Lincoln International Interview Prep

Company Values

Excellence

Entrepreneurship

Integration

Collaboration

Integrity

What does Excellence mean to you?

To me it means approaching perfection. Be it in sport, art, or in a job-for example in graphic design, my field. Excellence means standing out from the crowd, and being able to deliver designs that are easy to distinguish and remember. Designs that sell, that stay in the mind of anyone who spotted them, designs that shake the status quo in the given field. That's how I would define excellence, and you can be sure I always aspire to deliver it.

What does Entrepreneurship mean to you?

Entrepreneurship means creativity and the ability to use innovative ideas to make a difference in your community

What does Integration mean to you?

The idea of bringing everyone together

What does Collaboration mean to you?

Being able to work well with others and welcoming the team mentality.

What does integrity mean to you?

Remaining ethical and having a strong moral compass. Treating others with respect and taking responsibility for your own actions

What are some ways you can use a paperclip?

1. Clip paper

2. Clean iPhone charger

3. Reset Smoke detector

4. Dyeing Easter Eggs

5. Marshmallow Skewers

6. A Lock Pick

7. Fishing Hook

8. Earrings

9. Bookmark

10. Cleaning Finger nails

11. Improvised Key Ring

12. Hang Ornaments

13. Tie Clip

14. Money Clip

15. Fidget Spinner

16. Guitar Pick

17. Sundial

18. Golf Tee

19. Moving Specimen Under a Microscope

20. Picking Up small items like at a crime scene

What is your experience with financial modeling?

I have experience working on DCF's in a variety of different assets. I have been teaching myself how to do LBO and am taking a class on investment banking essentials which teaches modeling types in depth.

Why Lincoln International

Lincoln International has a culture that I can embrace and see myself joining. Hearing from senior members such as Mary Weber and Christine Tiseo speaking about the culture and the firm encourages employees to pursue their passion is the kind of welcoming environment I am looking for in a company. Building off that, hearing Rob Brown speaking on how culture is the most guarded asset of the company shows how the firm values the people working there. Every company something to offer but I truly feel that Lincoln International offers something special and different than other companies in the company culture.

Why VOG?

Through my own research I am draw to the Valuation and Opinions Group because there are lots of opportunity to get my hands on all kinds of investments and work with different sponsors. The group also provides the opportunity to learn a ton about private cap markets, especially private credit. Which is something I've recently become interested in over the summer with my job from JLL when trying to secure financing for particular assets.

Tell me about a time you learned a new technology

When I was a rising sophomore, I worked for a company that had me learn SQL as part of the training process. It was the first time I had learned any type of computer coding and at first, I was a bit intimidated since I had no experience with computer programing. However, I taught myself the course and managed to learn it and once I did, I was able to create queries and pull all types of raw data which I could then export to excel and evaluate.

Tell me about yourself

I am from outside Philadelphia, PA and currently attend Cornell University. I would personally describe myself as hard working both within a team and individually. I would also say that I am a happy person who likes to lighten the mood but also becomes serious when the situation requires it. I strive to achieve the best I can in every situation.

What are the top qualities of an investment banker?

1. Intellect - requires an intellectual curiosity such that you not only perform and understanding your silo of work, but you branch out to understand how a colleague's work or other factors fit into the overall puzzle

2. Discipline - Need to be able to perform efficiently and effectively under pressure and know how to time manage

3. Creativity - top-performing bankers are able to approach a task or provide a solution in a way that may be new, pioneering an avenue for products and services

4. Open-Mindedness - Broad-mindedness, which opens the door to a deeper understanding of culture and societies, expands the ability to work with and for international businesses

5. Relationship Building Skills - Social and relationship building skills, such as being able to deal with difficult people in extreme situations, having high energy and a positive attitude that exudes power but also an "I understand your needs" attitude and developing and maintaining client relationships are characteristics that bankers must possess in order to be successful

Rank the three valuation methods from highest to lowest

Trick question - there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it's best to say that it's more variable than other methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions.

Why do we use EBITDA?

