Interview Questions
Walk me through a basic merger model
"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 and project out an Income Statement for each Finally, 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; you apply the buyer's Tax Rate to get the Combined Net Income, and then divide by the new share count to determine the combined EPS."
Preferred stock
-is like a hybrid of a bond/common equity -preferred stock pays a constant dividend to its shareholders, and the principal value of the preferred stock can gain value as well -preferred stock may also carry a conversion feature-- can be converted to common stock later -paid prior to common stock in event of sale/bankruptcy
How could a company have positive EBITDA and still go bankrupt?
EBITDA is earnings BEFORE interest and taxes and other expenses etc. so a company could have really large expenses or huge debt obligations that it won't be able to meet with it's current revenue-- the financial distress would eventually lead a company into bankruptcy
What is insider trading and why is it illegal?
Insider trading is trading on private information that the public doesn't know and making a profit off of it. For example , in my current role, it would be insider trading for me to buy a stock of a company that I know will be taking on an acquisition in the coming months. It's illegal because the SEC says it's illegal and because it's obviously not fair to be making these gains.
How do you price a bond.
To price a bond, you lay out all the cash flows with the timing nad you discount all the cash flows back to the present. For example a 2 year $1000 FV, 10% annual coupon bond will have cash flows of $10 at end of year 1, $1000 at end of year 2 and $10 at end of year 2. If the risk free rate is 10%. I'd discount $10 back one year and $1010 back 2 years using the discount rate.
What is yield to maturity on a bond? What is yield to worst?
YTM is the rate of return of a bond if held to maturity date. Yield to worst is the lowest potential yield.
Mezzanine Debt
Arranged by an investment bank and sold on the bond market - may be secured or unsecured -bonds normally will have a fixed interest rate -bonds may have call or put options, may be convertible into equity etc.
Senior bank loans
- underwritten by an investment bank and syndicated to institutional buyers - First priority in the event of bankruptcy - Often secured in case of liquidation by company assets pledged as collateral
What are the three financial statements?
1) Balance sheet-- this really provides a snapshot of a company's assets and liabilities for example Dec - you'd have reporting period of dec 19, 20, 21 to compare Assets = Liabilities + Equity 2) Income statement-- this details the revenue and expenses of a company-- how the company operates over a period of time Net income-- revenues less all expenses Revenue- COGS- operating expenses = net income 3) Cash Flow statement: shows how cash flows in and out of a company from beginning to end of a period -Beginning Cash + CF from Operations + CF from Investing + CF from Financing = Ending Cash
What should an investor --- consider in a merger between two companies
1) Gaining market share-- may not project EBITDA break oven for years down the road, see a ton of white space in the market-- high operating margins -- can easily flip the growth switch off-- generating cash on ---> 2) Gaining new customers---> 3) Capital structure of the company -- is it overleveraged? 4) What is the P/E ratio of the company being acquired? Is it accretive or dilutive? 5) What are the cost saving synergies? Maybe they have multiple leases in the same place-- maybe they have two of the same talent
What is the formula for free cash flows
=EBIT(1- tax rate) + depreciation + amortization - capital expenditures - change in NWC You use unlevered free cash flows in a DCF because the DCF is meant to be capital structure agnostic-- meaning you'd be able to compare companies
How would a $10 increase in depreciation in year 4 affect the DCF valuation of a company?
A $10 increase in depreciation would decrease EBIT by $10, therefore reductin EBIT(1-t) by $10(1-t) . Assuming a 40% tax rate, it drops EBIT(1-T) by $6, but you must add back the $10 depreciation in the calculation of Free Cash Flow. Therefore your FCF increase by $4 and your valuation will increase by the PV of 4.
A callable bond
A callable bond is a bond that can be redeemed prior to the maturity date.
What is a cash offer?
A cash offer is a payment in cash for ownership of a corporation.
What could a company do with excess cash on its balance sheet?
A company can reinvest that cash back into the company or pay by paying a dividend to its shareholders, reinvesting in PPE, etc.
What is a floating interest rate?
A floating interest rate is typically seen on bank loans when a bank makes a loan to a company at a rate that will move with interest rates. The loan's rate typically is LIBOR plus a certain spread based on the default risk of the borrower (LIBOR IS london interbank offer rate
What is a merger model?
A merger model is a way to look at the financials of two companies, the purchase price, and how the purchase price is made to determine whether it is accretive or dilutive to the buyer. The analyst will first make assumptions about purchase price and structure, and then project and income statement for the new company and calculate an EPS for the combined entity.
What is amortization?
A method for computing equal periodic payments for an installment loan.
