Finance Interview Questions

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Daily Finance Interview Question – 03.24.2023

Question: What is the most important of the Three Financial Statements?

  • Income Statement
  • Balance Sheet
  • Cash Flow Statement

The most important of the three statements is the Cash Flow Statement because if a business runs out of Cash, it can no longer operate.

Daily Finance Interview Question – 03.23.2023

Question: What is the Matching principle?

  • Expenses are matched with the related revenue earned
  • Expenses are matched to their useful life
  • Revenues are matched to the transactions that created them

The Matching Principle says that we record expenses in line with the Revenue they helped to create.

Daily Finance Interview Question – 03.22.2023

Question: A company buys a Business that generates $10 of EBITDA at an EV of $100. The PE firm quickly doubles EBITDA via cost synergies. What is the ‘effective’ or ‘pro forma’ EV/EBITDA multiple?

  • 7.5x EV / EBITDA
  • 10x EV / EBITDA
  • 12x EV / EBITDA
  • 5x EV / EBITDA

Initial EBITDA is $10. The question explains that EBITDA doubles through Synergies. Therefore, Pro-Forma (i.e. including synergies) EBITDA is $20 ($10 Initial EBITDA * 2). To put it all together, 

EV/EBITDA Pro-Forma = $100 EV / $20 EBITDA 

Pro-Forma EV/EBITDA = 5x

Daily Finance Interview Question – 03.21.2023

Question: Which of the following is NOT a reason for a Minimum Equity Contribution %?

  • Lenders want Equity Investor alignment
  • Lower equity contribution for the PE Investor
  • Lower level of risk for all parties involved
  • Equity investors need ‘Skin in the Game’

Minimum Equity Contribution refers to the minimum Cash level that the Private Equity (‘PE’) Firm needs to put in for an LBO (‘Leveraged Buyout’) Deal. Minimum Equity Contribution ensures that the PE Firm has ‘Skin in the Game’ (i.e. is interested in success of the Deal because they have their own money on the line) which leads to lower risk. 

Since Minimum Equity Contribution establishes the minimum level of the payment that the PE Firm needs to make, it does not lead to a lower total payment that the PE Firm has to make. 

Daily Finance Interview Question – 03.20.2023

Question: What is the least preferred exit method in PE?

  • Sell to PE; no synergies
  • Sell to PE; smart buyers
  • IPO; low valuations
  • IPO; long process + lockup

Of all the exit methods with an LBO, an IPO is the least used route.

This is largely due to the time commitment required (and the associated risk). 

The process of going public often takes 6-9 months. 

After that point, the owners are typically ‘locked up’ (i.e. unable to sell) for another 6-12 months. 

Daily Finance Interview Question – 03.17.2023

Question: Which of the following is not a characteristic of Bonds?

  • Non-Call Provisions
  • Traded by Large Institutional Mutual Funds
  • Maintenance Covenants
  • Make Whole Premium

Maintenance Covenants

Daily Finance Interview Question – 03.16.2023

Question: What is the typical impact of pursuing a ‘Proprietary Deal’ in an LBO transaction?

  • Worse Relationship with Seller
  • Higher Purchase Price
  • Better Debt Terms
  • Lower Purchase Price

Proprietary Process means there is one specific Buyer who is offered an opportunity to buy a Company before other potential Buyers are notified of the process. Therefore, there is no Price competition – non-Auction. No Price competition also means that the Price might end up being lower than in other processes. 

Other processes include the following:

The Wide Process means there are a lot of potential Buyers. Narrow Process means there is only a small select group of potential Buyers. In both Narrow and Wide processes, Buyers typically compete on trying to offer the highest Price – Auction. 

Daily Finance Interview Question – 03.15.2023

Question: Net Income = $100, P/E Ratio = 10x, Debt = $500, Cash = $100. What’s Enterprise Value?

  • $1,000
  • $1,400
  • $1,500
  • $1,600

 This is a ‘Puzzle’ question. 

Given the information above, we can determine Enterprise Value by finding the missing pieces of information in the following steps:

1. Find Equity Value 

We are given a PE Ratio of 10x. Another way to think about PE Ratio is ‘Price per Share over Earnings Per Share’ or ‘Equity Value / Net Income’. We are given Net Income of $100. To put the numbers together:

10x PE = Equity Value / $100 Net Income 

Equity Value = 10x * $100 Net Income 

Equity Value = $1,000

2. Find Enterprise Value 

Enterprise Value and Equity Value are connected through the following formula, 

Enterprise Value = Equity Value + Debt – Cash

We found Equity Value = $1,000. We are also given Cash = $100 and Debt = $500. To piece the numbers together:

Enterprise Value = $1,000 Equity Value + $500 Debt – $100 Cash 

Enterprise Value = $1,400

Daily Finance Interview Question – 03.14.2023

Question: If a company raises $200m in equity and then uses $100m to build a new headquarters, how is Equity Value affected?

  • +$100
  • +$300
  • -$100

-$100

Daily Finance Interview Question – 03.13.2023

Question: Which of the following is a positive aspect of using a Discounted Cash Flow Analysis?

  • Requires less time to create
  • Reflects underlying cash flow value of the business
  • Not reliant on detailed assumptions

Reflects underlying cash flow value of the business

Daily Finance Interview Question – 03.10.2023

Question: Total Debt = $100, Total Equity = $100, Ke = 10%, Kd (After-Tax) = 5%, Tax Rate = 20%. What is WACC?