EBITDA boils down a company's financial information to its bare bones. Specifically, it provides a clearer understanding of operating profitability and general cash flow. This allows for an apples-to-apples comparison of profitability between two businesses.

Additionally, EBITDA Minus Capex Is A Vital Tool In Estimating A Company's Value

Where is Lincoln International's Sweet Spot?

Sell-side M&A, strong Industrials focus and sponsors coverage

Why did you attend [Your University / Business School]? I'm sure you had many options.

Explain

Why did you major in [Your Major]?

Explain

Where else did you apply for school? Did you get in anywhere else?

Explain

What do you do for fun?

Reteaching myself guitar, watching Philadelphia sports teams, and playing with my dog.

What was your favorite class in college / business school?

Wines. Explain

What are your favorite movies / books?

Movies: Inception, Interstellar, Truman Show

Books: Game of Thrones, Rich Dad Poor Dad

Tell me something interesting about you that's not listed on your resume

Explain

Where else are you interviewing? Is it just banking? Consulting? Other companies?

Just Banking!

Are you mostly interviewing at larger banks like us? What kinds of options within banking are you considering?

Deutsche Bank, JPM, and Morgan Stanley, with a mix of Real Estate and M&A

Recently some Analysts and Associates have left "early" and jumped to hedge funds or private equity. If the opportunity comes up, why would you stay here instead?

You looked into investing but realized you don't like the nature of the work - there's too much due diligence and "looking at deals" rather than taking action and actually doing deals. As a result, after all your research speaking with alumni and other connections, you're set on banking.

Tell me about a time when you failed to honor a commitment.

Sophomore year I told my group members I would be able to finish the remainder of project by the deadline even though I had a lot of work on my plate. I then had to let them know I would not be able to finish it and they had to finish it. I learned that it's important to be honest with your group and I should have let them know how overloaded I was and asked for support ahead of time. Ever since that project I have always time managed properly and emphasized clear communication within all groups.

If I gave you an offer right now on the spot would you take it?

"Yes, show me the dotted line and I'd sign it right now."

Let's say that we were to give you an offer - how long would you need to decide whether or not to accept it?

"Show it to me and I'll sign and accept it right now."

What do you think our bank's greatest weaknesses are?

Say something more innocuous and maybe point to a "weakness" like not being strong in Europe/Asia, or not having as much experience in one industry as another bank - but then indicate how it doesn't matter to you because you're more concerned with other aspects of the firm.

Which of our competitors do you admire the most?

Harris Williams has more of a one company culture which is great because it provides an emphasis on teamwork. Although I also see this in the culture at Lincoln International.

I realize it's still early in your career - you haven't even graduated yet - but have you given any thought to your long-term plans? Do you think you'll stick with investment banking?

Can be uncertain but say that banking is where you want to start.

What is your career goal?

I want to work in finance and move my way up higher

Looking into the future 10 years, do you think you'll still be an investment banker?

Looking ten years ahead I can't say for certain what I will be doing. I would like to still be involved in investment banking but I have always been told life goes in a crazy direction so I can't say for certain I will be because I feel there will be external factors I can't control.

Weaknesses

1. Getting caught up in details. I was told that sometimes I get too caught up on focusing on details. I have worked on this over the past summer and this past semester with my school with significant progress.

2. Having trouble asking for help. I have had situations where I don't always ask for help because I have felt I needed to do it myself. I have grown out of this over the past year and now look for help when needed and use the resources at my disposal.

Strengths

1. Creative - Whenever I work on a project I always try to think of a creative way to solve the problem. When I was an intern for MarginEdge in 2020 I was assigned a general research project and I was able to discover a new revenue stream which could lead to billions of dollars by seeking suppliers instead of individual clients. I was then asked to return back as a strategy intern the following year.

2. Team-work: I have been on sports teams my entire life and have valued teammates. Whether it was a sports team or a project group I have always strived for a strong team dynamic and making sure everyone has their opinion heard.

3. Managing - I have constantly found myself in leadership positions in groups and projects. I find myself naturally able to delegate work among groups and ensure everyone is working hard while also not overworked.

Why would we decide not to give you an offer today?

