Investment Banking Interview Prep

• The guide helps answer "fit" and technical questions in investment banking interviews.
• Focus is on what is important to say.
• Other guides are often not investment banking-specific, out-of-date, wrong or incomplete, and not written by bankers.
• The guide includes 400 investment banking interview questions and answers.
• Questions are divided into “fit” questions, technical questions, and other topics like restructuring.

Technical Questions & Answers

• Technical Questions are evolving beyond basic valuation and depreciation questions.
• It is important to admit when you don’t know the answer to a Technical Question.
• There is more leeway to say that you don’t have much experience or don’t know the specific answer, with advanced modelling questions.

Accounting Questions & Answers – Basic

• There are 5 Accounting concepts you need to know
• The 3 financial statements and what each one means.
• How the 3 statements link together and how to walk through questions where one or multiple items change.
• Different methods of accounting – cash-based vs. accrual, and determining when revenue and expenses are recognized.
• When to expense something and when to capitalize it, since not all expenses are created equal.
• What individual items on the statements, like Goodwill, Other Intangibles and Shareholders' Equity, actually mean.
• The 3 major financial statements are the Income Statement, Balance Sheet and Cash Flow Statement.
• The Income Statement shows revenue and expenses, going down to Net Income.
• The Balance Sheet shows assets, liabilities, and shareholders' equity (Assets = Liabilities + Shareholders' Equity).
• The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, then lists cash flow from investing and financing activities, and shows the company's net change in cash.
• Examples of major line items on the Income Statement include: Revenue, Cost of Goods Sold, SG&A, Operating Income, Pretax Income, and Net Income.
• Examples of line items on the Balance Sheet: Cash, Accounts Receivable, Inventory, Plants, Property & Equipment (PP&E), Accounts Payable, Accrued Expenses, Debt, and Shareholders' Equity.
• Examples of line items on the Cash Flow Statement: Net Income, Depreciation & Amortization, Stock-Based Compensation, Changes in Operating Assets & Liabilities, Cash Flow From Operations, Capital Expenditures, Cash Flow From Investing, Sale/Purchase of Securities, and Dividends Issued, Cash Flow From Financing.
• Net Income from the Income Statement flows into Shareholders' Equity on the Balance Sheet and into the top line of the Cash Flow Statement.
• Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, while investing and financing activities affect Balance Sheet items.
• Cash and Shareholders' Equity on the Balance Sheet act as “plugs,” with Cash flowing in from the final line on the Cash Flow Statement.
• Use the Cash Flow Statement to review the overall health of a company.
• TheIncome Statement and Balance Sheet can be used to create the Cash Flow Statement.
• An increase in Depreciation reduces Pre-Tax Income.
• Depreciation is a non-cash expense, but it is tax deductible.
• Depreciation reduces the amount of taxes and therefore affects cash.
• Depreciation usually shows up as a separate line item or can be embedded within Cost of Goods Sold or Operating Expenses on the Income Statement.
• With Accrued Compensation operating expenses on the Income Statement increase.
• With Accrued Compensation liabilities increase, and retained earnings decrease.
• The expense from Inventory expense is only recorded when the goods the items are associated with are sold
• Changes on the Income statement at the start of “Year 1,” occur a year later as depreciation and interest.
• Negative shareholders' equity is common after leveraged buyouts with dividend recapitalizations or with continued net losses.
• Operating Working Capital is (Current Assets – Cash & Cash Equivalents) – (Current Liabilities – Debt).
• Negative working capital is not necessarily a bad sign and depends on the company and the specific situation.

Accounting Questions & Answers – Advanced

• GAAP is accrual-based, while tax is cash-based.
• GAAP uses straight-line depreciation whereas tax accounting is different (accelerated depreciation).
• Deferred Tax Liabilities arise when a tax expense is on the Income Statement but hasn’t actually been paid. Deferred Tax Assets arise when taxes are paid but haven’t been expensed on the Income Statement yet.
• Bottoms-Up revenue build: Start with individual products/customers, estimate the average sale value or customer value, and then the growth rate in sales and sale values to tie everything together.
• Tops-Down revenue build: Start with “big-picture” metrics like overall market size, then estimate the company’s market share and how that will change in coming years, and multiply to get to their revenue.
• Bottoms-up expense model: Start with each different department of a company, the # of employees in each, the average salary, bonuses, and benefits, and then make assumptions on those going forward.
• Project Depreciation and Capital Expenditures as a % of revenue or previous PP&E balance.
• For Net Operating Losses reduce the Taxable Income by the portion of the NOLs that you can use each year, apply the same tax rate, and then subtract that new Tax number from your old Pretax Income number.
• Operating leases are for short-term leasing and don't involve ownership. Capital leases are for longer-term items, give the lessee ownership rights, and are counted as debt.
• The Common Stock is the par value of however much stock the company has issued.

