400 IB Questions

What's the difference between accounts receivable and deferred revenue?

- AR has not been collected, this is how much revenue the company is waiting on -DR has been collected and is waiting to be recorded as revenue one the services are proivded

Walk me through a $100 "bailout" of a company and how it affects the 3 statements.

- confirm if this is a debt or equity bailout. Likely to be an equity bailout from a government -IS - no changes are going to be occurring in the IS -CFS - CFF is going to increase by $100 as those $100 increases from bailout financing received, this increases net changes in cash by $100 BS- cash has increased by $100, SE would increase by $100

Could you ever end up with a negative RE?

-2 scenarios in which this could happen -LBO with dividend recapitalization - owner of comp has taken large portion of equity which can sometimes turn negative -if a company has been consistently losing money and has a declining RE balance, which is a portion of SE NOTE: only concerning when the company is consistently losing money, does not turn immediately negative after LBO, happens following the dividend recap or losses

Where could Depreciation be allocated on the income statement instead of its own line item?

-COGS - could allocate to cogs as its tied to production -OPEX - if a fixed asset is a part of normal operations, depreciation can be allocated here

How is GAAP different from tax accounting?

-GAAP is accrual based, tax is cash based -GAAP uses straight line depreciation, whereas tax accounting generally wants to accelerate depreciation -GAAP is more complex and accurately tracks assets/liabilities whereas tax is only concerned with rev/expenses in current period and what income tax you owe

At the start of Year 3, the factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk me through the 3 statements

-IS - it has been two years of depreciation, meaning 2*$10 of depreciation, leaving $80 of value for the PPE. value would be written down in the IS by $80, assuming tax rate of 40%, this would flow to NI, reducing it by $80(1-.4) = $48. -CFS, NI at top is $48 lower, but the write is a non-cash expense, thus we add it back, and are left with $32 increase in CFO; however, CFF will decrease by $100, meaning a net change in cash that is $68 lower -BS, cash that is $68 lower, then, PPE decrease by $80, a NI decrease by $48, and long-term debt is paid off, meaning a $100 decrease in cash

What happens to three FS if comp initiates a dividend?

-IS - no change on IS, however a line below NI will state DPS to show amount paid -CFS - CFF decreases by div amount -BS - cash balance will decline on the BS and offsetting entry will be a decrease in RE since dividends come out of RE

Now let's say they sell the iPads for revenue of $20, at a cost of $10. Walk me through the 3 statements under this scenario.

-IS - revenue has increased by $20, COGS decreases by $10, so from there pretax income is $10 higher. NI is going to increase by $10(1-t), assuming 40% it would increase by $6 -CFS - NI is going to start out $6 higher, inventory is added back for $10, increasing CFO by $16. Net change in cash is thus $16 higher -BS - cash is going to increase by $16, inventory is going to decrease by $10, NI is going to increase by $6 in SE

assume Apple is ordering $10 of additional iPad inventory, using cash on hand. They order the inventory, but they have not manufactured or sold anything yet - what happens to the 3 statements?

-IS, nothing is happening CFS - CFO is decreasing as there was a increase in inventory, thus reducing our net change in cash by $10 -BS - a cash account that is $10 lower, and then inventory is increase respectively by $10

Can you give examples of major line items on each of the financial statements?

-Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General & Administrative Expenses); Operating Income; Pretax Income; Net Income. -Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment (PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders' Equity. -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; Dividends Issued; Cash Flow From Financing

Disadvantages of Equity Financing

-Issuing equity dilutes ownership, and equity is a high cost of capital. -Public equity comes with more regulatory requirements, scrutiny from shareholders and equity analysts, and full disclosures of their financial statements. -The management team could lose control over their company and be voted out by shareholders if the company underperforms.

How do the 3 statements link together? part 2

-NI minus dividends is added to RE from prior period BS to determine RE on current BS -interest expense is calculated from debt on the balance sheet -CFI is purchases and sales of PPE and other capital assets Capex increase PP&E on BS -cash balanced determined by the CFS -debt is affected by CFF, amortization of debt, amortization, new debt issuance

Advantages of Equity Financing

-No required payments, unlike debt, giving management more flexibility around repayment. -Dividends to equity shareholders can be issued, but the timing and magnitude are at the board and management's discretion. -Another advantage of equity is that it gives companies access to a vast investor base and network.