If seems like humor is appropriate : "If you decide you aren't hiring"

Otherwise: State strengths for position

Tell me why we should hire you in 3 sentences.

Explain different experiences in different fields resulting in a unique background and brings a different perspective to the firm

What was your greatest failure?

Econ exam freshman year. I studied the wrong material and did the worst I have ever done on an exam. I then did a retake studied for it and got a 100% on it.

Can you talk about a team project or some kind of group activity you've worked on before?

Real Estate Finance Case Study 1 and taking lead

Can you describe a situation where a team did not work as intended? Whose fault was it?

Establishment Team. There were personality difference between people but we managed to work them out when it mattered at the end.

Can you discuss an ethical challenge you were confronted with and how you responded?

When I was a sophomore there was a student who was trying to copy someone else's paper for a project. I confronted the student and instead of directly turning them in I offered to help them with it and walk-through ideas rather than committing plagiarism.

What was the most difficult situation you faced as a leader and how did you respond?

In a group project two people were not getting along and it was affecting the group dynamic and performance. I managed to discuss the issues with both of them and find a way to work out the personal differences so the group could get back on track and finish our work.

Can you discuss a time where you had to sacrifice your time for the sake of a team project?

Fall semester of my Junior year I was in 6 classes along with in a mentor ship program and an advanced real estate program. The work load required me to work multiple hours everyday for the entire semester including weekends.

Do you work better as a leader or a follower?

I feel I am both. I can be a leader, but I can also take a step back and be a team member depending on what is required of me in the project.

What is your leadership style?

I am usually check in on people to ensure works gets done but not in a way that I'm micromanaging. I do check the work presented for mistakes to ensure the final product in correct and in the best shape possible for presentation.

Does the leader make the team?

No, the team makes the team. The leader can provide direction and unify everyone, but 1 person alone is not a "team." A leader can make things better and turn around a dysfunctional team, but it's equally important for everyone to pull their own weight.

You've never worked in finance before. How much do you know about what bankers actually do?

Acknowledge you haven't worked in the field before. Based on that, you know that bankers advise companies on transactions - buying and selling other companies, and raising capital. They are "agents" that connect a company with the appropriate buyer, seller, or investor. The day-to-day work involves creating presentations, financial analysis and marketing materials such as Executive Summaries.

Let's say I'm working on an IPO for a client. Can you describe briefly what I would do?

First, you meet with the client and gather basic information - such as their financial details, an industry overview, and who their customers are. Next, you meet with other bankers and the lawyers to draft the S-1 registration statement - which describes the company's business and markets it to investors. You receive some comments from the SEC and keep revising the document until it's acceptable. Then, you spend a few weeks going on a "road show" where you present the company to institutional investors and convince them to invest. Afterwards, the company begins trading on an exchange once you've raised the capital from investors.

How much do you know about the lifestyle in this industry? Do you know how many hours you're going to work each week?

Say that you've done your homework and you understand it's going to be an 80-100 hour per week job. It helps if you can reference specific times when you worked that much and how you dealt with it, whether it was in a summer internship or a previous job you've held.

Can you tell me about the different product and industry groups at our bank?

Product groups include : M&A, VOG, Private Funds Advisory, Capital Advisory

Industry Groups: TMT, Health Care, Energy Power and Infrastructure, and Industrials

What's in a pitch book?

1. Bank "credentials" (similar deals they've done to "prove" their expertise).

2. Summary of a company's options ("strategic alternatives" in banker-speak).

3. Valuation and appropriate financial models (for example, if you're pitching for an IPO you might show where the IPO proceeds would go).

4. Potential acquisition targets (buy-side M&A deal) or potential buyers (sell-side M&A deal). This is not applicable for equity/debt deals.

5. Summary and key recommendations.

How do companies select the bankers they work with?

This is usually based on relationships - banks develop relationships with companies over the years before they need anything, and then when it comes time to do a deal, the company calls different banks it has spoken with and asks them to "pitch" for the business. This is called a "bake-off" and the company selects the "winner" afterward.

