Investment Banking Interview Questions

Flashcards of key vocabulary and concepts from Investment Banking Interview technical questions.

Income Statement

Gives the company’s revenue and expenses, and goes down to Net Income.

Balance Sheet

Shows the company’s Assets, Liabilities, and Shareholders’ Equity. Assets must equal Liabilities plus Shareholders’ Equity.

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.

Examples of Income Statement line items

Revenue; Cost of Goods Sold; SG&A; Operating Income; Pretax Income; Net Income

Examples of Balance Sheet line items

Cash; Accounts Receivable; Inventory; Plants, Property & Equipment (PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders’ Equity

Examples of Cash Flow Statement line items

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

Cash Flow Rules

An asset going up decreases your Cash Flow, whereas a Liability going up increases your Cash Flow.

Debt write-down

You record it as a gain on the Income Statement (with an asset write-down, it’s a loss) – so Pre-Tax Income goes up

Cash-based accounting

Recognizes revenue and expenses when cash is actually received or paid out

Accrual accounting

Recognizes revenue when collection is reasonably certain and recognizes expenses when they are incurred rather than when they are paid out in cash.

Company Size and Accounting Method

Most large companies use accrual accounting because paying with credit cards and lines of credit is so prevalent these days

Capitalize vs Expense

If the asset has a useful life of over 1 year, it is capitalized. Then it is depreciated (tangible assets) or amortized (intangible assets) over a certain number of years.

Goodwill Impairment

Usually this happens when a company has been acquired and the acquirer re-assesses its intangible assets (such as customers, brand, and intellectual property) and finds that they are worth significantly less than they originally thought.

LIFO vs FIFO

LIFO stands for “Last-In, First-Out” and FIFO stands for “First-In, First-Out” – they are 2 different ways of recording the value of inventory and the Cost of Goods Sold (COGS).

GAAP vs Tax Accounting

GAAP is accrual-based but tax is cash-based. GAAP uses straight-line depreciation or a few other methods whereas tax accounting is different (accelerated depreciation). GAAP is more complex and more accurately tracks assets/liabilities whereas tax accounting is only concerned with revenue/expenses in the current period and what income tax you owe.

Deferred Tax Assets/Liabilities

Arise because of temporary differences between what a company can deduct for cash tax purposes vs. what they can deduct for book tax purposes.

Common Stock

Simply the par value of however much stock the company has issued.

Retained Earnings

How much of the company’s Net Income it has “saved up” over time.

Additional Paid in Capital

This keeps track of how much stock-based compensation has been issued and how much new stock employees exercising options have created. It also includes how much over par value a company raises in an IPO or other equity offering.

Treasury Stock

The dollar amount of shares that the company has bought back.

Accumulated Other Comprehensive Income

This is a “catch-all” that includes other items that don’t fit anywhere else, like the effect of foreign currency exchange rates changing.

Non-recurring charges added back to EBITDA/EBIT

Restructuring Charges, Goodwill Impairment, Asset Write-Downs, Bad Debt Expenses, Legal Expenses, Disaster Expenses, Change in Accounting Procedures

Operating Leases

Operating leases are used for short-term leasing of equipment and property, and do not involve ownership of anything. Operating lease expenses show up as operating expenses on the Income Statement.

Capital Leases

Capital leases are used for longer-term items and give the lessee ownership rights; they depreciate and incur interest payments, and are counted as debt.

Enterprise Value vs Equity Value

It represents the value of the company that is attributable to all investors; Equity Value only represents the portion available to shareholders (equity investors).

Enterprise Value in Acquisitions

It’s how much an acquirer really “pays” and includes the often mandatory debt repayment.

Enterprise Value Formula

Equity Value + Debt + Preferred Stock + Noncontrolling Interest – Cash

Noncontrolling Interest

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.

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

Book value vs market value

Technical you should use market value for everything. In practice you use market value only for the Equity Value portion.