  • 7.5%
  • 2.5%
  • 5%
  • 9%

WACC (‘Weighted Average Cost of Capital’) is the blended average of the Expected Returns from all Investors – both those who provide Debt and those who provide Equity.

The Expected Returns are different for Lenders and Equity Investors because of the differences in Risk that they take on – Risk is lower for Lenders because they get paid first in a Sale or a Liquidation of a Business. 

To calculate WACC, the formula is as follows: 

WACC = Cost of Equity (or ‘Ke’) * Proportion (or ‘Weight’) of Equity in the Capital Structure + After-Tax Cost of Debt (or ‘Kd’) * Weight of Debt in the Capital Structure 

Using the numbers from the question above,

WACC = [ 10% Ke * 100 Total Equity / (100 Total Equity + 100 Total Debt) ]  +  [ 5% After-Tax Kd * 100 Total Debt / (100 Total Equity + 100 Total Debt ) ]

WACC = 7.5%

Daily Finance Interview Question – 03.09.2023

Question: Which of the following reflects an Unlevered Valuation Multiple?

  • Price / Book
  • P/E Ratio
  • Equity Value / Revenue
  • EV / EBITDA

Unlevered means that the item does not include the effects of Debt. For example, EBITDA is an Unlevered metric because Interest Expense from Debt is not subtracted. Similarly, Enterprise Value (‘EV’) is also an Unlevered metric because it reflects the value of a Business to all Investors (‘Capital Providers’), including those who provide Debt. Therefore, the only Unlevered Valuation Multiple from the answer choices is EV/EBITDA. 

Price/Book and PE (‘Price-to-Earnings’) Ratio are Levered Multiples because Price reflects what you own in a Business after paying Debt. 

Equity Value/Revenue is an incorrect multiple. Equity Value is a Levered metric because it reflects what you own in a Business after paying Debt. On the other hand, Revenue is an Unlevered metric because Interest Expense from Debt is not yet subtracted. Therefore, the correct Multiple would be EV/Revenue since then both metrics are Unlevered. 

Daily Finance Interview Question – 03.08.2023

Question:  Company X is buying Company Y for $37.50 per share. Company Y is estimated to generate Earnings Per Share of $1.25 in the coming year. Company X funds the deal with 50% Debt (10% Rate) and 50% Cash (0.5% Rate). Assume both companies have a 20% tax rate. Is the deal Accretive or Dilutive?

  • Accretive
  • Dilutive
  • Can’t tell…

The after-tax cost of Debt is 8.0% (10% * (1 – 20% Tax Rate)

The after-tax cost of Cash is 0.4% (0.5% * (1 – 20% Tax Rate)

The blended cost of cost of Funding is 4.2%

The Target has a P/E of 30x, which implies a Seller Yield of 3.3%.

3.3% < 4.2%

So, the deal is Dilutive.

Want more? See the video explanation.

Daily Finance Interview Question – 03.07.2023

Question: Which of the following is not a typical name for a type of Purchase Agreement?

  • DPA
  • SPA
  • APA
  • Merger Agreement

DPA

Daily Finance Interview Question – 03.06.2023

Question: Which of the following describes the targeted level of Working Capital to be delivered with a Business upon sale?

  • The Working Capital Benchmark
  • The Peg
  • Cash Free, Debt Free
  • Accounts Receivable – Inventory

Net Working Capital (‘NWC’ or ‘Working Capital’) is how much money a Business needs to put into its operations to keep running it day-to-day. Net Working Capital is a measurement of day-to-day Capital Intensity of a Business. 

In M&A, Normalized Working Capital Peg (‘The Peg’) reflects what the Buyer and the Seller believe to be a Fair Value of the day-to-day investment into a Business to keep it running. 

Normalized Net Working Capital is an important assumption in determining how much a Business is worth.

Looking further at other answer choices, another relevant to M&A term is Cash Free Debt Free. 

Cash Free Debt Free indicates that the Buyer is willing to pay for the Seller’s Business but not carry along Post-Deal the Seller’s Cash or Debt. Cash Free Debt Free is typically relevant for Bids for Private Companies.

Daily Finance Interview Question – 03.03.2023

Question: Both the Non-Solicit and Standstill provisions in an NDA typically last for an undefined/indefinite period.

  • True
  • False

NDA (‘Non-Disclosure Agreement’) is a document that Parties, in Sell-Side M&A that is the Buyer and the Seller, sign to prevent Confidential Information from being shared with anyone else.

There are multiple sections in an NDA, including Non-Solicit and Standstill.

Non-Solicit prevents prospective Buyers from hiring the Seller’s Employees (with certain exceptions, such as if an employee decides to leave the Seller themselves independent of the M&A Deal process).

Standstill prevents the the Buyer from forcing a Deal on the Seller that they don’t want to pursue.

Non-Solicit and Standstill provisions last for a specific amount of time, usually for 12 months.

Daily Finance Interview Question – 03.02.2023

Question: The Client company typically manages the Virtual Data Room in an M&A engagement.

  • True
  • False

This is False.

In the Pre-Launch step of the Sell-Side M&A Process, one of the key components is setting up the Virtual Data Room (‘VDR’). 

VDR is used to store the Seller’s files for the Buyers. The Client (i.e the Seller) sends all sorts of information to the Bank. The files typically cover Financials, Product / Market data, Legal documents, and Organization information. 

The Bankers (typically Analysts and Associates) clean up that information and organize it in a presentable format. Bankers are also responsible for managing the VDR and determining which Buyer receives which pieces of information and so on.

