Stock buybacks Often you will hear that a company has announced that it will buy back its

own stock. Such an announcement is usually followed by an increase in the stock price. Why does a company buy back its stock? And why does its price increase after? The reason behind the price increase is fairly complex, and involves three major reasons. The first has to do with the influence of earnings per share on market valuation. Many investors believe that if a company buys back shares, and the number of outstanding shares decreases, the companys earnings per share goes up. If the P/E (price to earnings-per-share ratio) stays stable, investors reason, the price should go up. Thus investors drive the stock price up in anticipation of increased earnings per share. The second reason has to do with the signaling effect. This reason is simple to understand, and largely explains why a company buys back stock. No one understands the health of the company better than its senior managers. No one is in a better position to judge what will happen to the future performance of the company. So if a company decides to buy back stock (i.e., decides to invest in its own stock), these managers must believe that the stock price is undervalued and will rise (or so most observers would
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believe). This is the signal company management sends to the market, and the market pushes the stock up in anticipation. The third reason the stock price goes up after a buyback can be understood in terms of the debt tax shield (a concept used in valuation methods). When a company buys back stock, its net debt goes up (net debt = debt - cash). Thus the debt tax shield associated with the company goes up and the valuation rises (see APV valuation). New stock issues The reverse of a stock buyback is when a company issues new stock, which usually is followed by a drop in the companys stock price. As with stock buybacks, there are three main reasons for this movement. First, investors believe that issuing new shares dilutes earnings. That is, issuing new stock increases the number of outstanding shares, which decreases earnings per share, which given a stable P/E ratio decreases the share price. (Of course, the issuing of new stock will presumably be used in a way that will increase earnings, and thus the earnings per share figure wont necessa rily decrease, but because investors believe in earnings dilution, they often drive stock prices down) . There is also the signaling effect. In other words, investors may ask why the companys senior managers decided to issue equity rather than debt to meet their financing requirements. Surely, investors may believe, management must believe that the valuation of their stock is high (possibly inflated) and that by issuing stock they can take advantage of this high price. Finally, if the company believes that the project for which they need money will definitely be successful, it would have issued debt, thus keeping all of the upside of the investment within the firm rather than distributing it away in the form of additional equity. The stock price also drops because of debt tax shield reasons. Because cash is flushed into the firm through the sale of equity, the net debt decreases. As net debt decreases, so does the associated debt tax shield.

Technical Questions

What are betas for tech industry? Which precedent transactions did you use? For valuing manulife financial used Great West Co, Metlife For samual manutech used AM Castle and co Q. What has a cheaper cost of capital, Equity or Debt? Debt will have a cheaper cost of capital. Interest expense is tax deductable and creates a tax shield for the corporation. Debtholder also have higher priority over equity holders during liquidation, thus having less risk, thus requiring a lower rate of return. Q. How do I determine the Cost of Debt and Equity? The cost of equity you can find through the CAPM model. Which equals to risk free rate plus beta times excess market earnings (market earnings minus risk free rate). This will give you the required rate of return on equity based on the beta of the asset/company. If you dont know the Beta, use comparable company beta. The cost of debt can be found from yield to maturity on bonds if there is any debt oustanding. If no debt outstanding then look at comparable company YTM. Q. How do I determine the Weighted Average Cost of Capital (WACC)? The weighted average cost of capital equals to the weighted average of the cost of debt and cost of equity based on the capital structure. The cost of levered equity (found through CAPM model) times equity/(debt+equity) plus the cost of debt times debt/(debt+equity) times (1-t) will give you the WACC. Q. If my capital structure is optimized, what also should be optimized? Return on Equity. Basically you have the optimal amount of equity to produce your net income. Q. Define cash earnings per share. cash flow from opearting activities divided by earnings per share? Cash Earnings=NI+Depreciation and Amortization+Deferred Taxes. Q. A company is listed as an ADR on an American exchange. The ration of shares on the home exchange to ADR shares is 6 for 1. If the ADR earnings per share is $6 what is the EPS for a share listed on the home exchange? $1, treat as if a 6 for 1 stock split occurred, 6/6. Q. Suppose you have a company where EBITDA has been rising for the past several years and that company suddenly declares bankruptcy, name some reasons for why that could have happened? Companies declare bankruptcy because they have no cash (liquidity crunch); the best answer would be to walk down the cash flow statement and describe how each of the sections could contribute to a bankruptcy filing: - Working capital crunch (receivables could be rising; could be getting pushed on payables; might be required to build significant inventory) - Capex requirements could be large (ie telecom) - Might not be able to refinance a maturing issue of debt - Litigation (ie Philip Morris posting tobacco bond) Q. You are looking at acquiring a company, but that company has a negative book value of equity. Is this a big deal? Negative book value of equity means that liabilities are larger than assets. You would want to see why the BV of equity is negative, and there could be several reasons: - Could be from negative net income over the past several years - this might a problem from an operational perspective - Might be due to a write-down of assets - would want to understand this but might not be as