Enterprise / Equity Value Questions & Answers – Basic

• Enterprise Value represents the value of the company attributable to all investors.
• Equity Value only represents the portion available to shareholders (equity investors).
• Equity Value is the number public-at-large sees, while Enterprise Value represents its true value.
• Enterprise Value is how much an acquirer really “pays” and includes debt repayment.
• The formula for Enterprise Value is: Equity Value + Debt + Preferred Stock + Noncontrolling Interest – Cash
• "Noncontrolling Interest" was formerly known as Minority Interest.
• Necessary to add the Noncontrolling Interest to Enterprise Value to get to in keeping with the “apples-to-apples” theme.
• Calculate fully diluted shares by taking the basic share count and adding in the dilutive effect of stock options and any other dilutive securities.
• You use the Treasury Stock Method to calculate the dilutive effect of options.
• Cash is subtracted because it is considered a non-operating asset and because Equity Value implicitly accounts for it.
• Technically you have to subtract only excess cash above the cash needed to operate.
• In most cases debt must be refinanced in an acquisition.
• A company could have a negative enterprise value with extremely large cash balance, or an extremely low market capitalization.
• It is not possible to have negative equity value because there cannot be a negative share count or share price.
• Preferred Stock pays out a fixed dividend, and preferred stockholders have a higher claim to a company's assets than equity investors do, so it is seen as more similar to debt than common stock.
• If convertible bonds are in-the-money, you count them as additional dilution to the Equity Value. If they're out-of-the-money then you count the face value of the convertibles as part of the company's Debt.
• Equity Value is the market value and Shareholders' Equity is the book value. Equity Value can never be negative while Shareholders' Equity could be any value. For healthy companies Equity Value usually far exceeds Shareholders' Equity.

Enterprise / Equity Value Questions & Answers – Advanced

• There are problems with the Enterprise Value formula: it is too simple and there are a lot of other things you need to add into the formula with real companies.
• Technically, use market value for everything. use market value only for the Equity Value portion, because it's almost impossible to establish market values for the rest of the items in the formula.
• If your basic Equity Value is $100 million and the diluted Equity Value is $115 million, you might want to check your calculations – it's not necessarily wrong, but over 10% dilution is unusual for most companies.

Valuation Questions & Answers – Basic

• There are the 3 major valuation methodologies
• Comparable Companies,
• Precedent Transactions
• Discounted Cash Flow Analysis.
• Generally, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions.
• You do not use a DCF if the company has unstable or unpredictable cash flows or when debt and working capital serve a fundamentally different role.
• Other methodologies include Liquidation Valuation , Replacement Value , and LBO Analysis
• Liquidation Valuation: Valuing a company's assets if they are sold off and then subtracting its liabilities.
• LBO Analysis: Determining how much a PE firm could pay for a company to hit a "target" IRR.
• Liquidation Valuation is most common in bankruptcy scenarios to see whether shareholders will receive any capital.
• Sum of the Parts is most often used a company has completely different, unrelated divisions.
• LBO Analysis is used whenever you're looking at a Leveraged Buyout , and is also used to establish how much a private equity firm could pay.
• The most common multiples include EV/Revenue, EV/EBITDA, EV/EBIT, P/E, and P/BV.
• FFO is viewed as a “normalized" picture of the cash flow the REIT is generating.
• You use Enterprise Value because those scientists or subscribers are “available" to all the investors (both debt and equity) in a company. The same logic doesn't apply to everything, though – you need to think through the multiple and see which investors the particular metric is “available” to.
• Technically it could go either way, but in most cases the LBO will give you a lower valuation.
• With an LBO, you do not get any value from the cash flows of a company in between Year 1 and the final year.
• With a DCF, you're taking into account both the company's cash flows in between and its terminal value, so values tend to be higher.
• Unlike a DCF, an LBO model by itself does not give a specific valuation.
• Usually you use a the “football field” chart to present Valuation methodologies where you show the valuation range implied by each methodology.
• Valuing apple trees is done the same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the value of the apple tree's cash flows (intrinsic valuation).

