Breaking Into Wall Street Exam Questions & Answers
(All Technicals) 400 Questions & Answers: A+ Guide
Solution
What is financial modeling? - ANSWEROutlines similar to blueprints that show
quantifiable views of a company
What are the basic financial modeling steps? - ANSWER1. Identify purpose of the
analysis - stock pitch, calculating ratios, M&A, buyout
2. Background research - company reports, investor presentations and outside
research, equity research, channel checks via interviews
3. Identify key drivers - retailer, F&B, SAAS, hotel
4. Gather data on other companies
5. Build analysis - financial statements, sometimes comparable outside data and
scenarios
6. Present conclusions - what (buy the company, sell the stock, fund the project),
why (supporting reasons with supporting numbers), and how (best structure and
timing)
What Makes Financial Modeling Hard? - ANSWERDetermining company value across
all investor types - equity, debt, convertible bonds, etc; Measured by calculating
equity value and enterprise value
Evaluating different factors for different valuations:
- LBO looks at IRR vs targeted return
- M&A looks at metrics such as P/E, EPS, etc
- Recaps look at credit metrics
Time Value of Money - ANSWERMoney today is worth more than money tomorrow
Opportunity cost is based on how much you can earn from today's cash by investing
it elsewhere
PV formula = I / (1+R)^t; present value heavily depends on the opportunity cost
Methods to Make Investment Decisions - ANSWERMethod 1) asking price < intrinsic
value (+ NPV; IV is the calculated PV of all future CF using the discount rate)
Method 2) potential returns > opportunity cost (useful when you know the cash
flows and discount rate)
Discount Rate - ANSWERCalculates what future CFs are worth today
Otherwise known as the "opportunity cost", if better opportunities available
,Investor's perspective: where money should be allocated in stocks
Companies perspective: allocation across equity and debt
Cost of Capital - ANSWERCost of equity can be based on past stock market returns of
the company
Cost of debt could be based on the debt interest rate charged
Weighted Average Cost of Capital (WACC) - ANSWERWACC = (cost of equity * %
equity) + (cost of debt * (1-tax rate) * % debt) + (cost of preferred * % preferred)
Evaluating all of the different sources of capital, applying the discount rate for each
one, and getting to a weighted average
As leverage increases, cost of both debt and equity also increase because it becomes
more risky
E.g., $1,000 investment allocated across a savings account (1% discount rate),
bonds / loans (5% discount rate), stocks (10% discount rate)
Present Value - ANSWERWhat a payoff in the future is worth today, assuming there
is a discount rate associated and the returns compound each year; intrinsic value is
the calculated PV of all future CFs using the discount rate
PV results will change if CFs change or discount rate(s) change; lower discount rate =
higher PVs
Formulas:
Manual) = CF Yr1 / ((1 + discount rate)^t) + CF Yr2 / ((1 + discount rate)^t) + CF Yr3 /
((1 + discount rate)^t)...
Excel) = NPV
Internal Rate of Return (IRR) - ANSWERAnother type of discount rate, but more
useful when you know the CFs and asking price
IRR is what you'll actually receive vs WACC is what's expected; so, if IRR > WACC,
then invest because it's a +NPV
The Most Important Formula in Finance - ANSWERCompany Value = Cash Flow /
(Discount Rate - Cash Flow Growth Rate)
Assumptions:
- CF growth rate must be < discount rate
- If CF is higher, the company is worth more; vice versa
- If discount rate is higher, the company is worth less; vice versa
,The amount to invest in a company at a given time depends on the opportunity cost
elsewhere
Companies growth rates could change over time, as well as the discount rate as a
company's risk and potential returns change
Income Statement - ANSWERP&L statement which shows revenue, expenses, and 4
income metrics
All items must:
1) correspond to the current period
2) impact the company's taxes
Revenue - ANSWERRecognized when product/service is actually delivered
If it takes a long time to deliver (annual subscription), must recognize over time
Gross Profit - ANSWERHow much additional potential profit the company could
make with each sale before any fixed expenses
High gross profit margin means more can be spent on growing the business,
developing products, etc
Accounts Receivable and Installment Payments - ANSWERGoods / services delivered
but cash not received is revenue; Cash received upfront, but no goods / services
delivered is not revenue
Net income will always be higher than cash if a business offers install payments and
has high A/R, which creates an ongoing difference between cash generated and net
income
Prepaid Expenses - ANSWERIncludes rent, insurance, supplies, services, etc that are
paid for upfront in order to get a better price
Recorded as an asset on the BS because they've already been paid for and lower
future taxes
Accounts Payable - ANSWERCommon for industries with specific invoices including
legal, tax, marketing
Can be associated with any expense