Daily Finance Interview Question – 03.01.2023

Question: Which of the following describes a page (or pages) within a Pitchbook that shows past Deal Volume (Dollar Value or Number of Transactions) executed by an Investment Bank?

  • Case Study
  • Buyer Strips
  • League Tables
  • Deal/Transaction Volume Sweep

Pitchbook is one of the Marketing Materials that Investment Bankers use to win Clients. Pitchbooks are created to convince potential Clients in the Bank’s expertise and experience. 

One of the sections in a Pitchbook is Credentials. 

Credentials (‘Creds’) – aims to reflects the Bank’s expertise by showing prior deals the Bank worked on and etc. 

Within the Creds sections, Bankers typically include League Tables (i.e list of Deals a Bank has worked on compared to other Banks), Tombstones (i.e overview of Deals a Bank has worked on), and Case Studies (i.e overview of a specific Deal(s) that the Bank worked on).

Looking further at some of the other answer choices, Buyer Strips would be within the Strategic Alternatives & Buyers Section. Buyer Strips is a list of potential Buyers that could be interested in purchasing the Business. 

Daily Finance Interview Question – 02.28.2023

Question: A PE fund acquires a Business with Revenue of $1,000M and $100M of LTM EBITDA. Equity Value is $200M, Net Debt is $300M, and Minority Interest is $100M. Following the acquisition, the company generates synergies that improve margins to 15%. What’s the Stated/Optical LTM EV/EBITDA Purchase Multiple?

  • 6.5x
  • 6.0x
  • 5.0x
  • 4.0x

Stated/Optical reflects values at the time of the Deal and assumes no future Synergies.

To calculate the Stated EV/EBITDA, we need to find Purchase EV (‘Enterprise Value’) and use LTM EBITDA.

  1. Purchase EV. Equity Value and Enterprise Value are connected through the following formula:

Enterprise Value = $200 Equity Value + $300 Net Debt + $100 Minority Interest

Enterprise Value = $600

  1. Stated EV/EBITDA. Using the numbers from above,

Stated EV/EBITDA = $600 EV / $100 Pro-Forma EBITDA

Stated EV/EBITDA = 6.0x

Daily Finance Interview Question – 02.27.2023

Question: A deal is funded 50/50 with Equity (10x P/E Ratio) and Debt (5% Cost). What’s the blended cost of funding for the combined Equity and Debt? Assume a 20% Tax Rate.

  • 7%
  • 5%
  • 6.75%
  • 4.3%

To find a blended cost of funding reflects how much it costs for the Buyer to purchase a Target in an M&A Deal.

The formula is very similar to WACC (‘Weighted Average Cost of Capital’) –  we will take the proportion (‘Weight’) of each Consideration form (i.e. Cash, Equity, Debt) and multiply it by associated cost. 

Note that the Cost of Equity can be calculated as an inverse of Equity’s PE Ratio – it reflects how much it costs for a Business to issue additional Shares for an M&A Deal. 

Also note that Debt Cost should be calculated on After Tax basis. 

Using the numbers provided in the question,

Blended Cost = 50% Weight of Equity * (1 / 10x Equity PE Ratio)

+ 50% Weight of Debt * [5% Before Tax Cost of Debt * (1 – 20% Tax Rate)]

Blended Cost = 7%

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Daily Finance Interview Question – 02.24.2023

Question: In an M&A transaction, the Cost of Debt is 5%. What’s the implied P/E of Debt? Assume a 20% Tax Rate.

  • 30x
  • 20x
  • 23x
  • 25x

PE of Debt can be calculated as an inverse of the After Tax Cost of Debt.

Put simply, 

PE of Debt = 1 / After Tax Cost of Debt

Using the numbers from the question, 

PE of Debt = 1 / [ 5% Cost of Cash * (1 – 20% Tax Rate) ]

PE of Cash = 1 / 4% After Tax Cost of Cash 

PE of Cash = 25x 

Daily Finance Interview Question – 02.23.2023

Question: Because of its large Cash balance, Microsoft would be considered a ‘Financial’ buyer.

  • True
  • False

This is False.

Strategic Buyer is a common name for a Corporate Buyer. Corporate Buyer is usually a Company that is looking to grow, improve operations, become more competitive, and etc., and is choosing to accomplish that through buying other Companies. Therefore, Corporate Buyers usually have strategic reasons to do M&A (‘Mergers and Acquisitions’) – hence the name ‘Strategic’ Buyers.

Another common ‘type’ of Buyers is Financial Sponsors. Financial Sponsors are typically Private Equity Firms (‘PE Firms’ or “Financial Sponsors’). PE Firms are usually looking to purchase a Business, hold it for multiple years (typically 5-10), and sell to generate a return. PE Firms usually have financial reasons to do M&A – hence the name ‘Financial Sponsor’.

Therefore, Microsoft is likely to pursue Acquisitions for strategic reasons and would then be considered a Strategic Buyer.

Daily Finance Interview Question – 02.22.2023

Question: Which of the following is NOT a common benefit for the Acquirer in M&A?

  • Target Net Income
  • Equity Dilution
  • Increased Scale/Capability
  • Cost Synergies

Acquirer (‘Buyer’) is a Company that buys another Company. Acquirers usually want to do M&A (‘Mergers and Acquisitions’) transactions to grow, expand operations, and etc. Below is an overview of the answer choices:

Equity Dilution – occurs when a Company issues new Shares. More Shares for new Owners means that existing Investors now Own less than what they used to Own prior. Therefore, Equity Dilution is a Cost, not a Benefit.