bad a recurring negative net income - Firm might have levered up to issue a large dividend - will leverage be an issue going forward? Q. Which will place a higher value on the company, equity comparables or M&A comparables and why? M&A comparables will be higher due to a control premium that must be paid and synergies expected to be derived from the deal Q. Briefly walk through a discounted cash flow analysis. (including WACC) With a discounted cash flow analysis you can either find equity value or firm value. If you decide to find firm value then you will have to get unlevered cash flows and discount them at the weighted average cost of capital and add the present value of terminal year. The unlevered cash flows equals to EBIT(1-t) plus depreciation minus increase in WC, minus CAPEX. We discount the 5-10 years of forecasted unlevered cash flows at the WACC discount rate. WACC=D/(D+E)*(1-T)*Rd + E/(D+E)*Re. The WACC rate reflects both the riskiness of equity and debt holders since the cash flows are unlevered (going to both equity holders and debt holders). WACC is the weighted average, based on capital strucutre, of cost of equity from CAPM model and cost of debt. Next, you would calculate a terminal value for the firm either using a multiple of EBITDA or a perpetuity growth rate on the firm's free cash flow. Multiple Method - Multiply the final year's EBITDA by an appropriate EBITDA multiple for the firm (based on comparables). Terminal year calcluation is like the present value of a growing pepetuity. Perpetuity Growth Method - multiply the final year's free cash flow by (1+growth rate) and divide that by (r-g). Adding up the PV of the cash flows and terminal year will yield us enterpries value. From here we can get equity value by subtracting net debt which is total debt less cash then less preferred stock less minority interest. The same can be done for equity valuation however you would use levered cash flows (NI plus depreciation, minus CAPEX, minus increase in WC plus new issuance of debt minus repayment of debt). You would then need to discount these forecased levered cash flows at the cost of equity using CAPM model. Re levered = rf+ Betalevered(Rm-Rf). The rest is similar as above. To get firm value we would have to add net debt to equity value which again is total debt less cash. Q. If a company is considering an all-stock acquisition, what is the easiest way to determine (roughly) whether or not the acquisition will be accretive or dilutive? If the P/E ratio of the acquiring company is higher than the target then the merger will be accretive, if the P/E ratio is lower then it will be dilutive. For instance, if the acquirer's P/E is 20, and the target's is 10, then you are able to pay less per dollar of earnings for the target. Q. If you are going to graph a company's cost of capital, with the cost on the Y-axis and with the company's leverage level across the X-axis (from 0% leverage to 100% leverage), what would the graph look like? It would look approximately like a wide parabula (smile); the cost of capital would initially decline as you add leverage, however as the firm becomes increasingly levered, the cost of capital would increase due to bankruptcy risk Q. Why would two companies merge / What major factors drive M &A? Some are the synergies derived from the merger such as revenue - cross-selling; expenses cost cutting; exploiting economies of scale, common distribution channels, elimination of a competitor, etc., defensive (do not want someone else to acquire them), increased market share Q. Why might a firm choose debt over equity financing? Some reasons:

Does not want to dilute equity Cheaper cost of capital up to a reasonable level Wants to use leverage for increased returns

They believe that there is lots of upside potential

Q. How do you unlever at beta? Unlevered beta (also known as asset beta) will be the weighted average, based on capital structure, of levered beta (Equity beta) plus debt beta Unlevered beta = Beta levered times equity/(debt+equity) plus (1-t) times debt/(equity+debt) times Beta of debt. However beta of debt is usually zero since risk is usually taken upon the equity holders. OR Levered beta = Beta unlevered [1+(1-t)debt/equity] Q. How do you calculate the enterprise value of a firm? Enterprise value = equity value (shares outstanding under Treasury method * price) plus net debt (which is total debt less cash) + preferred stock + minority interest Q. How do you value a company that is not CF positive, has no public comps, nor any acquisition comps? Look at distribution, production methods of other companies and see if you can find any operational similarities. (i.e. find value drivers and see if there are companies that could be comps) Q. Give me an example of a coverage ratio? EBITDA/interest expense: shows ability of the firm to generate sufficient cash flow to cover fixed charges; (EBITDA-Capex)/interest expense: shows ability to cover interest expense after spending for capex

Q. What types of companies make good LBO targets? Has predictable, stable CF; mature, steady industry; well-established products; limited capex and product development expenses; undervalued; owned by a motivated seller; not highly levered
Q. Conglomerate X has a significant amount of debt maturing next year. With debt markets still tight, what options does the company have? It could renew the debt offering if possible as higher rates? It could sell some of its assets (but would lose cashflow from that unit) It could do a secondary offering to pay off the obligations Q. How would you value the naming rights of a stadium? You could look at comparables (adjusting for market differences, football, concerts, demographics, TV rights, size of stadium) to get the intrinsic value; you would then think about market specific details and willingness to pay of potential buyers (key points understand valuation is based on intrinsic value and willingness to pay).

Q. What are the 3 most common used valuation techniques? The 3 most common are DCF, public comp analysis using multiples, and precedent transactions. Discounted Cash Flow (DCF)- The value of a firm is the present value of all future cash flows. A basic DCF involves forecasting free cash flow for the firm over a specific time horizon and discounting these cash flows back at the weighted average cost of capital (WACC). Free cash flow (FCF) is usually defined as: Operating Income (also known as EBIT) * (1-Tax Rate)

Plus: Depreciation and Amortization (or other Non-Cash Charges) Less: Change in Net Working Capital and Capital Expenditures Generally, you would forecast a FCF number for each year over a certain time horizon (usually 5 or 10 years) and then attach a terminal value (TV) for the firm. The TV represents the firm as a growing perpetuity. You can estimate the TV one of two ways: TV= Final Year FCF (1+g)/(k-g) TV= Exit Multiple based on EBIT or EBITDA The FCFs and the TV are then discounted back at the WACC. This value is known as the Enterprise Value. By subtracting out net debt (debt outstanding-less cash), you are left with an equity value for the firm. The equity value divided by the number of diluted shares outstanding is the per share value. Trading/Public Comparables (Comps)- This method involves finding comparable companies in the marketplace and determining at what multiple they trade to a variety of factors. For example, if comparable companies have firm values anywhere from 5x-10x EBIT, and the company I am valuing has $100 million in EBIT, then the company could be worth anywhere from $500 million to $1 billion dollars. If you are asked about this, the best way is to give a quick example like the one described above. Acquisition Comparables (Precedent transaction comps) - Similar to Trading Comps. If comparable companies have been sold for 5x-10x revenues, and my company has $100 million in revenues, then my company may be worth anywhere from $500 million to $1 billion dollars. They key to comparable valuation is picking the right set of comps. Obviously picking companies in the same industry is necessary, but also think about other factors such as: capital structure (companies who use more leverage may trade differently than companies with all equity financing), size, seasonality, and operating margins. Other valuation methods include liquidation value and Leveraged Buy-Out. Q. Of these 3 techniques which is most likely to give the highest value of a company and which is most likely to give the lowest value? Highest will be from transaction comps and lowest will be from public comps. WHY? Q. How would you calculate unlevered free cash flow? EBIT(1-T) plus depreciation and amortization minus/plus increase/decrease in WC minus CAPEX Q. Give me an appropriate growth rate for a company's EBIT Don't think there was really one answer, just talked about how growth differs depending on where the company is in its life cycle and the industry outlook