Walk me through the process of a typical sell-side M&A deal

1. Meet with company, create initial marketing materials like the Executive Summary and Offering Memorandum (OM), and decide on potential buyers.

2. Send out Executive Summary to potential buyers to gauge interest.

3. Send NDAs (Non-Disclosure Agreements) to interested buyers along with more detailed information like the Offering Memorandum and respond to any follow-up due diligence requests from the buyers.

4. Set a "bid deadline" and solicit written Indications of Interest (IOIs) from buyers.

5. Select which buyers advance to the next round.

6. Continue responding to information requests and setting up due diligence meetings between the company and potential buyers.

7. Set another bid deadline and pick the "winner."

8. Negotiate terms of the Purchase Agreement with the winner and announce the deal.

Walk me through the process of a typical buy-side M&A deal.

1. Spend a lot of time upfront doing research on dozens or hundreds of potential acquisition targets, and go through multiple cycles of selection and filtering with the company you're representing.

2. Narrow down the list based on their feedback and decide which ones to approach.

3. Conduct meetings and gauge the receptivity of each potential seller.

4. As discussions with the most likely seller become more serious, conduct more indepth due diligence and figure out your offer price.

5. Negotiate the price and key terms of the Purchase Agreement and then announce the transaction.

Walk me through a debt issuance deal.

It's similar to the IPO process:

1. Meet the client and gather basic financial, industry, and customer information.

2. Work closely with DCM/Leveraged Finance to develop a debt financing or LBO model for the company and figure out what kind of leverage, coverage ratios, and covenants might be appropriate.

3. Create an investor memorandum describing all of this.

4. Go out to potential debt investors and win commitments from them to finance the deal.

The main differences vs. an IPO: there are fewer banks involved, and you don't need SEC approval to do any of this because debt is not sold to the "general public" but rather to sophisticated institutional investors and funds.

How are Equity Capital Markets (ECM) and Debt Capital Markets (DCM) different from M&A or industry groups?

ECM and DCM are both more "markets-based" than M&A. In M&A your job is to execute sell-side and buy-side transactions, whereas in ECM/DCM most of your tasks are related to staying on top of the market, following current trends, and making recommendations to industry and product groups for clients and pitch books. In ECM/DCM you go more in-depth on certain parts of the deal process, but you don't get as broad a view as you might in other groups.

What's the difference between DCM and Leveraged Finance?

They're similar but Leveraged Finance is more "modeling-intensive" and does more of the deal execution with industry and M&A groups on LBOs and debt financings. DCM, by contrast, is more closely tied to the markets and tracks trends and relevant data. But there's always overlap and some banks have just 1 of these groups, some have both, and some divide it differently altogether.

Let's say you had $10 million to invest in anything. What would you do with it?

Always ask for the investor's goals first. Are they looking to have big capital gains over 30- 40 years? Are they looking for tax-free retirement income? What types of assets interest them? Based on the response, you can give an appropriate answer. So if they're investing over 30-40 years and going for high capital gains, a well-diversified portfolio is probably best; if they are more concerned with tax-free income, maybe you should tell them about municipal bonds.

If you owned a small business and were approached by a larger company about an acquisition, how would you think about the offer, and how would you make a decision on what to do?

The key terms to consider would be:

1. Price

2. Form of payment - cash, stock, or debt

3. Future plans for the company vis-à-vis your own plans.

Let's say you could start any type of business you wanted, and you had $1 million in initial funds. What would you do?

You'll want to ask follow-up questions to see if the interviewer is looking for something more specific, because this one is wide open.

If no further direction is provided, you probably want to say that you'd think about some type of niche business with high margins that requires little startup capital ($1 million is not enough to build 10 factories) and ongoing maintenance - those make it harder to turn a profit and sell the business one day.

(This is one reason why some private equity investors focus on software companies).

It's better to focus on a niche market because most broad, horizontal markets are already dominated by major companies (Microsoft, Goldman Sachs, Exxon Mobil, etc.).

You should also explain your reasoning on why this type of business would be attractive and how it could grow with minimal future investment.