What kind of investment would have a negative beta?
A negative beta means an invesment reacts in the opposite direction of the market. This could be for example gold because when the market performs poorly-- people see gold as a safe investment and therefore will invest in gold instead.
What is an IPO?
An initial public offering (IPO) occurs when a company issues stock in the public market for the first time.
What is the differene between an investment grade bond and a junk bond?
An investment grade bond has a good credit rating usually AAA, A to BBB and a junk bond has a subpar rating like BB to D. Junk bonds have higher default risk and therefore lower ratings.
Difference between bank debt and high yield bonds?
Bank detbt is usually secured by company assets and bonds may be unsecured.
How/why do you lever/unlever beta?
By unlevering the beta, you are removing the financial effects from leverage (debt in the capital structure). This unlevered beta shows you how much risk a firm's equity has compared to the market. Comparing unlevered betas allows an investor to see how much risk they will be taking by investing in a company's equity (i.e. buying stock in the public market). When you have a Company A that doesn't have a beta, you can find comparable Company B, take their levered beta, unlever it, and then relever it using the Company A's capital structure to come up with their beta.
What is adjusted present value?
Calc. the NPV of a company as if its capital structure is all equity so unlevered firm value + net debt This is used for leveraged buyouts
Convertible bond
Can be converted into equity during the bond's lifetime
What is convexity ?
Convexity is the second derivative of price with respect to interest rates divided by the price. So if Bond 1 has a higher convexity compared to Bond 2-- then Bond 1 will have a higher price than bond 2-- so the higher the convexity, the more sensitive it is to changes in the interest rate. The higher the coupon rate, the lower convexity of the bond. This makes sense because zero coupon bonds are more risky as it relates to changes in interest rates.
Default premium
Default premium is paid to those who hold lower credit rated bonds because they are riskier-- because they are more risky bondholders expect a default premium in that they get paid more for the risk they're taking. This is the difference between a treasury bond and a corporate risky bond.
What did the S&P 500/Dow jones/Nasdaq close at yesterday?
Do your research?
Is debt or equity more expensive
Equity is more expensive because interest paid on debt is tax deductible and therefore debt has an interest tax shield.
If enterprise value is 150, and equity value is 100, what is net debt?
Equity value = Enterprise value - net debt 100 = 150 - 50 so net debt is 50.
examples of current liabilities
Examples of current liabilities include accounts payable, short-term debt, dividends, and notes payable as well as income taxes owed.
What is face value?
Face value is the amount that a bond issuer must pay back at the time the bond matures. I.e. if the face value of a bond is $1000 and its a one year bond-- then the bond issuer has to pay back $1000 at the end of $1 year.
Why do you subtract net working capital when calculating free cash flows?
Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. You subtract the change in NWC capital from free cash flow because when figuring out the cash flow that is available to investors - you must account for the money that is invested into the business through NWC.
Which of the valuation methodologies will result in the highest valuation?
From highest to lowest: 1) Precendent Transaction (a company will pay a control premium and a premium for synergies coming from the merger so values tend to be high) 2) DCF: those building the DCF model are frequently optimistic in their projections 3) Market comparisons-- based on other similar companies and how they trade in the market -- there is no control premium or synergies 4) Based on how the target is being valued by the market-- just equity value, no premiums or synergies
What are fully diluted shares?
Fully diluted shares are the number of shares that would be outstanding if all "in the money" options were exercised?
What is hte difference between technical analysis and fundamental analysis?
Fundamental analysis is based on the companys' fundamentals i.e. their financial statements, their industry etc. and identifying stocks that are undervalued. Technical analysis is the process of picking stocks based on historical trends or stock movements.
Goodwill and how it affects net income?
Goodwill is the premium paid over the fair market value due to a company's reputation, synergies etc. -- this is an example of an intangible asset and it affects net income because goodwill depreciates just like other assets do-- if an impairment test reveals that goodwill has significantly decreased in value -- this will ahve to be written down in the income statement as an expense.
IN what scenario would a company have negative shareholders equity?
IF a company has a negative net income for a long time-- it would have a negative retained earnings balance which would lead to negative shareholder's equity. (retained earnings is profit retained within the firm)
How would the following scenario affect the interest rates: the President is impeached and convicted.
IF a president is impeached and convicted, i'd imagine that this would cause consumers to have less confidence in general and therefore it would decrease demand. The government would probably engage in quantitative easing and lower interest rates to stimulate the economy.
What would cause the price of a treasury not to rise?
If yields are lower-- therefore if the government decides to lower interest rates
What is hte ideal amount of leverage to put on a company?