Discounted Cash Flow Questions & Answers – Basic

• A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value.
• First, financials are projected using assumptions for revenue growth, expenses and Working Capital to get to Free Cash Flow for each year.
• The Free Cash Flows are summed up and discounted to a Net Present Value based on your discount rate
• The company's Terminal Value is deteremined using either the Multiples Method or the Gordon Growth Method, and can be discounted back to NVP via WACC
• Finally, the two discounted amounts are added together to determine company’s Enterprise Value.
• Then, multiply by (1 – Tax Rate), add back Depreciation and other non-cash charges, and subtract Capital Expenditures and the change in Working Capital.
• Use WACC unless it is specified to use what other discount rate to calculate free cash flow .
• Formula for WACC is Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) + Cost of Preferred * (% Preferred).
• For Cost of Equity, you can use the Capital Asset Pricing Model (CAPM.

Discounted Cash Flow Questions & Answers – Advanced

• In a DCF withiout mid-year convention, discount period numbers of increases by 1 each year from year 1 increasing.
• With mid-year convention, in the DCF is it increases by .5 each year starting at .5 increasing.
• "Tenor" is just the fancy word for “How many years will this loan be outstanding?"
• "Seniority" refers to the order of claims on a company's assets in a bankruptcy – the Senior Secured holders are first in line.
• “Floating” or “Fixed” Interest Rates: A “floating" interest rate is tied to LIBOR.
• “straight line” amortization : means the company pays off the principal in equal installments each year, while “bullet” means that the entire principal is due at the end of the loan's lifecycle.
• Call Protection: Is the company prohibited from “calling back” – paying off or redeeming – the security for a certain period?

Merger Model Questions & Answers – Basic

• A merger model is used to analyze the financial profiles of 2 companies, the purchase price and how the purchase is made, and determines whether the buyer's EPS increases or decreases.
• Step 1 is making assumptions about the acquisition – the price and whether it was cash, stock or debt or some combination of those. Next you determine the valuations and shares outstanding of the buyer and seller.
• You combine the Income Statements, adding up line items such as Revenue and Operating Expenses, and adjusting for Foregone Interest on Cash and Interest Paid on Debt in the Combined Pre-Tax Income line.
• Then, the buyer's Tax Rate is applied to get the Combined Net Income, and then divide by the new share count to determine the combined EPS.
• There's always a buyer and a seller in any M&A deal – the difference between “merger” and “acquisition” is more semantic than anything.
• An acquisition is dilutive if the additional amount of Net Income the seller contributes is not enough to offset the buyer's foregone interest on cash, additional interest paid on debt, and the effects of issuing additional shares.
• But if the deal involves cash, stock, and debt, there's no quick rule-of-thumb you can use unless you're lightning fast with mental math.
• Foregone Interest on Cash, Additional Interest on Debt , Additional Shares .
• After the acquisition, the Combined Financial Statement.
• Goodwill & Other Intangibles Creation.
• It might be saving its cash for something else or it might be concerned about running low
• Its stock may also be trading at an all-time high and it might be eager to use that instead.

Merger Model Questions & Answers – Advanced

• There are multiple advanced topics
• Accounting Treatment Of Ma Deals,
• DEferred Tax Assets, -Liabilities And Different Purchase Methods Like A Stock Purchase. -An Asset Purchase And Section 338(H)(10) Election.
• In purchase accounting the seller's shareholders' equity number is wiped out and the premium is paid over that value is recorded as Goodwill is on the combined balance sheet post-acquisition.
• An exchange ratio is a way to structure a stock deal where the seller receives a fixed of the buyer's shares.

LBO Model Questions & Answers – Basic

• In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt and other variables.
• Step 2 is to create a Sources & Uses section, which shows how you finance the transaction and what you use the capital for; this also tells you how much Investor Equity is required.
• Step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figures, and also add in Goodwill & Other Intangibles on the Assets side to make everything balance.
• Step 4is to project Company's Income Statement.
• Balance Sheet And Cash Flow statements and determine how much debt is paid off each year, based on the available Cash Flow and the required Interest Payments.
• You also want to look at “Debt Comps” for companies in the same industry and see what types of debt and how many tranches they have used.
• The most important part is stable cash flow.
• In an LBO, the debt is “owned” by the company , which assum es more of the risk