Accrued Expenses - ANSWERMore for ongoing expenses without a real invoice
including wages, rent, etc
Usually associated with OpEx
, More common in long-standing business relationships
Deferred Revenue - ANSWERWhen a payment is made upfront for goods / services
that will be provided over a period such as subscriptions, smartphone, insurance,
gym
Recorded as a liability because the company already received the cash, but revenue
will continue to be recorded and taxed
Inventory - ANSWERVery prevalent for retailers, restaurants, etc that offer physical
products, but have to order supplies and package them first
Can't record the expense of buying materials until the products sell (acct matching
principle)
- This scenario causes net income to always be higher than cash
CapEx and Depreciation - ANSWERCapEx is something that lasts 1+ yrs and is tangible
(stocks, contracts, and IP are not CapEx)
- Depreciation is the allocation of the expense over multiple years
Initially, cash is going to be lower than net income because the upfront expense is
not recorded on the IS; over time, the expense is depreciated on the IS and cash will
be higher
Investments - Short-Term and Long-Term - ANSWERWhen a business has an excess
of cash, they can buy PP&E, hire staff, R&D, or invest (similar to how it works for
personal cash)
Recorded as BS assets because 1) generate cash via interest income and 2) selling
them
Raising Debt - ANSWERRaising debt is for companies that need additional funds to
complete a purchase
Income Statement - no immediate impact after borrowing; recorded as interest
expense but only in the year that the interest expense is paid
Raising Equity - ANSWERCompanies generally raise equity when they have a high
valuation because they don't have to grant as much ownership (E.g. $100 at 10% =
$200 at 5%)
Raising equity dilutes ownership of the company, but it avoids the downsides of
raising debt such as interest expense and principal repayment
Deferred Taxes - ANSWERLarger companies frequently pay taxes differently for a
couple reasons:
1) Front loading taxes when the asset is most valuable
(All Technicals) 400 Questions & Answers: A+ Guide
Solution
What is financial modeling? - ANSWEROutlines similar to blueprints that show
quantifiable views of a company
What are the basic financial modeling steps? - ANSWER1. Identify purpose of the
analysis - stock pitch, calculating ratios, M&A, buyout
2. Background research - company reports, investor presentations and outside
research, equity research, channel checks via interviews
3. Identify key drivers - retailer, F&B, SAAS, hotel
4. Gather data on other companies
5. Build analysis - financial statements, sometimes comparable outside data and
scenarios
6. Present conclusions - what (buy the company, sell the stock, fund the project),
why (supporting reasons with supporting numbers), and how (best structure and
timing)
What Makes Financial Modeling Hard? - ANSWERDetermining company value across
all investor types - equity, debt, convertible bonds, etc; Measured by calculating
equity value and enterprise value
Evaluating different factors for different valuations:
- LBO looks at IRR vs targeted return
- M&A looks at metrics such as P/E, EPS, etc
- Recaps look at credit metrics
Time Value of Money - ANSWERMoney today is worth more than money tomorrow
Opportunity cost is based on how much you can earn from today's cash by investing
it elsewhere
PV formula = I / (1+R)^t; present value heavily depends on the opportunity cost
Methods to Make Investment Decisions - ANSWERMethod 1) asking price < intrinsic
value (+ NPV; IV is the calculated PV of all future CF using the discount rate)
Method 2) potential returns > opportunity cost (useful when you know the cash
flows and discount rate)
Discount Rate - ANSWERCalculates what future CFs are worth today
Otherwise known as the "opportunity cost", if better opportunities available
,Investor's perspective: where money should be allocated in stocks
Companies perspective: allocation across equity and debt
Cost of Capital - ANSWERCost of equity can be based on past stock market returns of
the company
Cost of debt could be based on the debt interest rate charged
Weighted Average Cost of Capital (WACC) - ANSWERWACC = (cost of equity * %
equity) + (cost of debt * (1-tax rate) * % debt) + (cost of preferred * % preferred)
Evaluating all of the different sources of capital, applying the discount rate for each
one, and getting to a weighted average
As leverage increases, cost of both debt and equity also increase because it becomes
more risky
E.g., $1,000 investment allocated across a savings account (1% discount rate),
bonds / loans (5% discount rate), stocks (10% discount rate)
Present Value - ANSWERWhat a payoff in the future is worth today, assuming there
is a discount rate associated and the returns compound each year; intrinsic value is
the calculated PV of all future CFs using the discount rate
PV results will change if CFs change or discount rate(s) change; lower discount rate =
higher PVs
Formulas:
Manual) = CF Yr1 / ((1 + discount rate)^t) + CF Yr2 / ((1 + discount rate)^t) + CF Yr3 /
((1 + discount rate)^t)...