In an LBO, the private equity firm wants to finacnce the transaction with the least amount of equity possible-- so the ideal amount would be the maximum debt that wouldn't put the company into financial distress.
Why would a private equity firm buy a company that was considered more risky than a typical LBO candidate?
Many private equity firms will look to purcahse companies in distressed situations or out of bankruptcy--- they can negotiate a really cheap price in this situation and work with management to improve the business and make profit and then sell it for a higher multiple and valuation and get a good ROI.
How does issuing debt affect the EPS of a company?
Issuing debt means a higher interest expense for the company. The denominator of earnings per share would increase because there would be a greater outstanding number of shares-- the numerator would decrease because of the increased interest expense-- overall this would decrease a company's earnings per share.
How can a company raise it's stock price?
It can buy treasury shares,i.e. repurchasing shares because they believe their company is undervalued and this would push the price up due to increased demand. If they are going to do a merger soon, making this announcement can be seen as good news and would also increase the stock price.
IF you read a certain mutufal fund achieved 50% returns last year, would you invest in it?
It depends on what you believe. If you believe prices are reflective of all past information -- the efficient weak form of the EMH -- then I'd say this wouldn't inform your investment. I'd need to know more about the mutual fund to make a better informed decision
What is liquidity?
Liquidity means the ability to convert an asset into cash. For a company liquidity is important because they may had debt obligations and interest expenses that need to be paid in the short term with cash. Liquid assets are stocks that are traded in the open market. An illiquid asset for example is anything taht would be in the PP&E category, like land or a building.
What is Beta?
Mathematically, beta is equal to the covariance between the asset and the market divided by the variance of the market return it measures how sensitive an asset it is compared to the market as a whole. For example, if a beta of an asset is greater than 1, it will have larger upswings when the market is experiencing positive returns-- if it is less than 1 then the asset will react less compared to the market
Would I be able to purchase a company at its current stock price?
No because that does not fully comprise the enterprise value of a company.
What is operating leverage ?
Operating leverage is the percentage of costs that are fixed versus variable. comes from use of fixed costs in business operations--- so a company that uses more fixed costs has a high level of operating leverage
Why pay in stock vs. cash?
Pay in stock because those who receive cash will have to pay taxes on it--- and stock can increase in value. However, if the market is performing poorly, cash may be preferred.
Is 15 a high P/E ratio?
Price / Earnings per Share This all depends on the industry--- for something like facebook this would be low but for a something like a basic materials company-- this would be high.
What is the difference between public equity value and book value of equity?
Public equity value is the market value while the book value is the accounting number--- public equity value can't be negative
How do you pick purchase multiples and exit multiples in an LBO model?
Purchase and exit multiples for an LBO transaction are determined using many of the same techniques used in general valuations for an M&A transaction such as precedent transaction analysis or public company comparables analysis.
What is Gross Margin?
Revenues - COGS
What are the three types of activities in the cash flow statement?
See VEE Accounting set?
Where do you think the stock market will be in the next 3/6/12 months?
Seeing that we're coming out of a more artificial recession due to COVID-- I see in the next three months that we will be gradually getting back to the highs of the 2020 pre-COVID. Now that people are slowly getting more vaccinated-- I believe the travel industry will be experiencing large gains as countries slowly open up. In the mid term and long term-- I still see online collboration companies doing well like Zoom or Cisco because the workforce has transformed and will stay relatively transformed even when we return to offices.
Subordinated High Yield Bonds
Similar to mezzanine debt/bonds but lower in the capital structure (subordinated) -have fewer rights in the event of bankruptcy -investors will require a higher interest rate on this layer of debt
What does spreading comps mean?
Spreading comps means calculating relevant multiples from comparable companies and summarizing them for easy analysis and comparison-- this requires a lot of research
What is a primary market vs a secondary market?
The primary market is issuing new equity and the secondary market is issuing existing equity.
How many basis points equal .5 percent.
That is 50 basis points because one basis point is equal to .01 percent.
Why is the DCF considered the most volatile of the valuation methods? What can the terminal value growth rate not be higher than?
The DCF is based on several inputs- you have to project the cash flows, use the right discount rate, and estimate the terminal value The terminal value growth rate can't be higher than GDP and is usually in line with the long term rate of inflation.
When looking at the acquisition of a company, do you look at Equity Value or Enterprise Value?
The buyer purchase both debt and equity of the company so you'd look at enterprise value
How do you determine the discount rate on a bond?
The discount rate for a governmentt bond is hte risk free rate since it is issued by the government. For a riskier bond-- the discount rate is determined by the company's default risk.