Can you talk about a company you admire and what makes them attractive to you?/Pitch me a stock

ImmunoGen got an accelerated approval for its ovarian cancer drug on November 15th 2022 and has seen its stock price double since 2020 from $2.44 per share to $5.00. Although ImmunoGen Missed their EPS by about $0.06 compared to the estimate for the quarter revenue was still up $6.17 million YOY and with the new drug getting accelerated approval expecting the numbers to increase once it is in circulation.

Let's assume you are going to start a laundry machine business. How would you analyze whether it's viable?

To assess whether it's "viable," you have to determine whether you can make a profit with the business. For a laundry machine operation, you'd start by looking at the location (the most important part of any retail business), estimate how many customers you could get, how frequently they do laundry and how much they pay each time to do their laundry. Those variables give you an idea of monthly / annual revenue.

On the expense side, the biggest cost would be the upfront construction and/or purchase of the building and the machines. You would probably need a loan for this unless you had a spare $500K in your bank account.

You would also have to take into account the cost of maintaining and servicing the machines, building maintenance, and hiring someone to collect cash, clean, and open/close the building each day.

Overall, location plays the biggest role in the success of this type of business - if you put your new company next to an apartment complex where everyone has laundry machines, you're doomed from the beginning.

Incidentally, laundry machines happen to be very profitable businesses if run correctly - mostly because they are not labor intensive and do not require huge investments after you've gotten started. So you could even use this as an example for the "What kind of business would you start with $1 million?" question.

Tell me about an M&A deal that interested you recently.

Microsoft acquiring Activision Blizzard for $68.7 billion. When predicting the future of consumer software, looking at Microsoft's acquisitions is rarely a bad place to start. In January of this year, it acquired the world's largest video game maker for $95 per share, in an all-cash transaction valued at $68.7 billion, suggesting to many that this was the beginning of a new phase for the gaming industry.

With the acquisition, Microsoft added a series of globally renowned franchises to its portfolio including Warcraft, Diablo, Call of Duty, Overwatch, and Candy Crush. Significantly, the deal also meant that Microsoft jumped into the world's third-largest gaming company by revenue slot, now just behind Tencent and Sony.

What's the play behind the acquisition? Well, it looks as though Microsoft is betting that the future of gaming is on the cloud, and not on consoles (such as the Playstation). By bringing all of its stable of beloved games onto Game Pass, its flagship subscription service, it could become the go-to destination for gamers across the world.

Can you explain to me, in simple terms, the subprime crisis?

Explain

Do you agree with the $700 billion bank bailout?

"Yes" because, as we witnessed with the bankruptcy of Lehman Brothers, if a financial institution that's large enough collapses, it can have ripple effects and bring down the rest of the economy and financial markets along with it.

I see you have no relevant finance experience - why should we hire you over someone who's had a previous banking internship?

I have skills from a number of different industries that provides different perspectives than someone who has only worked in banking/finance internships. Banking isn't just how many internships you have had in banking but rather the skills a prospective hire can bring. I believe my experience working on different projects and teams can translate well since I have had to adapt quickly and adjust strategy in different fields.

You're a smart guy/girl with a lot of options, and right now the economy is not doing well and lots of banks have failed. Why are you still interested in banking when you could do anything else?

Talk about your long-term view and how a downturn could be an even better time to enter the industry because you'll know how to work when times are both good and bad. In addition, you've been interested in finance for a long time and are not going to let short-term difficulties deter you from entering the field - you've explored other options and concluded that this is the best one for you.

Where did your interest in finance begin?

When I was in 6th grade I took part in a stock market project where we were given money to "invest." I became interested in the process and soon opened my own account where I could trade stocks and that was began my love for finance, it wasn't until this past summer however working in real estate finance that I realized I was more interest in investment banking. I was interested in how banks decided to loan money and how the process was done and that's when I began doing my research and decided this was where I wanted to go in my career.

What's your greatest fear about investment banking?

I am afraid of putting in lots of work on deals and not always getting to see them through to conclusion because anything could cause a large transaction to collapse, especially with the current market status.

That guy over there has a 4.0 from Wharton/Harvard - why should I hire you over him, given that you're much less impressive?