Walk me through how Depreciation going up by $10 would affect the statements. Assuming 35% tax rate

-On the income statement, depreciation exp increases by $10, its going to reduce pretax income by $10, but it deducts $10(1-.35) from Net income, reducing NI by $6.5. -CFS, recall that it starts with a NI $6.5 lower. But, $10 is added back as it is a noncash expenditure, thus increasing CFO by $3.5. -Balance sheet, that would increase cash by $3.5, PP&E declines by $10 thus increasing the overall asset account. SE would decrease by $6.5 as a result of the lower NI

Disadvantages of Debt Financing

-Required interest and principal payments that introduce the risk of default. -Loss of flexibility from restrictive debt covenants prevents management from undertaking a variety of activities such as raising more debt, issuing a dividend, or making an acquisition. -Less room for errors in decision-making, therefore poor decisions by management come with more severe consequences.

Walk me from Revenue to EBITDA.

-Revenue - COGS = Gross Margin -Gross Margin - OPEX - SG&A = EBIT -EBIT + D&A = EBITDA

Walk me from Revenue to EBITDA.

-Revenue - COGS = Gross Margin -Gross Margin - OPEX - SG&A = EBIT -EBIT*(1-t) + D&A - CAPEX + Changes in NWC

Walk me through the 3 financial statements.

-The 3 major financial statements are the Income Statement, Balance Sheet and Cash Flow Statement. -The Income Statement gives the company's revenue and expenses, and goes down to Net Income, the final line on the statement. -The Balance Sheet shows the company's Assets - its resources - such as Cash, Inventory and PP&E, as well as its Liabilities - such as Debt and Accounts Payable - and Shareholders' Equity. Assets must equal Liabilities plus Shareholders' Equity. -The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company's net change in cash."

cash flow statement indirect approach

-The indirect method for the preparation of the statement of cash flows involves the adjustment of net income with changes in balance sheet accounts to arrive at the amount of cash generated by operating activities. -generally easier to put together, can be done with accounts the company usually keeps record of

Advantages of Debt Financing

-The interest expense on debt is tax-deductible, unlike dividends to equity shareholders (although recent tax reform rules limit the deduction for highly levered companies). -Debt results in no ownership dilution for equity shareholders and has a lower cost of capital. -Increased leverage forces discipline on management, resulting in risk-averse decision-making as a side benefit.

What happens to a company's EV if they take on too much debt?

-Theoretically nothing as the cash received would offset the debt taken on -although too much debt could affect the equity value of a company, remember, shareholders are the last to claims of the business

how could a company have positive EBITDA and still go bankrupt?

-bankruptcy happens when a company cannot pay back its interest or debt -EBITDA is before interest, if interest exceeds EBITDA, and they have little cash on hand, they will soon default on debt

What happens when Accrued Compensation goes up by $10?

-clarify it is being recognized as a expense, expenses increase by $10, thus decreasing pretax Income by $10, flowing down to net income, reducing net income by $10(1-t), say 40%, then it would decrease by $6 -$6 lower NI, adjustment to CFO by $10 upwards, thus increasing the change in cash by $4 -$4 increase in cash, we recognized a decrease in accrued expenses of $10 increasing liabilities by $10, and a decrease in NI of $6

When would a company collect cash from a customer and not record it as revenue?

-company pay up front for goods or services -web based subscriptions, magazine subscriptions, cell phone annual contract, prepaid insurance -collecting upfront produces stabler revenues -Sirius XM -rev only recorded when good or service is provided

Talk to me about a recent M&A deal

-deal overview - company acquired company for X, you were the fin advisor for the company and this bank was the bank for the financial advisor to the other firm -3 key rationale - include one or two stats and 3 rationales behind the deal -Why it interests me - use consulting reports, how does that deal fit in with industry trends, drive to ESG, show understanding of industry report

If cash collected is not recorded as revenue, what happens to it?

-deferred revenue on the BS under Liabilities -over time as services are provided, deferred revenue becomes real revenue on the IS

walk me through an LBO

-estimates the returns a PE firm will pay to buy a company -we need to determine an entry valuation and find how much PE firm would pay to buy the company -we need to build a sources and uses section, and detail how we will finance the transaction, how much leverage and equity will be used -then, project our future levered FCF over holding period of 5-7 years -when done, we can perform last step, building return analysis to calculate the multiple on invested capital and IRR

Under what circumstances would Goodwill increase?

-generally happens when a company reassesses its value and finds that it is worth more -company is acquired and goodwill changes as a result, accounting plug for the purchase price of an acquisition -company acquires another company and pays more than what its assets are worth, which would be reflected in the goodwill

How long does it usually take for a company to collect its accounts receivable balance?