Cost Synergies – refers to the opportunity to cut down Costs in a Combined Company after an M&A Deal. For example, a Company might combine accounting departments of two firms, simplify processes, and save money. Therefore, Cost Synergies are a Benefit.

Increased Capacity – refers to the size and opportunities for a Company. For example, Acquirer might have greater international exposure after buying an international Business and have greater Capacity to grow. Therefore, Increased Capacity is a Benefit.

Target Net Income – refers to the earnings of another Company that the Buyer will ‘Own’ after the transaction. More Earnings is generally better, so Target’s Net Income is a Benefit.

Daily Finance Interview Question – 02.21.2023

Question: Walk me through the impact of a $10 increase in Depreciation on the 3 Financial Statements? (20% Tax Rate)

  • NI +$8; Cash +2; PP&E ($10); RE +$8
  • NI ($10); Cash +2; PP&E ($8); RE ($10)
  • NI ($10); Cash +0; PP&E ($10); RE ($10)
  • NI ($8); Cash +2; PP&E ($10); RE ($8)

The $10 Depreciation Expense reduces Taxable Income by $10 which creates a tax credit of $2 ($10 Depreciation * 20% Tax Rate).

The net impact to Net Income is ($8) which carries to CFO where we add the $10 Depreciation back which results in a net impact to CFO of +$2. The +$2 of CFO flows down to a Net Change in cash of +$2.

The +$2 Cash impact increases the Cash account by +$2 and PP&E decreases by the ($10) Depreciation expense, leading to a net impact to Assets of ($8).

The offsetting entry is adding the ($8) Net Income impact to Retained earnings to balance the Balance Sheet.

Want to better understand this? Check out our video on how to answer this question: https://youtu.be/9DHi3Ef9S2k

Daily Finance Interview Question – 02.20.2023

Question: If we pay less Tax to the IRS now (vs. Income Tax Expense)…and have higher Taxes Paid in the future, we record a…

  • No Way to Tell
  • Deferred Tax Liability
  • Deferred Tax Asset

Deferred Tax Liabilities (‘DTL’) arise when a Company owes taxes to the IRS that are to be paid in Cash in the future. It means a Company pays less Tax to IRS now and records a Deferred Tax Liability on the Balance Sheet. Therefore, the answer to the above question is Deferred Tax Liability. 

On the other hand, Deferred Tax Assets (‘DTA’) arise when a Company paid more in Cash to the IRS now than what it actually owes to IRS. 

Daily Finance Interview Question – 02.17.2023

Question:  A Business sells a truck for $50, that’s a list on the Balance Sheet at $20. What is the Tax impact of the transaction? (Assume a 20% Tax Rate)

  • Income Tax Expense higher by $30
  • Income Tax Expense lower by $30
  • Income Tax Expense lower by $6
  • Income Tax Expense higher by $6

A Business sells a truck for more than what the truck appears to be worth on the Balance Sheet. A $50 Selling Price is greater than a $20 Book Value (what it is on the Balance Sheet) – it creates a Gain of $30. 

A Business records a $30 Gain on the Income Statement which increases Pre-Tax Income by $30. Assuming a Tax Rate of 20%, 

Income Tax Expense = $30 * 0.2 = $6 

Income Tax Expense is higher by $6

Daily Finance Interview Question – 02.16.2023

Question: How would we account for a purchase of Inventory if we pay for it today? Then, what is the Income Statement impact if we haven’t yet sold the Inventory to a Customer?

  • (+) Cash / (-) Inventory; Record Expense
  • (-) Cash / (+) Inventory; Record Expense
  • (+) Cash / (-) Inventory; None
  • (-) Cash / (+) Inventory; None

When we purchase the Inventory, we would reduce (i.e. ‘Credit’) the Cash account to reflect an outflow of Cash.

To offset the reduction in Cash, we would then increase (i.e. ‘Debit’) the Inventory account to reflect the fact that we now own the Inventory.

Remember that in Accounting we record Expenses when they are incurred (the ‘Accrual Principle’) and we match costs to the Revenues they helped to generate (the ‘Matching Principle’).

Because we haven’t yet completed the sale of the inventory (in the form of ‘Finished Goods’), we would not record any Expense.

Daily Finance Interview Question – 02.15.2023

Question: What is the difference between Cash and Accrual-based accounting?

  • Cash reflects dollars paid/received; Accrual reflects economic substance
  • Nothing
  • Accrual reflects dollars paid/received; Cash reflects economic substance

Cash basis accounts reflects actual dollars in and out. Accrual basis accounting reflects underlying Economic Substance.

Daily Finance Interview Question – 02.14.2023

Question: A company has $25 of EBITDA and raises 3.0x in Term Loans and 2.0x in Bonds. The Company has offered 10.0x EV / EBITDA and needs a 40% Minimum Equity Contribution. What is the max additional Debt that it can raise?

  • $50
  • $0
  • $25
  • $75

$25

Daily Finance Interview Question – 02.13.2023

Question: An investment generates at 20% annual return on investment. Approximately how long will it take for the investment to double?

  • About 3 years
  • About 5 years
  • About 4.5 years
  • About 3.5 years

The phrase “investment to double” refers to a MoM (‘Money on Money’ or ‘Money on Invested Capital’ or “MOIC’ which measures initial investment against the money we get at the end) Multiple being 2x.