What makes a company an attractive target for a leveraged buyout?
The most important characteristic of a good LBO candidate is steady cash flows. The firm ideally could pay off a significant portion or all the debt raised in the acquisition over the life of the investment horizon, with minimal bankruptcy risk. Some other attractive characteristics include strong replaceable mgmt, cost cutting opportunities, and a non-cyclical industry.
If you have two companies that are exactly the same in revenue, growth, risk, etc. but one is private and one is public, which company's shares would be higher priced?
The public company is likely to be priced higher because the liquidity premium investors will pay for hte ability to trade their stock quickly on the market and there are a lot of requirements to be a public company-- if you're a company you have to do many SEC Filings and your audited financials have to be made public-- this transparency also comes at a premium.
If you bought a Stock X a year ago for $10, sold it today for $15, and received $5 in dividends over the year, what would your overall return be?
The return would be $100.
A stock is trading at $5 and another stock is trading at $50. Which has the greatest growth potential.
This can't be answered with just that information because you don't know the underlying probability of either stock to increase or decrease in price. A stock's growth potential is a function of its volatility -- a higher volatility stock has potential for higher returns while a lower volatility stock is more stable and therefore will have lower returns. So either could have greater volatility.
If the price of the bond goes up, what happens to the yield?
The yield goes down because price and yield are inverse of each other. Usually when a bond is more expensive, the yield is low and you have to pay a premium for the security of the bond.
If Company A purchases Company B, what will the combined company's Balance Sheet look like?
Their balance sheet will be the sum of the two companies' balance sheets plus the addition of "goodwill", which would be an intangible asset, to account for any premium paid on top of COmpany B's actual assets.
Company XYZ released increased quarterly earnings yesterday, but their stock price still dropped. Why?
This could be because the earnings weren't as good as expected even though they did increase. Also, it could be a day that stocks tend to not do well-- like a Friday
What is duration?
There is Maccalay Duration and Modified duration-- Maccaulay duration is the weighted average time in years until the cash flows occurs -- so for example, a 1 year ZCB would have a MacD of 1. Modified duration is the bond prices' first derivative with respect to interest rates-- so its a measure of how sensitive prices are with respect to interest rates. Duration can be used to estimate price with first order linear approximations.
What does the government do when there is fear of hyperinflation?
To fight inflation in general, the government can engage in contractionary policy by raising interest rates and making money less available. They could also increase taxes and slow government spending which would decrease demand and fight inflation.
What is a company's leverage ratio? interest coverage ratio?
Total Debt/EBITDA ; Total Interest/EBITDA --- these ratios are used for comparing companies based on their amount of debt compared with the amount of cash they are generating that can service the interest on their debt
What is valuation and what is it used for?
Valuation is the procedure of calculating the worth of an asset, security, company etc.
What are three types of mergers and what are the benefits of each?
Vertical/horizontal/conglomerate? Horizontal: a merger with a competitor and ideally will result in synergies Vertical: merger with a supplier or distributor and ideally will result in cost cutting Conglomerate: merger with a company in a completely unrelated business and is most likely done for market or product expansions or to diversify its product platform and reduce risk exposure
How do you calculate a firm's terminal value?
You can use the exit method which is the take a common operation metric like EBITDA and apply a comparable company's multiple to that number from the final year of projections. You can also use the gordon growth model-- i.e. the terminal value = FCF10 (1+g)/(WACC - g)
How do you value a private company?
You can use the same techniques as a publicly traded company except for the market valuation technique as private companies are not publicly traded in the market. Also, if doing a DCF -- you'd have to use an equity beta of a close comparison in your weighted average cost of capital calculation.
What are hte major lines of hte income statement.
You first start with Revenues -Cost of Goods Sold -Operating expenses -Interest Expense/other expenses -Taxes = net income
What is the CAPM?
You know it required rate of return= risk free interest rate + beta (market risk premium)
When calculating enterprise value, do you use book value or the market value of equity?
You use the market value of equity because it represents the true supply and demand value of the company's equity in the open market
When do you not want to use a DCF?
You wouldn't use a DCF when a company has very unpredicatable cash flows-- you'd have to use another valuation method like precendent transactions or comparable companies.
Would you be calculating Enterprise Value or Equity Value when using a multiple based on free cash flow or EBITDA?