That person has impressive credentials. But at a bank you want someone who is smart, can do the work, and is easy to get along with. I've done well in school and am taking classes next semester specifically to assist in this type of role. I am also reteaching myself the guitar and paint and draw in my free time. So, while they may be qualified on paper, in banking it all comes down to real-world experience and what kind of camaraderie you have with everyone. I'm confident that I will excel in both of those areas.

Let's say your MD is meeting with a client and you have been invited. As he's presenting, you notice a mistake in the materials - do you point it out?

No. Unless it comes up in the meeting then I would speak about it if the MD asks me to.

Why did you NOT receive a return offer from your internship?

"I did well in my internship and got positive reviews, but I didn't fit in with the group's culture. From those I've spoken with so far at your firm, I think this is a much better fit for me."

What type of animal / vegetable would you be?

Hedgehog. I would have spikes on the outside to an observer, but actually warm and fuzzy on the inside

Tell me a joke.

A man was in a job interview when the manager handed him her laptop and said, "I want you to try and sell this to me."

So he put it under his arm, walked out of the building and went home. Eventually, she called his cell phone and said, "Bring back my laptop!"

He said, "$200 and it's yours."

What's your personal Beta?

1.3 I am much more ambitious than the average person, which causes me to try lots of new things and achieve quite a bit, so that inevitably carries some risk

What's the riskiest thing you've ever done?

My previous internship when I suggested a new strategy for the company to the executives. It was a different direction than the way they were planning to go, and I knew it would turn some heads I just didn't know if it would be taken positively or negatively. I stood by my research and decision and still gave the presentation, and it went over terrifically.

Let's say that you have $1 million, but you are NOT allowed to invest it or otherwise use it to create more money. What would you spend the capital on instead?

I would use it to buy more equipment like speakers and amplifiers for my guitar since I can't invest it I might as well use it for my hobbies. New art equipment and finally get the chance to travel the world like I've wanted.

What are the advantages and disadvantages of each option?

Refinance

Sale

Restructuring

Bankruptcy

1. Refinance - Advantages: Least disruptive to company and would help revive confidence; Disadvantages: Difficult to attract investors to a company on the verge of going bankrupt.

2. Sale - Advantages: Shareholders could get some value and creditors would be less infuriated, knowing that funds are coming; Disadvantages: Unlikely to obtain a good valuation in a distressed sale, so company might sell for a fraction of its true worth

3. Restructuring - Advantages: Could resolve problems quickly without 3rd party involvement; Disadvantages: Lenders are often reluctant to increase their exposure to the company and management/lenders usually don't see eye-to-eye

4. Bankruptcy - Advantages: Could be the best way to negotiate with lenders, reduce obligations, and get additional financing; Disadvantages: Significant business disruptions and lack of confidence from customers, and equity investors would likely lose all their money

What is Valuations and Opinions Group

Provide a supported, well document opinion of the actual value of a company (or intangible asset, business line, etc.)

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."

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.

How do the 3 statements link together?

"To tie the statements together, Net Income from the Income Statement flows into Shareholders' Equity on the Balance Sheet, and into the top line of the Cash Flow Statement.

Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, and investing and financing activities affect Balance Sheet items such as PP&E, Debt and Shareholders' Equity. The Cash and Shareholders' Equity items on the Balance Sheet act as "plugs," with Cash flowing in from the final line on the Cash Flow Statement."

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.

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).

Walk me through how Depreciation going up by $10 would affect the statements.

Income Statement: Operating Income would decline by $10 and assuming a 40% tax rate, Net Income would go down by $6.

Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4.

Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow Statement.

Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders' Equity on the Liabilities & Shareholders' Equity side is down by $6 and both sides of the Balance Sheet balance.

Note: With this type of question I always recommend going in the order:

1. Income Statement

2. Cash Flow Statement

3. Balance Sheet

This is so you can check yourself at the end and make sure the Balance Sheet balances.

Remember that an Asset going up decreases your Cash Flow, whereas a Liability going up increases your Cash Flow.

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.

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 happens when Accrued Compensation goes up by $10?