Given the Annual Return on Investment (i.e. ‘IRR’ or ‘Internal Rate of Return’) of 20% and using the MoM versus IRR table, we can approximate that it will take about 3.5 years. 

Note: IRR on 2x MoM on 3 years is 26% and IRR on 2x MoM on 4 years is 18%, which means that a 20% IRR with a 2x MoM would fall sometime between year 3 and year 4. 

Daily Finance Interview Question – 02.10.2023

Question: An investment generates at 20% annual return on investment. Approximately how long will it take for the investment to double?

  • About 3 years
  • About 5 years
  • About 4.5 years
  • About 3.5 years

The phrase “investment to double” refers to a MoM (‘Money on Money’ or ‘Money on Invested Capital’ or “MOIC’ which measures initial investment against the money we get at the end) Multiple being 2x.

Given the Annual Return on Investment (i.e. ‘IRR’ or ‘Internal Rate of Return’) of 20% and using the MoM versus IRR table, we can approximate that it will take about 3.5 years. 

Note: IRR on 2x MoM on 3 years is 26% and IRR on 2x MoM on 4 years is 18%, which means that a 20% IRR with a 2x MoM would fall sometime between year 3 and year 4. 

Daily Finance Interview Question – 02.09.2023

Question: Which of the following likely has the lowest Cost of Debt?

  • Mezzanine
  • 2nd Lien Term Loan
  • Revolving Credit Facility
  • Senior Notes

Revolving Credit Facility

Daily Finance Interview Question – 02.08.2023

Question: Which of the following describes a non-Auction sale process?

  • Proprietary Deal
  • Wide Process
  • Narrow Process
  • Pre-Deal Fireside Chat

Auction sale process refers to a situation when there are multiple potential Buyers for a Company. Non-Auction means that there is only one Buyer involved. 

Wide Process means there are a lot of potential Buyers. Narrow Process means there is only a small select group of potential Buyers. In both Narrow and Wide processes, Buyers typically compete on trying to offer the highest Price – Auction. 

Proprietary Process means there is one specific Buyer who is offered an opportunity to buy a Company before other potential Buyers are notified of the process. Therefore, there is no price competition – non-Auction. 

Pre-Deal Fireside Chat refers to a series of Q&A and discussion sessions that happen between Buyer, Seller, and their Advisors.

Daily Finance Interview Question – 02.07.2023

Question: Which of the following is the most common Valuation Multiple for an LBO?

  • EV / EBIT
  • P/E Ratio
  • EV / EBITDA
  • Price / Book

EV/EBITDA is the most common Valuation Multiple for an LBO because EBITDA is the proxy (i.e. approximation) for Cash Flows. EBIT excludes D&A (‘Depreciation and Amortization’) and thus is not as good of a proxy for Cash Flows. 

Price/Books and PE are not common because Price is usually a characteristic of Public Companies while LBO Transactions are usually for Private Businesses.

Daily Finance Interview Question – 02.06.2023

Question: How does a $100m debt issuance affect a company’s Equity Value?

  • +$100
  • No effect
  • -$100

No effect

Daily Finance Interview Question – 02.03.2023

Question: Why is Price/Earnings considered a levered multiple?

  • It is not a levered multiple
  • It is attributable to the entire company
  • It is only attributable to equity holders

It is only attributable to equity holders

Daily Finance Interview Question – 02.02.2023

Question: When would you use EV/Revenue as opposed to EV/EBITDA?

  • When a company has low margins
  • For all Industrial companies
  • When a company is unprofitable

When a Company doesn’t have profit, you can’t use EV / EBITDA and thus are required to use EV/Revenue.

Daily Finance Interview Question – 02.01.2023

Question: Walk me through the CAPM formula.

  • Cost of Equity = Beta + RFR + ERP
  • Cost of Equity = Beta + RFR * ERP
  • Cost of Equity = Beta + RFR
  • Cost of Equity = RFR + Beta * ERP

The CAPM formula, also called the Cost of Equity Formula, is calculated as: Cost of Equity = Risk Free Rate + Beta * Equity Risk Premium.

Daily Finance Interview Question – 01.31.2023

Question: We typically use the highest valuation from all Valuation methods (DCF, Trading, Transaction, etc.) to determine the Valuation of a Business.

  • True
  • False

The answer is False. 

We use the Valuation methods to get an idea of what Price should be paid for a Business today. It can be the highest, the middle, or the lowest valuation from all methods.

Daily Finance Interview Question – 01.30.2023

Question: Which of the following is a typical Component of the Purchase Price Section of a Non-Binding Bid for a Privately-held Company?

  • Price Per Share
  • Number of Shares
  • Cash Free, Debt Free
  • Latest Debt & Cash Values

A typical Component of the Purchase Price Section of a Non-Binding Bid for a Private Company is Cash Free Debt Free. 

In Sell-Side M&A, a Non-Binding Bid is an indication of interest from prospective Buyers to Purchase the Seller. A Non-Binding Bid usually identifies a Price that a Buyer would be willing to pay for the Seller. 

Importantly, a Non-Binding Bid does not legally obligate the Buyer to actually pay and buy the Seller. 

A typicall Component of the Purchase Price Section for a Privately-held Company is Cash Free, Debt Free. Cash Free Debt Free indicates that the Buyer is willing to pay for the Seller’s Business but not carry along Post-Deal the Seller’s Cash or Debt. 