3 major valuation methodologies

Comparable Companies, Precedent Transactions and Discounted Cash Flow Analysis

Liquidation Valuation

Valuing a company’s assets, assuming they are sold off and then subtracting liabilities to determine how much capital, if any, equity investors receive

Replacement Value

Valuing a company based on the cost of replacing its assets

LBO Analysis

Determining how much a PE firm could pay for a company to hit a “target” IRR, usually in the 20-25% range

Sum of the Parts

Valuing each division of a company separately and adding them together at the end

M&A Premiums Analysis

Analyzing M&A deals and figuring out the premium that each buyer paid, and using this to establish what your company is worth

Future Share Price Analysis

Projecting a company’s share price based on the P / E multiples of the public company comparables, then discounting it back to its present value

Most common multiples used in Valuation

EV/Revenue, EV/EBITDA, EV/EBIT, P/E, and P/BV

Technology (Internet) Specific Multiples

EV / Unique Visitors, EV / Pageviews

Retail / Airlines Specific Multiples

EV / EBITDAR

Energy Specific Multiples

EV / EBITDAX, EV / Daily Production, EV / Proved Reserve Quantities

REITs Specific Multiples

Price / FFO per Share, Price / AFFO per Share

Free Cash Flow and Which Value to Use

Unlevered Free Cash Flow - Enterprise Value, Levered Free Cash Flow - Equity Value

How do you select Comparable Companies/Precedent Transactions?

Industry classification, Financial criteria (revenue, EBITDA, etc.), and Geography

How do you apply the 3 valuation methodologies to actually get a value for the company you’re looking at?

Take the median multiple of a set of companies or transactions, and then multiply it by the relevant metric from the company you’re valuing

NOL Tax Implications - 'Quick and Dirty' Method

Reduce the Taxable Income by the portion of the NOLs that you can use each year, apply the same tax rate, and then subtract that new Tax number from your old Pretax Income number

NOL Tax Implications - Correct Method

Create a book vs. cash tax schedule where you calculate the Taxable Income based on NOLs, and then look at what you would pay in taxes without the NOLs. Then you book the difference as an increase to the Deferred Tax Liability on the Balance Sheet.

Examples of Sensitivity Analyses

Revenue Growth vs. Terminal Multiple, EBITDA Margin vs. Terminal Multiple, Terminal Multiple vs. Discount Rate, Long-Term Growth Rate vs. Discount Rate

Dividend Discount Model (DDM)

Sum up the present value of a bank’s dividends in future years and then add it to the present value of the bank’s terminal value, usually basing that on a P / BV or P / TBV multiple.

Residual Income Model

You take the bank’s current Book Value and simply add the present value of the excess returns to that Book Value to value it.

DCF Overview

A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value

WACC Formula

Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) + Cost of Preferred * (% Preferred)

Cost of Equity

Risk-Free Rate + Beta * Equity Risk Premium

Unlevered Beta

Beta / (1 + ((1 - Tax Rate) x (Total Debt/Equity)))

Levered Beta

Un-Levered Beta x (1 + ((1 - Tax Rate) x (Total Debt/Equity)))

Formula for Terminal Value using Gordon Growth

Terminal Value = Year 5 Free Cash Flow * (1 + Growth Rate) / (Discount Rate – Growth Rate).

Getting from Revenue to FCF

Subtract COGS and Operating Expenses to get to Operating Income (EBIT). Then, multiply by (1 – Tax Rate), add back Depreciation and other non-cash charges, and subtract Capital Expenditures and the change in Working Capital.

Alternate way to calculate Free Cash Flow

Take Cash Flow From Operations and subtract CapEx and mandatory debt repayments

Dividend Recap

the company takes on new debt solely to pay a special dividend out to the PE firm that bought it.

Brain Teaser Question

The hose along with a 3 liter bucket and a 5 liter bucket. How do you get exactly 4 liters of water?