Q. What would be an appropriate growth rate to use in the terminal year? Usually 3-5 percent, can put it as the growth rate of GDP. Q. Give me the changes in each of the three financial statements when accrued liabilities increases by $10 and the tax rate is 40%. IS expenses will increase by $10, decreases EBT, and gives a tax savings of 4 dollars but NI decreases by 6 causing net income to fall by 6 dollars BS liabilities will increase by $10, the equity will be lowered by $6 due to the expense which reduces the net income which goes into retained earning which goes into total equity. Assets increase by $4 due to tax saving or liabilities will decrease by 4 due to tax payable decreasing by $4 CF net income will decrease by 6, working capital will decrease causing cash flows from operating activities to increase by $4 as seen in increase of cash. Q. If a private company wishing to sell the company approached you, how would you go about advising the company? a. Would value the company with comparables or precedent transactions i. Acquisition-look at DCF analysis for valuation ii. Merger-synergies look at market comps, precedent transactions Q. Where do you think interest rates will be 2 year from now? In 2008 we have seen huge rate cuts so if economy starts stabilizing by 2009 then we might see some increase in the previous months. In 2010 we will probably see a more stabilized level of rates maybe even a bit of increase if economy starts growing at a rapid rate Q. What is EBITDA? Earnings Before Interest Taxes Depreciation Amortization, used as a proxy for cash flow Q. Walk me through a typical cash flow statement, balance sheet, or income statement. CF Cash flow from operating activities, investing activities, financing activities. Operating activities consists of net income plus depreciation & amortization and any other non cash expenses, less increase in WC. Investing activities consists of any CAPEX made throughout the year Financing activities consists of dividend payments, issuance of new debt, repayment of debt BS consists of assets, liabilities and equity Assets includes short and long term assets Liabilities includes short and long term liabilities such as debt

Equity includes shareholders equity and retained earnings and other comprehensive income IS consists of revenues, expenses and net income. Expenses can be recurring or one time such as extraordinary and unusual losses. Q. Company X's net income is ___; how do I compute their cash flow? Net income + depreciation and any non cash expenses, less increase in WC Q. What is goodwill? How does it affect net income? Goodwill is generated only when acquiring another company, the excess paid over the value of assets. Measure of synergies when purchasing another company. It is not amortized, however if believed to be impaired you can do a loss on goodwill which will affect net income. Q. What is working capital? Current assets minus current liabilities. Measure of a companys efficiency and short term financial health. Q. What are deferred taxes? Where do they come from? Deferred taxes are the difference between the tax payable arising from depreciation at the companies own rates (financial accounting) and the depreciation rates used for tax purposes (capital cost allowance for tax accounting). Q. What is beta, what are limitations of beta? Beta measures the sensitivity of security compared to the market, a measure of market/systematic risk. Beta gives no information about the trend of an asset with respect to the trend of the index. In fact, calculation of beta explicitly removes the trend, so has no dependency on it. Q. What is CAPM, what are limitations of CAPM? Capital asset pricing model. Required return = risk free plus beta times excess market earnings. Limitations - sensitive to historical period used, beta may change, markets are inefficient Q. What is duration, convexity? a. Duration is weighted average of present value of cash flows b. Measures DP/DR, price sensitivity to rate changes c. Convexity is second derivative, how sensitive is DP to large changes in DR Q. Define Sharpe Ratio The optimal portfolio that is tangent to the efficient frontier Measure of the excess return (or Risk Premium) per unit of risk (slope of the security market line)