Therefore, a Bid for a Private Company includes language to indicate that the Seller will be purchased at a certain Enterprise Value (i.e Totall Price) assuming no Cash or Debt will be carried forward (‘Cash Free Debt Free’). 

Unlike with a Private Company where the Buyer can just Purchase the Business, a Public Company has multiple individual Owners (‘Shareholders’) each holding some Shares of the Company. The Byuer has to buy out those Shares.

In addition, Lenders (i.e Debt Investors) usually have provisions in the Debt Agreements to indicate that if the Control of a Company changes (i.e the Business is bought by another Company), the Buyer of the Company has to purchase it with the Debt or pay down the Debt. 

Therefore, a Bid for a Public Company includes language to indicate that the Seller will be purchased at a certain Price Per Share, assuming a certain level of Debt and Cash. 

Both Private and Public Company Non-Binding Bids include language about Normalized Working Capital. 

Net Working Capital (‘NWC’ or ‘Working Capital’) is how much money a Business needs to put into its operations to keep running it day-to-day. Net Working Capital is a measurement of day-to-day Capital Intensity of a Business. 

Normalized Working Capital (‘The Peg’) reflects what the Buyer and the Seller believe to be a Fair Value of the day-to-day investment into a Business to keep it running. 

Normalized Net Working Capital is an important assumption in determining how much a Business is worth. 

Daily Finance Interview Question – 01.26.2023

Question: CIM’s were historically a long-form, written memo, but now are typically slide decks.

  • True
  • False

This is True. 

CIM (‘Confidential Information Memorandum’) is a detailed and often lenghty Marketing Material about the Seller’s Business created by Investment Bankers for the Buyers. CIMs contain more details about the Seller than a Teaser (i.e short anonymized Company analysis).

Historically, CIMs would be presented in a written memo. Now CIMs take a form of long Slide Decks (typically Power Point Presentations). 

Daily Finance Interview Question – 01.25.2023

Question: Which of the following describes a section, within a Pitchbook, that shows a detailed overview of a successful past deal executed by an Investment Bank?

  • Case Study
  • Tombstone
  • Corporate Overview
  • Buyer Strip

Pitchbook is one of the Marketing Materials that Investment Bankers use to win Clients. Pitchbooks are created to convince potential Clients in the Bank’s expertise and experience. 

Credentials (‘Creds’) is one of the sections in a Pitchbook that aims to reflect the Bank’s expertise by showing prior deals the Bank has worked on. 

Within the Creds sections, Bankers typically include League Tables (i.e Deal volume and success of the Bank compared to other Banks), Tombstone (i.e list of a lot of Deals a Bank has worked on), and Case Studies (i.e overview of a specific Deal(s) that the Bank worked on) 

Looking further at other answer choices:

Buyer Strip is within the Strategic Alternatives & Buyers Section. Buyer Strip highlight potential Buyers that could be interested in putchasing the Business (the Bank’s Client). 

Market / Company Overview  is a section in a Pitchbook that summarizes recent M&A trends in the overall Market and the Industry that’s relevant to the Client.

Daily Finance Interview Question – 01.24.2023

Question: An M&A deal is funded 50% Equity (10x P/E Ratio), 25% Debt (6% Cost), 25% Cash (3% Cost). The Target Company’s P/E Ratio is 25x. Is the deal Accretive or Dilutive? Assume a 33% Tax Rate.

  • Accretive
  • Dilutive
  • Breakeven
  • None of the Above

Accretive means that the Earnings of a Company go up after an M&A Deal. Dilutive means that the Earnings of a Company go down after an M&A Deal.

There is a ‘shortcut’ to determine if a Deal is Accretive or Dilutive without calculating the new Earnings. We can compare the Cost of Funding (i.e. how much it costs the Buyer to purchase the Target) against the Seller Yield (i.e. how much the Buyer gets for purchasing the Seller). 

If the Cost of Funding is lower than the Yield, then the deal is Accretive. If the Cost of Funding is higher than the Yield, then the Deal is Dilutive. Put simply: 

Accretive: Cost of Funding < Seller’s Yield 

Dilutive: Cost of Funding > Seller’s Yield 

For the question above, we need to calculate Cost of Funding and Seller’s Yield. 

1. Cost of Funding is a weighted average of all costs. Note that Cost of Equity can be calculated as an inverse of PE. Also note that Costs for Debt and Cash must be After Tax.

Put simply, 

Cost of Funding = 50% Weight of Equity * (1 / 10x Equity PE Ratio)

+ 25% Weight of Debt * [6% Before Tax Cost of Debt * (1 – 33% Tax Rate)]

+ 25% Weight of Cash * [3% Before Tax Cost of Cash * (1 – 33% Tax Rate)]

Cost of Funding = 6.5%

2. Seller’s Yield. Similarly to Cost of Equity, Seller’s Yield can be calculated as an inverse of Seller’s PE. 

Seller’s Yield = 1 / 25x Seller PE

Seller’s Yield = 4.0%

To sum up, 

6.5% Cost of Funding > 4.0% Seller’s Yield 

Dilutive

Daily Finance Interview Question – 01.23.2023

Question: A deal is funded 50/50 with Equity (10x P/E Ratio) and Debt (5% Cost). What’s the blended cost of funding for the combined Equity and Debt? Assume a 20% Tax Rate.

  • 5%
  • 4.3%
  • 6.75%
  • 7%

To find a blended cost of funding reflects how much it costs for the Buyer to purchase a Target in an M&A Deal.