You'd be calculating enterprise value because EBITDA is pre debt and enterprise value is also pre-debt; i.e. EBITDA/free cash flows represent cash that is available to repay holders of a company's debt and equity
An investor should buy preferred stock when....
they want to ensure payment in the event of bankruptcy as preferred stock has higher seniority over common stock-- so they'd get equity without the higher risk of common stock-- they'd also insure income through the dividend
A perpetual bond-- how do you price a bond that pay's $1000 coupon per year
bond that pays coupons into perpetuity I'd assume the risk free rate is 10% To price this bond, you just divide $1000/.10 to get the value.
What is net working capital ?
current assets - current liabilities Measures a company's ability to pay off its short term liabilities with its short term assets
What is EBIT?
earnings before interest and taxes Revenue - COGS- Operating Expenses
Credit default swaps
financial insurance contracts that provide payments to holders of bonds if they default
A put bond
gives you the right to sell prior to the maturity date
Current liabilities
liabilties that are due within a short time/ a year-- will be satisfied within a year
What is the enterprise value? Why do you subtract cash from Enterprise Value?
this is the value of the entire firm-- both debt and equity and is the price that would be paid in an acquisition The formula to keep in mind is: Enterprise Value = Market Cap + Debt + Value of outstanding preferred stock + value of minority interest - cash the company holds - NOLs - Investments + capital leases + unfunded pension obligations Cash is already accounted for within the market value of the equity; you also subtract cash because it can be used to either pay a dividend or to reduce debt, effectively reducing the purchase price of the company
How are the three financial statements connected?
-Net income is the bottom line on the income statement which is revenue - cogs - expenses. -Net income minus dividends is added to retained earnings from the prior period's Balance Sheet to come up with retained earnings on the current period's Balance Sheet. -Beginning Cash on the CF statement is cash from the prior period's Balance Sheet, and Ending cash on the CF statement is Cash on the current period's Balance Sheet
What are the three valuation methods?
1) Market valuation/market capitalization: this is simply the number of outstanding shares multiplied by the share price (for publicly traded companies) 2) Precedent transactions: you can ascertain a company's worth by comparing it to prices paid for similar companies in the past-- so an analyst wuld research historical transactions similar to the transaction so they'd look at the size, industry, geogrpahy of the company, purpose of the transaction (strategic or financial) etc. Then they'd calculate the valuation multiple based on the sale prices in the similar transactions and apply the multiple to the comparable metric of the company being valued-- i.e. if the average revenue multiple for software companies is 4, and Company X's revenue is 100m-- I'd multiply 100m by 4 to value the company at approximately $400mm 3) Discounted cash flow analysis-- walk me through a DCF 4) Comparable companies: Calculates either the enterprise value or the equity value--- get the average multiple from comparable companies and multiply it by the metric you're using---- i.e. EBITDA
When should a company issue equity rather than debt to fund its operations?
A company should issue equity rather than debt if its a high R&D intensive firm and therefore has low cash flow -- these types of firms don't have free cash flows and therefore are vulnerable to financial distress and can't handle higher levels of debt. They also may want to have a lower debt to equity ratio.
Who is a more senior creditor, a bondholder or stockholder?
A bondholder is definitely more senior to a stockholder. Most stockholder hold common stock which has the lowest seniority in the event of a sale or bankruptcy and would therefore be paid last in these events.
What is an exchange ratio and why would a company use it?
A company would use an exchange ratio to protect themselves in case their own stock price falls since they'd be receiving shares of company B. (the target) --the seller would probably prefer to get paid in cash instead if they believe the price of the stock will fall.
What are covenants?
A covenant is a requirement included in the legal documents governing a bond or loan. The company must comply with these requirements during the life of the bond or loan in order to avoid a default.
What is dividend recapitalization?
A dividend recap typically occurs in the middle of a PE firm's investment in a company when that company has been performing and paying down debt, reducing leverage. The owners of the business (normally the PE firm) will go back to market looking to issue new debt both to repay the existing debt and to fund a distribution to shareholders.
What are some defensive tactics that a target firm may employ to block a hostile takeover?
A poison pill-- shareholder rights plan gives existing shareholders the right to purchase more shares at a discount in the event of a takeover, making the takeover less attractive by diluting the acquirer. A Pac-Man-- when the company that is the target of the hostile takeover turns around and tries to acquire the firm that originally attempted the hostile takeover. Acquire another company and therefore become too big to buy. White knight-- company comes into the company which is the target of a hostile takeover with a friendly takeover offer
What does it mean to short a stock?
A short sale of a stock means that you borrow the stock and immediately sell it in the open market. Then when you the price decreases, as you expect it to, you buy the stock again, and return it to who you borrowed it from and keep the difference between the higher price you sold it at and the lower price you bought it at. This is a way to speculate that a stock price will decrease.