Q. If a company has bank loans, secured credit lines and high yield bonds, which would de-value first if the company were to move insolvent. Q. What assumptions would you make in valuing a business in a highly cyclical business? Would have to make some kind of assumption about the cash flows and the timing of the cash flows. Q. What is the difference between a leveraged buyout and a merger? A merger involves the mutual decision of two companies to combine and become one entity; it can be seen as a decision made by two "equals". The combined business, through structural and operational advantages secured by the merger, can cut costs and increase profits, boosting shareholder values for both groups of shareholders. A typical merger, in other words, involves two relatively equal companies, which combine to become one legal entity with the goal of producing a company that is worth more than the sum of its parts. Takeover is the combination of unequals. A larger company buying a smaller one. This combination of "unequals" can produce the same benefits as a merger, but it does not necessarily have to be a mutual decision. A larger company can initiate a hostile takeover of a smaller firm, which essentially amounts to buying the company in the face of resistance from the smaller company's management. Q. What are common multiples used to gauge equity performance? Some common equity multiples are price to earnings (P/E), price to book value, price to free cash flow to equity Q. How are the multiples computed (numerator, denominator)? There are usually equity multiples and firm value (EV) multiples. Numerator for equity multiples is price per share or market cap and denominator can be earnings per share, book value per share, net income, free cash flow to equity. For EV multiples the numerator is usually enterprise value and denominator would be things such as operating income (EBIT), EBITDA or book value of capital. Firm value multiples are easier to work with than equity multiples when comparing companies with different debt ratios. Q. What multiples are generally used in a merger/acquisition? Most commonly used multiple in M&A is the P/E multiple. Add more, and talk about why.

Q. What are common ratios used to assess the debt of a company? Two main ones are Debt/equity ratio, EBIT/interest expense (interest coverage ratio) Q. Why use EBIT in the DCF? EBIT is a good proxy for cash flows. It can be used in DCF if you are trying to find the firm value since EBIT will give you unlevered cash flows. Q. How do you go from P/E to ROE? Or How do you go from ROE to Ke P/E = 1/ROE x Price/Book ratio ROE x Price/Book = Ke (cost of equity) why is this???

Q. What are some reasons why you would have a positive cash flow and a negative cash flow? Will have positive cash flows if net income is generated mainly through cash sales and payments are made through payables. If there are sales of assets and no CAPEX. If there are debt offerings and no repayments of debt or no dividends. Opposite for negative cash flows. If net income is generated through sales on account and payments are made by cash. If there are no sales of assets and high CAPEX and if there is repayment of debt and no issuance and if there are dividends distributed. Q. Why add back depreciation and amortization to find Unlevered Free Cash Flow? Depreciation and amortization are non cash expenses, meaning they will reduce your EBIT on paper but in reality there is no cash outflow from that expense. Q. I see you worked for Company X. What valuation methods would you use to value Company X and why? Which companies would you use as comparables and why? What multiples would you use to compare and why?

Q. How would you go about valuing a company whose stock you were considering buying? Q. What project in a previous job or class involved valuing a company and how did you value that company?