For this question, confirm that the accrued compensation is now being recognized as an expense (as opposed to just changing non-accrued to accrued compensation).

Assuming that's the case, Operating Expenses on the Income Statement go up by $10, Pre-Tax Income falls by $10, and Net Income falls by $6 (assuming a 40% tax rate).

On the Cash Flow Statement, Net Income is down by $6, and Accrued Compensation will increase Cash Flow by $10, so overall Cash Flow from Operations is up by $4 and the Net Change in Cash at the bottom is up by $4.

On the Balance Sheet, Cash is up by $4 as a result, so Assets are up by $4. On the Liabilities & Equity side, Accrued Compensation is a liability so Liabilities are up by $10 and Retained Earnings are down by $6 due to the Net Income, so both sides balance.

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

No changes to the Income Statement. On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow from Operations - it goes down by $10, as does the Net Change in Cash at the bottom. On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10, so the changes cancel out and Assets still equals Liabilities & Shareholders' Equity.

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

In the case of Inventory, the expense is only recorded when the goods associated with it are sold - so if it's just sitting in a warehouse, it does not count as a Cost of Good Sold or Operating Expense until the company manufactures it into a product and sells it

What is working capital? How is it used?

Working Capital = Current Assets - Current Liabilities.

If it's positive, it means a company can pay off its short-term liabilities with its short-term assets. It is often presented as a financial metric and its magnitude and sign (negative or positive) tells you whether or not the company is "sound."

Bankers look at Operating Working Capital more commonly in models, and that is defined as (Current Assets - Cash & Cash Equivalents) - (Current Liabilities - Debt).

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

Not necessarily

1. Some companies with subscriptions or longer-term contracts often have negative Working Capital because of high Deferred Revenue balances.

2. Retail and restaurant companies like Amazon, Wal-Mart, and McDonald's often have negative Working Capital because customers pay upfront - so they can use the cash generated to pay off their Accounts Payable rather than keeping a large cash balance on-hand. This can be a sign of business efficiency.

3. In other cases, negative Working Capital could point to financial trouble or possible bankruptcy (for example, when customers don't pay quickly and upfront and the company is carrying a high debt balance).

When looking at an acquisition of a company, do you pay more attention to Enterprise or Equity Value?

Enterprise Value, because that's how much an acquirer really "pays" and includes the often mandatory debt repayment.

What's the formula for Enterprise Value?

EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash

Why do you need to add Minority Interest to Enterprise Value?

Whenever a company owns over 50% of another company, it is required to report the financial performance of the other company as part of its own performance. So even though it doesn't own 100%, it reports 100% of the majority-owned subsidiary's financial performance. In keeping with the "apples-to-apples" theme, you must add Minority Interest to get to Enterprise Value so that your numerator and denominator both reflect 100% of the majority-owned subsidiary.

How do you calculate fully diluted shares?

Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities, such as warrants, convertible debt or convertible preferred stock.

To calculate the dilutive effect of options, you use the Treasury Stock Method (detail on this below).

Let's say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each - what is its fully diluted equity value?

$1,000. In this case the options' exercise price is above the current share price, so they have no dilutive effect.

Why do you subtract cash in the formula for Enterprise Value? Is that always accurate?

The "official" reason: Cash is subtracted because it's considered a non-operating asset and because Equity Value implicitly accounts for it. The way I think about it: In an acquisition, the buyer would "get" the cash of the seller, so it effectively pays less for the company based on how large its cash balance is. Remember, Enterprise Value tells us how much you'd really have to "pay" to acquire another company. It's not always accurate because technically you should be subtracting only excess cash - the amount of cash a company has above the minimum cash it requires to operate.

Is it always accurate to add Debt to Equity Value when calculating Enterprise Value?

In most cases, yes, because the terms of a debt agreement usually say that debt must be refinanced in an acquisition. And in most cases a buyer will pay off a seller's debt, so it is accurate to say that any debt "adds" to the purchase price. However, there could always be exceptions where the buyer does not pay off the debt. These are rare and I've personally never seen it, but once again "never say never" applies.