The formula is very similar to WACC (‘Weighted Average Cost of Capital’) –  we will take the proportion (‘Weight’) of each Consideration form (i.e. Cash, Equity, Debt) and multiply it by associated cost. 

Note that the Cost of Equity can be calculated as an inverse of Equity’s PE Ratio – it reflects how much it costs for a Business to issue additional Shares for an M&A Deal. 

Also note that Debt Cost should be calculated on After Tax basis. 

Using the numbers provided in the question,

Blended Cost = 50% Weight of Equity * (1 / 10x Equity PE Ratio)

+ 50% Weight of Debt * [5% Before Tax Cost of Debt * (1 – 20% Tax Rate)]

Blended Cost = 7%

Daily Finance Interview Question – 01.20.2023

Question:  In an M&A transaction, the Cost of Debt is 5%. What’s the implied P/E of Debt? Assume a 20% Tax Rate.

  • 30x
  • 25x
  • 20x
  • 23x

PE of Debt can be calculated as an inverse of the After Tax Cost of Debt.

Put simply, 

PE of Debt = 1 / After Tax Cost of Debt

Using the numbers from the question, 

PE of Debt = 1 / [ 5% Cost of Cash * (1 – 20% Tax Rate) ]

PE of Cash = 1 / 4% After Tax Cost of Cash 

PE of Cash = 25x 

Daily Finance Interview Question – 01.19.2023

Question:  Which of the following would likely generate the highest after-tax earnings impact?

  • $100 of Revenue Synergies
  • $100 of Cost Synergies
  • Revenue and Cost Synergies have the same after-tax earnings impact

$100 of Cost Synergies

Daily Finance Interview Question – 01.18.2023

Question: Which one of the following is NOT a reason for a company to pursue M&A?

  • Dis-Synergies
  • Acquire Top Talent
  • Gain access to new channels
  • Growth

Companies are interested in pursuing M&A (‘Mergers and Acquisitions’) because they believe they will be better off after M&A than before. 

There are financial reasons to pursue M&A, such as Synergies (i.e. cost savings), Growth, etc. 

There are qualitative reasons to pursue M&A, such as bringing in new talent, building stronger brand image, gaining access to new channels (i.e. new customers or new suppliers), etc. 

Dis-Synergies is when instead of experiencing cost savings, a company actually sees an increase in costs. Dis-Synergies is not a Benefit and therefore are not a reason to pursue M&A.

Daily Finance Interview Question – 01.16.2023

Question: If we pay more Tax to the IRS now (vs. Income Tax Expense)…and have lower Taxes Paid in the future, we record a…

  • Deferred Tax Liability
  • Deferred Tax Asset
  • Neither

Deferred Tax Assets (‘DTA’) arise when a Company paid more in Cash to the IRS now than what it actually owes. It means a company will be able to pay less in Cash for Taxes sometime in the future. Therefore, the answer to the question above is Deferred Tax Asset.

On the other hand, Deferred Tax Liabilities (‘DTL’) arise when a Company owes taxes to the IRS that are to be paid in Cash in the future. It means a Company pays less Tax to IRS now and records a Deferred Tax Liability on the Balance Sheet.

Daily Finance Interview Question – 01.13.2023

Question: Net Income = $10, D&A = $3, NWC increased by $5, Capital Expenditures = $1, what is CFO?

  • $1
  • $19
  • $9
  • $8

CFO (‘Cash from Operations’) is a section on the Cash Flow Statement (‘CFS’) that reflects Cash Inflows and Outflows that are related to running a Business day-to day. To calculate CFO, we start with Net Income (‘NI’), adjust it for any Non-cash Expenses (i.e D&A and others), Gains and Losses, and Changes in NWC. 

Using the numbers from the question above, 

CFO = $10 Net Income + $3 D&A – $5 Increase in NWC 

CFO = $8 

We subtract Increases in NWC because it means we had to put in more Cash to run day-to-day operations for a Business. We would add a Decrease in NWC because it would reflect that we had to put in less Cash to run a Business. 

Daily Finance Interview Question – 01.12.2023

Question: A company has $20 of Interest Expense, $20 of Net Income, $100 of Cash, $50 of EBITDA, a 5% cost of Debt and trades at a 25x P/E multiple. Is the company’s EV/EBITDA multiple greater or less than 10x?

  • Greater than 10x
  • Less than 10x
  • Equal to 10x

This is a Valuation ‘Puzzle question.’

Given the information above, we can follow these steps to solve for the EV/EBITDA multiple:

1. Calculate Debt

We know that Interest Expense = Interest Rate * Debt.

So, we can take Interest Expense / Interest Rate = Debt

–> $20 Interest Expense / 5% Interest Rate = $400 Debt

2. Calculate Equity Value

We know that Equity Value = P/E Ratio * Net Income.

–>  25x P/E Ratio * $20 Net Income = $500 Equity Value

3. Find Enterprise Value (EV)

Enterprise Value = Equity Value + Debt – Cash

–> $400 Debt + $500 Equity Value – $100 Cash = $800 Enterprise Value

4. Calculate EV / EBITDA Multiple

–> $800 EV / $50 EBITDA = 16x

–> The Company’s EV / EBITDA Multiple is >10x

Daily Finance Interview Question – 01.11.2023

Question: LTM EBITDA = $20. Purchase Price is 10x EV / EBITDA. Term Loan = 2.0x EBITDA. Bond Debt = 3.0x EBITDA. Transaction Fees = $10, Financing Fees = $10. How much Sponsor Equity will the PE firm need to contribute?

