We were able to get our hands on a cheat sheet of actual interview questions asked of prospective investment bankers. The questions were compiled by MBA students at the University of Virginia Darden School of Business with, what we were told, the help of some other Ivy League students who have been interviewing on Wall Street.
The students put together what they felt were the most appropriate answers. How’d they do?
Suppose your client had significant excess cash on the balance sheet. How would you recommend its use?
First, you must define what you think is significant excess cash. For companies that are in cyclical industries, paying out large amounts of cash might leave the company unprepared for a subsequent market downturn. Once you have established that your client does indeed have excess cash on the books, there are a few tried and tested uses for excess cash.
- Invest in positive NPV projects (acquisitions, CapEx, R&D)
- Return money to shareholders in the form of share repurchases, dividends, and debt repayments
- Must take into account Kd, Ke, WACC, and tax considerations
How do you determine the debt capacity of a company?
Brief Answer: “IT DEPENDS”… Sales are the biggest unknown factor when determining debt capacity. Debt capacity is determined by borrower’s repayment ability, which depends on its ability to cover interest and principal payments out of cash flows. This depends on cash flows in both good and bad times.
REMEMBER: Company source of repayment will not be from profits but rather its cash remaining after meeting company’s asset investment requirements (including net working capital and fixed assets and dividends). Need to perform sensitivity analysis on the upsides and downsides of sales, variable operating expenses, networking capital, additions to fixed assets. Also depends on attitude toward risk by company’s managers, owners and lenders.
BEWARE of using debt‐to‐equity ratios of comparable companies because two companies can have identical debt-to-equity ratios but significantly different cash flow operating and loan capabilities because of differences in growth rates and cost structures.
What are the drivers to value a company?
When thinking through how to value a firm, there are three key areas that drive value.
Those key drivers of value are the things in your business that:
- Increase cash flow, such as efficiencies, technology and scale.
- Decrease risk, such as a strong compliance culture, no one client or set of clients represents large % of revenues, stability, infrastructure and a strong employee “bench.”
- Increase growth, such as a systematized marketing capability, streamlined operations that can scale easily, broad service offering and a location in an affluent growing community.
If you were looking for a company for your client to acquire, how would you go about doing it?
There are five common valuation methodologies:
- Trading Range (the range the stock has been trading in during the past 52‐weeks). If we trust the market we should assume this is a reasonable place to start our analysis.
- Discounted Cash Flow (DCF), also called Intrinsic Value, seeks to find a present value of all future cash flows of the firm that are available to stakeholders. This can be done using WACC or APV.
- Public Comparables looks at peer companies to determine how the market values companies in the same or similar businesses using multiples including P/E and EV/EBITDA.
- Acquisition Comparables, also called Deal Comps or Precedent Transactions, looks to see how much acquirers recently paid for similar businesses.
- Asset Value, also called liquidation or breakup value, examines what you can sell the company’s assets for (including real estate).
In addition, valuation can be framed through:
- Leveraged Buyout looks at what a financial sponsor could pay considering a target IRR and the debt capacity of the firm.
- Merger Consequences Analysis is actually an affordability analysis (what can an acquirer pay) rather than an analysis of the value of a target.
If a company was looking to raise debt or equity, what are the 3 most important questions to ask?
1.) Whether they will generate enough cash flows to cover interest obligations. How many multiples in excess of current interest payments is their operations generating in cash flow?
2.) What is their current capital structure and can they bring on more debt and leverage the company further without being too levered versus industry and peers so that their credit rating and stock price isn’t negatively impacted.
3.) What is the current equity value, if the stock price is appropriately valued or has a potentially high value, then equity might be better.
A company with a lower P/E is buying a company with a higher P/E. What is the effect of this transaction? Is it “accretive” or “dilutive”? Explain.
As a general rule, a dilutive merger or acquisition occurs when the P/E ratio of the acquiring firm is less than that of the target firm.
What kind of financial modeling have you done in the past?
I used to walk the runway wearing nothing but cashmere socks and wingtips.
Editor’s Note: Ah, Wall Street humor