What are swaps?
A swap is an agreement to exchange future cash flows for a set period of time. The most prominent "swap" lately has been credit default swaps issued by banks as a type of insurance against companies not being able to pay back their debt.
What is a tender offer?
A tender offer is often a hostile takeover technique. It occurs when a company or individual offers to purchase the stock of the target company for a price usually higher than the current market price in an attempt to take control of the company without management approval.
What are trends going on in the tech industry now?
Alot of trends have to do with workforce and I think tech companies are really leading these trends for example, twitter moved to the entirely work from home model. Spotify did the same but is still compensating at the pre WFH levels. Because of companies shifting to the remote working model-- a lot of companies have to pivot to SaaS based offerings (these could be Google Workspace, Dropbox, Salesforce, Cisco WebEx, Zoom)--- this makes tech companeis attractive M&A targets to supplement companies' existing capablities. As more and more companies shift towards being cloud based -- SaaS will definitely continue to grow and larger companies with huge capital will acquire the smaller competitors. VC Funding in 2020 was really large about $70 billion so the tech sector is raising capital at record amounts Gaming has also been a huge trend since Covid 19 so this may cause a shift to advertising dollars towards the gaming industry. Microsoft acquired Zenimax for $7.5 billion
What is a leveraged buyout?
An LBO is when a group, usually a private equity firm, purchases a company using a relatively high amount of financial leverage, meaning the purchase is financed mostly using debt, with a relatively low equity investment. Ideally the company then pays off the debt over the investment horizon using cash flow from the business. Over the course of the investment, the capital structure changes from a high percentage of debt to a high percentage of equity. Think Succession --- when they were trying to do a leverage buyout of the competing media conglomerate.
What is the difference between an accretive merger and a dilutive merger?
An accretive merger is one in which the acquiring company's earnings per share will increase following the acquisition. A dilutive merger is one in which the opposite occurs. The quickest way to figure out if a merger is accretive/dilutive is to look at the price to earnings ratio of the firms involved in the transaction. If the acquiring firm has a higher P/E ratio than the firm it is purchasing, the merger will be accretive because the acquirer will pay less per dollar of earnings for the target company than where the target's stock is currently trading.
What are some examples of items that may need to get added back to EBITDA to get a better sense for the financial health of a company?
An example of this could be a one time loan such as a PPP loan -- there would be a cost savings if the government gave a loan to a company which would be artificial and not reflective of general company operations -- therefore there would be a quality of earnings adjustment that would have to be made to the purchase price
What is the P/E ratio?
P/E Ratio = Can be applied to anticpate future earnings in order to determine the current stock price. It requires that earnings be greater than zero.
If the Fed increases interest rates, what will happen to the price of a bond?
Bond prices will decrease as yields will increase
What is EPS and what does it tell you?
Company's profit/outstanding shares of stock it allows you to gauge the overall profitability of the company If a company consistently has increasing EPS growth, then that means the company is able to sustain profits over time. IF a company has negative earnings per share- this means they're operating at a loss
What is diversification?
Diversification is the act of investing in different assets in different industries to eliminate diversifiable risk. There is risk inherent in the market that isn't diversifiable, but you can immediately rid your portfolio of non-systemic risk by diversifying. Non-systemic risk is idiosyncratic and industry specific whil systemic risk affects the entire market.
How does a $10 increase in depreciation expense affect each of the three financial statements?
Do we know the tax rate? IF the tax rate is 30%-- to caluclate the after tax cost we multiply 10(1-.3) = 10(.7) = 7 This shows up on the income statement as -7 as the depreciation expenses. Assuming this is the only thing on the income statement- net income is -7. This is the last line on the income statement and is the first line in cash flow statement. The depreciation would show up as a change in net income. You'd have to add back the $10 because depreciation is not a cash flow-- therefore you'd be left with $3 net cash flow. For the balance sheet-- the positive $3 would show up as net cash in the assets, also the -10 depreciation would show up under PP&E -- this is a -7 on the assets side. THere is no change in liabilities. For equity, there is a -7 decrease in retained earnings because net income decreased by 7.
What do EBITDA and free cash flows represent?
EBITDA and free cash flows represent cash flows that are available to pay holders of a company's debt and equity-- so any multiple based on these metrics would represent the entire value of the firm or the enterprise value; if you were using the P/E ratio --- that would represent cash flows that are available to shareholders of the company which would mean you'd be calculating the equity value
What are the most common multiples used in valuation?