  • $100
  • $120
  • $110
  • $140

First, we need to determine the Purchase Price, then determine how much of it is funded by Debt. The remained will represent Equity Contribution. 

1. Purchase Price

The Purchase Price is 10x EV/EBITDA on EBITDA of $20. Therefore, Purchase Price is $200 (10x EV/EBITDA * $20 EBITDA). There are also Total Fees of $20 ($10 from Financing and $10 from Transaction) that need to be paid. So the total amount of money needed for the transaction is $220. 

2. Debt

Total level of Debt is 5.0x EBITDA (2x from Term Loan and 3x from Bonds). Therefore:

5x Debt/EBITDA = Debt / $20 EBITDA

Debt = $100

3. Equity 

Using the numbers calculated above, we know that $100 for the $220 Transaction Value come from Debt. It means the remaining $120 need to be from Equity Contribution. 

Daily Finance Interview Question – 01.10.2023

Question: A company has $20 of Interest Expense, $20 of Net Income, $100 of Cash, $50 of EBITDA, a 5% cost of Debt and trades at a 25x P/E multiple. Is the company’s EV/EBITDA multiple greater or less than 10x?

  • Greater than 10x
  • Less than 10x
  • Equal to 10x

This is a Valuation ‘Puzzle question.’

Given the information above, we can follow these steps to solve for the EV/EBITDA multiple:

1. Calculate Debt

We know that Interest Expense = Interest Rate * Debt.

So, we can take Interest Expense / Interest Rate = Debt

–> $20 Interest Expense / 5% Interest Rate = $400 Debt

2. Calculate Equity Value

We know that Equity Value = P/E Ratio * Net Income.

–>  25x P/E Ratio * $20 Net Income = $500 Equity Value

3. Find Enterprise Value (EV)

Enterprise Value = Equity Value + Debt – Cash

–> $400 Debt + $500 Equity Value – $100 Cash = $800 Enterprise Value

4. Calculate EV / EBITDA Multiple

–> $800 EV / $50 EBITDA = 16x

–> The Company’s EV / EBITDA Multiple is >10x

Daily Finance Interview Question – 01.09.2023

Question: An LBO generates an Equity MOI of 2.75x over 5 Years. What’s the approximate IRR?

  • 22.5%
  • 15%
  • 17.5%
  • 25%

The IRR formula is complex. Instead of working through such mental math, it is easier to memorize the IRR versus MOI (‘MoM’ or ‘MOIC’ or ‘Money on Invested Capital’) Multiple. 

Using values from the table for a 5-year horizon:

2.5x MOI is 20% IRR

3x MOI is 25% IRR

2.75x MOI should be something between 20% and 25%. The best answer choice is therefore 22.5%

Daily Finance Interview Question – 01.06.2023

Question: LBO Debt is expressed typically in multiples (‘turns’) of EBIT or EBITDA – CapEx.

  • True
  • False

This is False. 

LBO Debt is typically expressed in multiples (‘turns’) of EBITDA. EBITDA is usually the closest proxy (i.e. approximation) for Cash Flows so multiples on EBITDA can give Lenders a good idea if a Business is capable to pay Interest Expense of Debt. 

Daily Finance Interview Question – 01.05.2023

Question: Which of the following is not a common filter used when looking for an LBO candidate?

  • Strong Management
  • Steady, Visible Business
  • High Capital Intensity
  • High Free Cash Flow

High Capital Intensity

Daily Finance Interview Question – 01.04.2023

Question: The cut of profit a PE Firms earns when it sells a Business is called…

  • Management Fee
  • Ticking Fee
  • Carried Interest
  • Upside Fee

Carried Interest is the Profit that the PE Firms (‘Private Equity’) earn when they sell a Business that they have invested in. 

Management Fee is what the PE Firm earns for managing the funds it received to buy the Businesses (‘Portfolio Companies’). 

Daily Finance Interview Question – 01.03.2023

Question: Equity Value = $200, Debt = $200, Cash = $0, EV/EBITDA =8x, D&A = $20. What’s EBIT?

  • $35
  • $30
  • $25
  • $40

This is a ‘Puzzle’ question. 

Given the information above, we can follow these steps to solve for EBIT:

1. Find Enterpise Value

We know that Equity Value and Enterprise Value are linked through the following formula:

Enterprise Value = Equity Value + Debt – Cash 

Using the numbers from the question above, 

Enterprise Value = $200 Equity Value + $200 Debt -$0 Cash 

Enterprise Value = $400

2. Find EBITDA

We are given a multiple of EV/EBITDA = 8x, where EV (‘Enterprise Value’) is $400 as we determined above. To put the numbers together:

8x = $400 Enterprise Value / EBITDA

EBITDA = $400 Enterprise Value / 8x

EBITDA = $50

3. Find EBIT

EBITDA is a financial metric before D&A (‘Depreciation and Amortization’) is subtracted, while EBIT is a financial metric after D&A. The question indicates that D&A is $20. To put the numbers together:

EBIT = $50 EBITDA – $20 D&A

EBIT = $30

Daily Finance Interview Question – 01.02.2023

Question: EV is Eq + ND. A business has a $100 EV, $40 of Debt and $10 of cash and generates an extra $10 of cash, what’s the EV?

  • 100
  • No Way To Tell
  • 110
  • 90

The Equity Value changed here, but Enterprise Value (i.e. the purchase price of the entire Business), should be the same.