Investment Banking - Technical Interview Questions Rated A+

Investment Banking - Technical Interview Questions Rated A+ A company has had a positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen? ️1. Excessive capital expenditures (cash-flow neg) 2. Unaffordable high interest expense 3. Credit crunch for loan maturity. 4. Significant one-time charges (from litigation, etc.) that are high enough to bankrupt the company. A company makes $100 cash purchase of equipment on Dec. 31. How does this impact the three financial statements this year and next year? ️Year 1 Assume FY ends Dec. 31. Why? No depreciation for the first year. IS: Capital expenditure so no affect on net income, i.e. no change on IS. CFS: No change in net income = no change in cash flow from operations; however, $100 increase in capex ($100 use of cash in cash flow from investing activities) = $100 use of cash. BS: Cash down $100, PP&E up $100. Year 2 Assume straight line depreciation over 5 years with 40% tax rate. IS: $20 of depreciation = $12 reduction in net income. CFS: Net income down $12 and depreciation up $20 = Net effect is cash up $8. BS: Cash (asset) up $8 and PP&E (asset) down $20. Retained earnings down $12 to balance. A company makes $100 debt purchase of equipment on Dec. 31. How does this impact the three financial statements this year and next year? ️Year 1 IS: No depreciation and no interest expense. CFS: No change to net income = no change to cash flow from operations. $100 increase in capex = $100 use of cash in cash flow from investing activities. Increase in cash flow from financing section = increase of debt of $100. Net effect on cash = 0. BS: No change to cash (asset), PP&E (asset) up $100 and debt (liability) up $100 to balance. Year 2 Assume straight line depreciation over 5 years with 40% tax rate. Assume a 10% interest rate on debt and no debt amortization. IS: $20 depreciation + $10 of interest expense = $18 reduction in net income ($30 * (1-40%)). CFS: Net income down $18 and depreciation up $20 = Net effect of cash up $2. BS: Cash (asset) up $2, PP&E (asset) down $20, Retained Earnings down $18. Balance Sheet ️1. Assets Current Assets (Cash, AR, Inventory, etc) Long-term Assets (PP&E, Amortization, etc.) 2. Liabilities Current Liabilities (AP, etc.) Long-term Liabilities (Debt, Minority Interest) 3. Shareholder Equity Assets = Liabilities + Shareholder Equity Can you explain how the Balance Sheet is adjusted in an LBO model? ️1. Liabilities and Equities side is adjusted. The new debt is added on, and the Shareholders' Equity is 'wiped out' and replaced by however much equity the private equity firm is contributing. 2. Assets, cash is adjusted for any cash used to finance the transaction, and then Goodwill and Other Intangibles are used as a "plug" to make the balance sheet balance. Explain the concept of synergies and provide some examples. ️2+2=5 When the sum of the value of the Buyer and the Target as a combined company is greater than the two companies valued apart. Two types of synergies: cost synergies and revenue synergies. Cost synergies refer to the ability to cut costs of the combined companies due to the consolidation of operations, i.e. closing one corporate headquarters, shutting down redundant stores, etc. Revenue synergies refer to the ability to sell more products/services or raise prices due to the merger, i.e. cobranding. Economies of scale. How can we calculate Cost of Equity WITHOUT using CAPM? ️Cost of Equity = (Dividends per Share/Share Price) + Growth Rate of Dividends *Use where dividends are more important or when you lack proper information on Beta and the other variables that go into calculating Cost of Equity in CAPM. How do the 3 statements link together? ️Net income from 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 Cash Flow investing and financing activities affect Balance Sheet items such as PP&E and Shareholders' Equity How do we use the Treasury Stock Method to calculate diluted shares? ️1. Tally the company's issued stock options and weighted average exercise prices (from the company's 10K) If using for precedent transactions or M&A analysis, we will use all of the options outstanding. If our calculation is for a minority interest based valuation (comparable companies) we will use options exercisable. Options exercisable are options that have vested while options outstanding takes into account both options that have vested and that have not yet vested. 2. Subtract the exercise price of the options from the current share price (or per share purchase price for an M&A analysis), divide by the share price (or purchase price) and multiply by the number of options outstanding. Repeat for each subset of options reported in the 10K. 3. Aggregate to get the amount of diluted shares. Options where the exercise price is greater than the share price then the options are out of the money and have no dilutive effect. How do you account for converitble bonds in the Enterprise Value formula? ️If the convertible bonds are in-the-money, meaning that the conversion price of the bonds is below the current share price, then 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'