EV/EBITDA; P/E; EV/EBIT; Price/Book; EV/Sales I.e. if a similar company is trading at an EV/EBIDTA multiple of 6x and the company I'm valuing has an EBITDA of $100m -- i'd value the company's enterprise value at $600m
What is EBITDA ?
Earnings before interest, taxes, depreciation and amortization. It measures a company's profitability. It is also used as a proxy for free cash flow because it allows you to determine how much cash is available from operations to pay interest, capital expenditures, etc.
What is EV/EBITDA?
Enterprise Value/EBITDA Measures the enterprise value of a company as a multiple of it's EBITDA This is a commonly used multiple for valuation of companies because it removes the effects of a companies capital structure--so you can more effectively compare different companies; the drawbacks however have to do with the fact that it doesn't include capital expenditures and that may over value a company that is very capital intensive-- like anything that has to do with manufacturing
What is the difference between Enterprise Value and Equity Value?
Equity value is a piece of enterprise value where you add net debt, preferred stock, and minority interest to equity value to get enterprise value. So equity is post debt and enterprise value is pre-debt
What is the best financial statement to assess the overall health of the company?
I would choose the cash flow statement because it provides info about the ability for a company to generate future cash flows -- the source of cash flows determine if a company can persist in the future. Also you can assess whether the company is able to pay dividends and future obligations such as debt--- you'd be able to see if cash inflows are enough for a company to be run & return cash to investors Also, cash vs non cash investing/financing transactions for the period can indicate the long term health of the company -- i.e. a negative investment cash flow indicates the company is investing long term in itself and is willing to take on debt
Why investment banking?
I recently graduated from UC Berkeley and I studied Applied Math and Economics. Now I'm a deals consultant at PwC working mostly on buy-side acquisitions in the TMT space. I'm very familiar with being on the other side of the calls opposite the seller plus the investment bankers that are representing them. We consult the buyers-- mostly private equity firms and some strategic corporate buyers on the deal price and issues like benefits harmonization, executive compensation, equity comp, and for post deal projects, employee integration- so we look at deals from a people perspective. We basically look for any quality of earnings or pro forma price adjustments that can be made. I also have an actuarial background and I've taken 3 exams so far. I've learned through my time here that I don't want to do people consulting in the long run and want to go into finance which is why I've applied at BMO. Going into investment banking would allow me to have a more impactful role since I'd be helping companies make strategic financial decision as opposed to affecting just one aspect. I love to learn and thrive in challenging environments. Alot of my current work is doing diligence sprints and I'd like to be involved arranging the deals.
Why tech banking?
I specifically want to work in the TBS group because I enjoy working in the technology space-- I find the most interesting deals to be from tech companies. I worked on a deal with Okta when they bought Auth0 and even though we were looking at it from a people perspective -- it was definitely the most interesting. For example we actually priced their options for them using the Black Scholes pricing model. And for another deal I worked on where Verra Mobility was buying Redflex Traffic systems-- we actually used the treasury stock method to calculate the fully diluted share count. I enjoy when deals are more strategic and I've definitely found that to be the case when working on tech deals. I've also noticed that the Clients on tech deals are more demanding and they know what they're talking about. Chase also mentioned the lean deal team for the TBS group in the SF office-- I feel like working in smaller groups would help me grow as an analyst because you get more ownership from your work and you work more closely with the teammates. This is also what's especially attractive to me about the bank. I think it would be a great place for me to start my career and my transition away from consulting.
Why BMO?
I'm trying to make the switch from a more consulting based role to a finance role. I know these roles are very demanding and of course success is performance based-- I believe working in these sorts of environments to be highly motivating. Working at BMO would also give me a wider range of opportunities in the future as I'd develop modelling skills. Also, after speaking to multiple professionals at the bank, they had several great things to say about the bank. I spoke with Maura, an analyst in the New York office and she said she decided on BMO because of the great support they offered her. It was shocking to hear such good things about the culture especially in this field and especially with the recent Goldman sachs survey. Maura was very willing to talk to me as was Chase from the SF office. I was completely taken aback on the amount of support they offered me. Usually, people don't reply when you send a message on LinkedIn but both professionals were super responsive and kind. I'd love to work in that type of environment where I can learn from the people around me and work with people that want me to succeed.
Tell me about a company
I've been really interested in Pinterest-- first of all because I love the product but its ability to sustain itself throughout the years. Its stock has more than doubled in a year, I remember back in Jan 2020 it was about $18 and now its trading at $74-- its earnings per share is no .30 and a year ago it was deeply negative-- It earns its money basically through ad revenue much like other social media companies but i think it has a good customer base and its average monthly user base is also increasing -- it definitely is a different enough product as a whole
How could a firm increase the returns on an LBO acquisition?