-generally, AR is expected to be received within 30-60 days, could be higher if it selling luxurious products

goodwill remains on the BS - why would it be impaired and what does goodwill impairment mean?

-happens when company has been acquired and the acquiring company realizes the intangibles are worth significantly less than what they originally thought -when a company has been acquired and overpaid for the seller and result in net loss -can also happen when a company discontinues part of its operations

How do you decide when to capitalize rather than expense a purchase?

-if the asset you are acquiring has a useful life greater than 1 year then you should capitalize it on the balance as it will be depreciated over that useful life -things like COGS and paying salaries are short term operational items and show up as IS expenses

Why do bankers use EBITDA?

-it helps measure profitability devoid of accounting differences and different financing structures, thus providing clear operational performance -acts as a proxy for FCF -Used commonly as a high-level valuation multiple -also helpful for leverage and coverage ratios such as total debt/EBITDA and EBITDA/interest

Why is the Income Statement not affected by changes in Inventory?

-it is not affected by changes in inventory because no expense has been recognized, instead once that inventory is sent to the customer a revenue would be recognized and a COGS expense would be characterized with that revenue

What happens when inventory goes up by $10 assuming you pay for it with cash?

-no change in the IS -CFS, increasing an asset would produce a decrease in the CFS adjustment, reducing CFO by $10, thus decreasing the net change in cash during the period by $10 -cash that is $10 lower, and an inventory account increasing by $10, thus the balance sheet has balanced out.

Let's say Apple is buying $100 worth of new iPad factories with debt. How are all 3 statements affected at the start of "Year 1," before anything else happens?

-no initial effect on the income statemnt -CFS would reflect a $100 increase in CFF and with the acquisition of an asset would reflect a $100 reduction in CFI, thus a net change in cash of $0 -The BS would show an initial change in cash, increasing by $100, and then a increase in long term notes, or long-term debt by $100, thus remaining balanced. change in as well as an increase in PP&E of $100 with a balance of a $100 decrease in the cash account.

What does negative Working Capital mean? Is that a bad sign?

-not necessarily a bad thing could be as a result of contracts which means there are higher deferred revenue liabilities -or it could be obtaining its short-term assets primarily when goods are exchanged, meaning they can pay off AP when cash is receive4d, this means they have consistent cash inflowing which could indicate business efficiency -WC could indicate financial trouble or bankruptcy risk as they cannot meet their short term obligations

Why do companies report both GAAP and non-GAAP (or "Pro Forma") earnings?

-some say all the deductions GAAP require blurs the profitability of a company. Non-GAAP reports generally report higher earning and may be more reflective of a company's ability to turn a profit?

why are tech companies considered risky?

-technologies are new, may be unproven and given the uniqueness of different technologies, it's hard to say which tech companies will be successful

What are deferred tax assets/liabilities and how do they arise?

-temporary differences between what a company can deduct for cash tax purposes vs. what they can deduct for book tax purposes -deferred tax liabilities - expense on IS but have not yet paid that tax in cash -deferred tax revenue - arise when you pay taxes in cash but have not expensed them on the IS -common when there is an asset write up or write down in M&A deal. Asset write up will produce a deferred tax liability while a write down will produce a deferred tax asset

What's the difference between cash-based and accrual accounting?

-these are two different methods for recording revenues and expenses -accrual based records revenues when products or services have been provided and records expenses when they are incurred -cash based accounting records revenues and expenses when cash is received or changes in hands, respectively

What's the difference between LIFO and FIFO? Can you walk me through an example of how they differ?

-these are two inventory cost methods for allocating a respective COGS unit cost as they sell this good and earn a revenue -FIFO - stands for first in first out, so the oldest inventory received would be where the cost is allocated -LIFO - stands for the last in last out, so the most recent inventory would be where COGS exp are allocted first -FIFO is beneficial is costs are rising, so the lowest costs would be allocated first LIFO is beneficial is costs are decreasing, in which case the lowest costs would be allocated first

A company has had positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen?

-too many capital expenditures which are generally excluded from EBITDA as they are generally thought to be one time expenses -cannot meet interest expense obligations -large amount of debt matures on one day, meaning they are unable to refinance and run out of cash on hand -one time charge high enough to bankrupt -EBITDA excludes investment in LT assets, interest and one time charges

Now let's go out 1 year, to the start of Year 2. Assume the debt is high yield so no principal is paid off and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens?