Excel) = NPV
Internal Rate of Return (IRR) - ANSWERAnother type of discount rate, but more
useful when you know the CFs and asking price
IRR is what you'll actually receive vs WACC is what's expected; so, if IRR > WACC,
then invest because it's a +NPV
The Most Important Formula in Finance - ANSWERCompany Value = Cash Flow /
(Discount Rate - Cash Flow Growth Rate)
Assumptions:
- CF growth rate must be < discount rate
- If CF is higher, the company is worth more; vice versa
- If discount rate is higher, the company is worth less; vice versa
,The amount to invest in a company at a given time depends on the opportunity cost
elsewhere
Companies growth rates could change over time, as well as the discount rate as a
company's risk and potential returns change
Income Statement - ANSWERP&L statement which shows revenue, expenses, and 4
income metrics
All items must:
1) correspond to the current period
2) impact the company's taxes
Revenue - ANSWERRecognized when product/service is actually delivered
If it takes a long time to deliver (annual subscription), must recognize over time
Gross Profit - ANSWERHow much additional potential profit the company could
make with each sale before any fixed expenses
High gross profit margin means more can be spent on growing the business,
developing products, etc
Accounts Receivable and Installment Payments - ANSWERGoods / services delivered
but cash not received is revenue; Cash received upfront, but no goods / services
delivered is not revenue
Net income will always be higher than cash if a business offers install payments and
has high A/R, which creates an ongoing difference between cash generated and net
income
Prepaid Expenses - ANSWERIncludes rent, insurance, supplies, services, etc that are
paid for upfront in order to get a better price
Recorded as an asset on the BS because they've already been paid for and lower
future taxes
Accounts Payable - ANSWERCommon for industries with specific invoices including
legal, tax, marketing
Can be associated with any expense
Accrued Expenses - ANSWERMore for ongoing expenses without a real invoice
including wages, rent, etc
Usually associated with OpEx
, More common in long-standing business relationships
Deferred Revenue - ANSWERWhen a payment is made upfront for goods / services
that will be provided over a period such as subscriptions, smartphone, insurance,
gym
Recorded as a liability because the company already received the cash, but revenue
will continue to be recorded and taxed
Inventory - ANSWERVery prevalent for retailers, restaurants, etc that offer physical
products, but have to order supplies and package them first
Can't record the expense of buying materials until the products sell (acct matching
principle)
- This scenario causes net income to always be higher than cash
CapEx and Depreciation - ANSWERCapEx is something that lasts 1+ yrs and is tangible
(stocks, contracts, and IP are not CapEx)
- Depreciation is the allocation of the expense over multiple years
Initially, cash is going to be lower than net income because the upfront expense is
not recorded on the IS; over time, the expense is depreciated on the IS and cash will
be higher
Investments - Short-Term and Long-Term - ANSWERWhen a business has an excess
of cash, they can buy PP&E, hire staff, R&D, or invest (similar to how it works for
personal cash)
Recorded as BS assets because 1) generate cash via interest income and 2) selling
them
Raising Debt - ANSWERRaising debt is for companies that need additional funds to
complete a purchase
Income Statement - no immediate impact after borrowing; recorded as interest
expense but only in the year that the interest expense is paid
Raising Equity - ANSWERCompanies generally raise equity when they have a high
valuation because they don't have to grant as much ownership (E.g. $100 at 10% =
$200 at 5%)
Raising equity dilutes ownership of the company, but it avoids the downsides of
raising debt such as interest expense and principal repayment
Deferred Taxes - ANSWERLarger companies frequently pay taxes differently for a
couple reasons:
1) Front loading taxes when the asset is most valuable