It could increase the sale price at the time of monetization either through an increase in operating profits or through multiple expansion. Up front, it could negotiate a lower purchase price or increase the amount of leverage used to purchase the company, which would imply a smaller equity check with a higher internal rate of return on the capital deployed.
Weighted average cost of capital
It is used as the discount rate in a discounted cash flow analysis You take the weighted average of the capital structure of the company so weight of debt times cost of debt ( 1- tax rate )to get the interest tax shield and equity and preferred stock It represents the overall cost for a company to raise new capital and also represents the riskiness of investing in the company
What is a Eurobond?
It's a bond that isn't priced in the currency of country of origin.
Correlation. What is it?
Mathematically-- correlation is rho-- which is the covariance of two stocks or assets divided by the product of the standard deviation of both stocks. Correlation is bounded by -1 and 1. Two assets are perfectly correlated if they have a correlation coefficient of 1-- this means they move in the same direction together. IF two assets have a correlation of 0, then that means the two assets have no linear relationship. But it doesn't necessarily mean they are independent.
What steps can the Fed take to influence the economy?
OMO --- buy bonds bigger- sell securities smaller Quantitative easing-- this means lowering interest rates--> expansionary policy Lower the RRR so more cash can be loaned and pumped into the economy-- this is expansionary policy
What is PIK interest?
PIK interest is interest that is Paid In Kind. This means that rather than making a cash interest payment, the bond or loan will increase in face value each period by the PIK interest rate. Because of compounding, the company will be required to pay more overall, but the cash outflow will be at maturity rather than annually, semi annually, or quarterly.
Walk me through a DCF
Project 5-10 years of unlevered cash flows --- Enterprise Value -- Determine what discount rate you're going to use to discount the cash flows back to the present-- you'd use WACC-- weighted average cost of capital if you're trying to arrive at enterprise value and you'd use the cost of equity for the post debt view-- which is the equity capital Then you'd have to determine the terminal value of hte company which is the value of the company beyond the explicit forecast period-- use the same discount factor Sum these discounted cash flows to get an enterprise value Subtract debt from the Enterprise value and that will give you the equity value. If you want to find the price per share, divided by the outstanding number of shares WE use unlevered cash flows because DCF is supposed to be capital structure agnostic-- meaning its better to take the affect of debt out of the analysis so we can make companies more comparable
What does the WACC represent?
The WACC represents how risky it is to invest in the company based on its capital structure
Could a company have a negative book equity value
Yes a company can have a negative book equity value if its owners are taking out large cash dividends or if the company has been operating for a long time at a net loss, both of which reduce shareholders' equity.
Coupon payment
These could be annual/semi annual/quarterly and are stated as a percentage of par value. For example if a $1000 1 year bond has an annual payment 10% coupon, at the end of 1 year, the bond issuer owes $1010 bucks as the FV + Coupon.
What are appropriate coverage and leverage ratios for a business through an LBO or other acquisition?
This depends on the type of business. The appropriate levels are what the market is willing to bear for similar companies in similar industries, determined by what deals have ben closed recently. All else equal, higher leverage or lower interest coverage is going to make investors demand a higher interest rate on the debt because the investment is considered more risky. However, in a typical LBO or M&A deal, the company most likeley will be levered somewhere between 2x and 10x, depending on the industry.
What is net debt?
This is a company's total debt minus the cash it has on the balance sheet
What is the treasury stock method?
This is a way to calculate the number of fully diluted shares. You'd find the number of current outstanding shares, add the number of optinos that are currently in the money- and then subtract the number of shrares that could be repurshed using options.
If you add a risky stock to a portfolio, what happens to the overall risk of your portfolio?
This is dependent on the correlation between the new risky asset and the portfolio. If they have a negative correlation-- it could potentially lower the volatility.
Where do you find the risk free rate?
This is the current yield on the 10 year gov. treasury
Suppose a report released today showed that inflation last month was very low, yet bond prices closed lower. Why might this happen?
This might happen because of a reaction to interest rates. If bond prices are lower, that means interest rates are high-- when interest rates are high, the economy contracts and inflation maintains low. Inflation expectations would be high since they are low and so bond prices would decrease because of the expectation of higher yields.
Why do firms distribute dividends..
Why firms distribute dividends is really a puzzle most mature firms do distribute dividends and its a way to signal to investors that the firm is healthy but alot of research has been done to show that whether a firm pays dividends or no isn't indicative of its future earnings/operating performance So it seems more like a social norm