-two things would be reflected on the income statement, we would see a increase in D&A expenditures of$10 and an increase in interest expense by $10, we would see a $20 reduction in pre tax income, incorporating a tax rate, we would see a reduction in NI of $20(1-t), assuming a 40% tax rate, that would mean a $12 reduction -CFS would see a NI that is $12 lower, then CFO would increase by $10 to incorporate depreciation, resulting in a net change in cash that is $2 lower -BS, the cash account would be $2 lower, $10 decrease in PPE to reflect depreciation, lastly SE would be down by $12 thus the account is balanced

why is it that all PE multiples (P/B, P/E, and P/CF) are before interests expenses?

-we are capturing the entire capital structure, so we don't want to have deducted any of the debt, This EBITDA value represents claims to all shareholders and debt holders

why is it that all EV multiples (EV/EBITDA, EV/EBIT, and EV/sales) are before interests expenses?

-we are capturing the residual left to equity holder, interest is subtracted out to represent the fact that debt holders have received their share of the claims to earnings.

3 types of intercompany investments

1. Investments in Securities 2. Equity Investments Method 3.Consolidation Method

What are the three sub-classifications of investment securities?

1. Trading Securities 2. Available-for-Sale Securities 3. Held-to-Maturity Securities

Illiquidity Discount

A reduction or discount to value that reflects the lack of depth of trading or liquidity in that asset's market.

8-K

A report filed with the SEC by a public company to update investors of any material event.

If Depreciation is a non-cash expense, why does it affect the cash balance?

Although Depreciation is a non-cash expense, it is tax-deductible. Since taxes are a cash expense, Depreciation affects cash by reducing the amount of taxes you pay

Why would you consider geography when doing a CCA?

Because a companies in different countries/regions can have different business drivers and be impacted by different macroeconomic conditions

why is capex included in the FCF calculation?

Because capital expenditures are recurring and considered non-discretionary and important parts of operations removes costs like interest, depreciation and amortization, so it does not reflect the effect of buying or selling CAPEX, as depreciation will not be impacting the metric

how does a company evaluate a project or investment?

Cost of Capital: represents what he or she could earn by investing in another asset (opportunity cost) if investment expected to generate return > cost of capital INVEST!

What is the difference between FCFF and FCFE?

FCFF excludes the impact of interest expense and net debt repayments

FCFE

Free Cash Flow to Equity

FCFF

Free Cash Flow to the Firm

Write down of debt

IS - when writing down an asset, you actually report a gain on the IS, so that flows down to pretax income, which increases by $100. Next, you will see an increase in net income of $100(1-t), assuming 40%, that would mean a $60 increase in NI CFS - NI starts out $60 higher, but is reduced by the $100 write down, resulting in a $40 net change in cash BS - cash starts out $40 lower, debt is written by $100 and then SE decreases by $60, thus the net effect is -40

Banks have been writing down their assets and taking huge quarterly losses. Walk through 3 statements on whether there is a write down of $100?

IS - write down $100 on the IS, that flows lowering pretax income by $100, NI is reduced by $100(1-t), assuming TR of 40%, that would mean a decline in NI of $60 CFS - starting at the CFS, your NI would start $60 dollars lower, from there that would flow down write down would be adjusted within CFI and would increase by $100, leaving $40 increase in the net change of cash on hand BS - cash account is $40 higher, PPE is decreasing by $100, and then net income is decreasing by $60

PIK Interest

Interest that is added to the principal due instead of being paid in cash when the interest accrues

Where does Depreciation usually show up on the Income Statement?

It could be in a separate line item, or it could be embedded in Cost of Goods Sold or Operating Expenses - every company does it differently. Note that the end result for accounting questions is the same: Depreciation always reduces Pre-Tax Income.

What is the CAPM attempting to do?

It is trying to quantify the relationship between the beta of an asset and its corresponding return

What is the effect of a share buyback

It will increase share prices, based on supply and demand of outstanding shares, less outstanding shares precipitates a price increase company could shock a stock price by buying back shares

How do the 3 statements link together? part 1

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

Conceptually, what does the discount rate represent?

The discount rate represents the expected return on an investment based on its risk profile (meaning, the discount rate is a function of the riskiness of the cash flows). Put another way, the discount rate is the minimum return threshold of an investment based on comparable investments with similar risks.

Investment in Securities

The investment in securities method is used when a company invests in another company's equity, but the ownership percentage is less than 20%.

Definition of EV

The value of the operations of a company to all stakeholders including common shareholders, preferred shareholders, and debt lenders.

Trading securities

These are debt or equity investments intended to generate short-term profits.

