borrowed funds. Most often,
the target company’s assets serve as security for the loans taken out by the acquiring firm,
which repays the loan out of cash flow of the acquired company. Management may use
this technique to retain control by converting a company from public to private. A group
of investors may also borrow funds form banks, using their own assets as collateral, to
take over another firm. In almost all LBOs, public shareholders receive a premium over
the current market value for their shares. When a company that has gone private in a
leveraged buyout offers shares to the public again, it is called a REVERSE LEVERAGED BUYOUT.
(Dictionary of Finance and Investment Terms – UBS Warburg).

Therefore it is necessary to have a target company that has stable earnings such as the
noodles company. The risk of whether the tech company will really “take off” is high.

Q: 47. If a company's stock price is depressed, how do you unlock value?

It is necessary to look into details as to why the company’s stock price fell.
Must trace and find the reasons: is it a change in leadership? Production problems?
Cash flow problems? Not enough communication and marketing efforts to the brokerage
firms? Etc. This is a broad question. Focus on one topic…

Q: 48. If I have a company with three divisions, and one of the divisions is underperforming,
which leads to the stock price depression of the entire firm. What five things could I do
to improve the firm's stock price?

. Spin off the company


. Reduce costs of that company, i.e. reduce headcount or transfer them to other divisions
. Shut down the business
. Restructure the company
. Modify accounting methods for the third company (i.e. alter depreciation schedule or
inventory recognition method)

Q: 49. If your were valuing a private company looking to do an IPO, what steps would you
take?

1. Build a cash flow over 5, 10, 15 yr horizon depending on industry, and determine “Terminal Value”
2. Calculate DCF
3. Use comparable company analysis to determine fair value of company

Q: 50. Of those, how many will blow up in the first two-year? Why?

NOT A STANDARD QUESTION.

Q: 51. If you're looking at an industry specialization, have some sound bites prepared about
how technology is affecting that industry (and, consequently, how the bank can fish for
transaction opportunities arising out of the effects of technology upon the industry).

DEPENDS ON YOUR INDUSTRY FOCUS

Q: 52. What are the three financial statements? Which one would you pick to value a company
if you could only pick one?

They are Balance Sheet, Income Statement, and Statement of Cash Flow.

It really depends on which viewpoint you emphasize most in valuing a company – that is,
Balance Sheet would be preferable if snapshot of the state of affairs at one point in time
is sufficient to value the company, Income Statement might be good if only following the
results of operations over a period of time is sufficient, and Cash Flow Statement would
be fine if you can value the company by only looking at cash flow during the period.

However, a company should be valued based on the outlook for earnings which might be
reflected in Income Statement and Cash Flow Statement and the market value of assets
on the Balance Sheet. Not a single financial statement alone gives enough information for
valuation of a company.

Q: 53. If it is 1:15 pm, how many degrees are between the two clock hands?

30 * 2 -7.5 = 52.5 degrees

Notes) Short hand sweeps 30 degrees (=360degrees/12hr) per 1 hour. It sweeps 7.5
degree (=30degree/4) per 15 minutes (=1/4hr). Therefore, the degree between two clock
hands is expressed as above.

1. How many degrees (if any) are there in the angle between the hour and the minute hands of a
clock when the time is a quarter past three? [Typically asked during investment banking
interviews for entry level investment banking graduate jobs]
2. Find the smallest positive integer that leaves a remainder of 1 when divided by 2, a remainder of 2
when divided by 3, a remainder of 3 when divided by 4, ... and a remainder of 9 when divided by
10 [Typically asked during interviews for quantitative finance jobs]
3. Two standard options have exactly the same features, expect that one has long maturity, and the
other has short maturity. Which one has the higher gamma? [Typically asked during interviews for
bank derivatives trading jobs]
4. How do you calculate an option's delta? [Typically asked during investment banking interviews
for derivatives trading jobs]
5. When can hedging an options position make you take on more risk? [Typically asked during
interviews for trading jobs]
6. Are you better off using implied standard deviation or historical standard deviation to forecast
volatility? Why? [Typically asked during interviews for quantitative finance jobs]
7. Describe "duration" and "convexity". Describe their properties and uses [Typically asked during
investment banking interviews for graduate investment banking jobs]
8. Two players A and B play a marble game. Each player has both a red and a blue marble. They
present one marble to each other. If both present red, A wins $3. If both present blue, A wins $1. If
the colors do not match, B wins $2. Is it better to be A or B, or does it matter? [Typically asked
during interviews for quantitative finance or derivatives jobs]
9. How do you "value" yourself? Here "value" means in financial terms [Typically asked during
interviews for MBA finance jobs or experienced banking hires]
10. What distinguishes you from other candidates we might hire? [Typically asked during investment
banking interviews for graduate investment banking vacancies]
11. If you could go on a cross-country car trip with any three people, who would you choose? Why?
[Typically asked during interviews for corporate finance / mergers & acquisitions banking jobs]
12. Tell be about a stock you like or hate and why [Asked by job interviewers for any accounting,
finance or job!]
13. What is the difference between default and prepayment risk? [Typically asked during interviews
for credit jobs / risk management jobs]
14. How would you move mount Fuji? [Typically asked during investment banking interviews for
consulting jobs or graduate accounting jobs]
15. Estimate the annual car demand for car batteries [Typically asked during interviews for corporate
finance jobs, mergers & acquisition banking jobs or consulting jobs]

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