Available-for-sale securities

These are debt or equity securities held for the long-term but sold before maturity

Held-to-maturity securities

These are long-term investments in debt securities held until the end of their term.

What is WC?

WC = current assets - current liabilities -can indicate whether a company can fulfill short term olbigations -positive - company can pay off short term liabs with short term assets -in banking usually calulate operating WC as (current assets - current liabilities) - (current liabilites - debt) -operating WC is meant to exclude items relating to a company's financning activites - cash and debt - from calculation

Equity Investments Method

When a company owns between 20-50% of another company, this is considered a significant level of influence.

Consolidation Method

When the parent company has majority control over 50% ownership, the consolidation method is used.

Let's say I could only look at 2 statements to assess a company's prospects - which 2 would I use and why?

You would pick the Income Statement and Balance Sheet, because you can create the Cash Flow Statement from both of those (assuming, of course that you have "before" and "after" versions of the Balance Sheet that correspond to the same period the Income Statement is tracking).

If I were stranded on a desert island, only had 1 statement and I wanted to review the overall health of a company - which statement would I use and why?

You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non-cash expenses you might have. And that's the #1 thing you care about when analyzing the overall financial health of any business - its cash flow.

CAGR Formula

[(Ending Value / Beginning Value) ^ (1 / # of years)] - 1

Let's say a customer pays for a TV with a credit card. What would this look like under cash-based vs. accrual accounting?

accrual- service is immediately being provided, no cash is provided up front, however since goods have been received the revenue and respective COGs would be recorded as revenues are earned and expenses have been incurred accordingly with that sale cash-based - cash basis cares about when cash changes hands, so a revenue and respective expense will not be recorded until cash is received, at which point cash would also be recorded

Meaning behind depreciation

allocating the cost of a tangible asset over its useful life represents how much of an asset's value has been used. Allows companies to earn revenues from the assets they own by paying for them over certain period of time

How do you create a revenue model for a company?

bottoms up build - start with individual products/customers, estimate average sale value or customer value and then the growth rate in sales and sale values to tie everything together botoms-up - start with big picture metrics like market size then estimate the company's market share and how that will change in the coming years, then multiply by their revenue

restricted cash

cash that is not available for general use but instead is restricted for a particular purpose

Dilution

company issues new shares that result in a decrease in existing stockholders' ownership percentage of company

what is net debt?

company's total debt minus the cash it has on the balance sheet. assumes comp pays off any debt with excess cash can simplify EV formula by subtacting cash from debt and adding net debt

How does EBITDA not factor in CAPEX?

considers earnings before depreciation with no accommodations for CAPEX

Does treasury stock reduce or increase the SE balance?

decreases

When would it be appropriate to use a sum-of-the-parts approach to valuing a company?

each division of a company will have its unique risk/return profile and need to be broken up to value the entire company more accurately as a whole.

Why do we typically look at EV over equity value?

enterprise value represents the whole value of the company. It would, strips out the capital structure and looks at the value of the whole company

Multiple on Invested Capital (MOIC)

estimates return, both unrealized and realized, of the investments, calculating the gross value focuses on how much rather than when, MOIC does not account the time it takes to achieve that level of returns and how much the returns are (Realized value + Unrealized Value)/Total Dollar Amount Invested

Could you define a company's capital structure?

how a company funds its ongoing operations and growth plans. Most companies' capital structure consists of a mixture of debt and equity, as each source of capital comes with its advantages and disadvantages.

what are the two main approaches to valuation?

intrinsic valuation and relative valuation

What is valuation and what is it used for?

procedure of calculating worth of something IB are hired to value company in transactional context valuations used in pitch books to guide clients PE, VC, and hedge perform valuation to evaluate investments

What is the portion of the purchase price not funded by debt in an LBO called?

sponsor equity

example of restricted cash

taking out of line of credit and a mandatory amount of cash percentage of loan at all times

What leads to DTLs and DTAs?

temporary timing differences in book and tax accounting, DTA's and DTL's unwind the balance to zero

equity value represents...

the residual value to equity holders

Retained Earnings

the total cumulative amount of net income held onto by a company since inception after accounting for any dividends paid out to its common and preferred shareholders.

What is the point of valuation?

to assess the fair market value of an asset to determine if it is a good investment. can place intrinsic valuation, or derive a market valuation for a company

EV represents...

value to all providers of capital

Relative Valuation

valuing a firm relative to other comparable firms often using median or average multiples from peer groups, like EV/EBITDA or P/E

if an EBITDA/Revenue multiple is 27% what does that mean?

you could infer that 73% of their revenue goes to operating expenses