Talk about Amazon and dwell. How used DCF to find firm value, which betas you used, which discount rates you used, how you determined terminal value. Q. How do you value a company with no revenue? Based on comparables. If it is a company with a pending patent then value it as a put option. Q. Tell me how you would go about valuing a privately held construction company? What if there are no publicly traded peers? Would use multiples based on comparables in the industry. If there are no publicly traded peers then forecast potential cash flows and use them? No idea Q. What are the main issues in valuing a privately held firm? Acquiring betas, discount rates, cash flows. Q. How would you value a non-U.S. company? With multiple analysis of comparable non-US firms. Can do DCF valuation with appropriate discount rates? Q. How would you value a company with no earnings such as a start up? Would use revenue multiples, what else? Q. How do you compute a terminal value on a DCF? If it's a strategic deal, you'll probably use a perpetuity model since they want the asset for the long term. If it's a financial deal the sponsor will want to sell in the terminal year and you'll use a multiple, like EV/EBITDA. There are two methods. You can use terminal EBIDTA exit multiples and you can view the final year FCF as a growing perpetuity. Multiply final year EBIDTA by a multiple of comparable firms. Take final year FCF and apply appropriate growth rate, discount by discount rate minus growth rate. Discount this total value to present date. Q. How do you determine your Free Cash Flows? Why is there a need to calculate it? You can calculate either unlevered free cash flows or levered free cash flows. Unlevered free cash flows = EBIT(1-T) + depreciation & amortization increase in WC CAPEX Levered free cash flows = NI + depreciation & amortization increase in WC CAPEX + (Debt issuance debt repayment). FCFF = Net income + Noncash charges (such d&A) + Interest expense * (1-Tax rate) Capex - Working capital expenditures = Free Cash Flows to the Firm (FCFF) FCFE = Net income + Noncash charges (such d&A) - Capex + Net borrowing - Net debt repayment - Working capital expenditures = Free Cash Flows to the equity (FCFE) Q. Where do you get EBIT? Income statement, same as operating income

Q. What is EBIT? Earnings before interest and taxes. A proxy for cash flows. Q. What is EBITDA? Earnings before interest, taxes, depreciation & amortization. Proxy for cash flows without including depreciation, D&A is always added back to EBIT to get EBITDA for calculations of FCFF Q. Why is EBITDA a surrogate for operating cash flows? Q. What is the difference between EBIT and Operating Income? EBIT includes non operating income Q. What type of discount rate would I use in valuing the cash flows of a particular company? For firm valuation would use the WACC, use the cost of debt from bonds outstanding and use the cost of equity from CAPM model based on the levered beta of the company, risk free rate, and market returns. For equity valuation would use the CAPM rate which is the return on equity consisting of risk free rate, levered beta, and market returns. Q. What is the value ratio? Selecting companies with low P/E ratios who pay out high dividends and low price to book ratio. Q. What is price to book value? Price per share divided by book value per share (equity/# of shares) Whether you're paying too much for what would be left if the company went bankrupt immediately. Q. What beta do you use in CAPM and how do you obtain it? Usually you would use leveraged beta if you are trying to find levered equity. However if you are doing the APV approach you would use the unlevered beta to get the unlevered return on equity to find the unlevered value of the firm then add back the present value of the tax shield from having debt. You can obtain it by regressing the stock returns to the market returns or more mathematically its covariance between market and security divided by variance of market. Q. How do you unlever a Beta? Why do you unlever a beta? Beta levered = Beta unlevered[1+(1-t)D/E]. If you are trying to find the unlevered beta of a firm for APV valuation then you could use the levered beta and unlever it. Q. How do you lever a Beta? Why do you lever a beta? Beta unlevered = Beta equity times E/(D+E) plus (1-t) times D/(D+E) times Debt Beta. However Beta of debt is usually zero since all risk is usually borne by equity holders.

If you have unlevered beta and want to get levered beta for CAPM model or for WACC. Where does the 1-t come from in the unlevering a beta equation?

Q. In calculating CAPM, do you use an asset beta or an equity beta? In CAPM you use equity beta because you are trying to find out the required return to equity. However you can use the asset beta (unlevered beta) if you want to find the unlevered firm value for APV approach. Q. When do you use an unlevered Beta or a levered Beta? You would use levered beta when doing equity valuation or when doing firm valuation using WACC. You would use unlevered beta if you are doing firm valuation with APV method in order to find unlevered firm value. Q. If you have an asset beta how do you derive your equity beta? Beta equity = Beta asset/(Equity/(Debt+Equity) Q. What companies or industries have high Betas? Volatility in earnings is what determines beta. Three things that affect beta are financial leverage, operating leverage and industry characteristics such as cyclical businesses. High beta companies would be tech stocks, financials, and construction. Q. You are interested in X company, what is its beta and the industry average beta? Q. What index is used to calculate beta? Usually S&P 500 or some other market index. Q. Is beta constant or does it vary over time? Beta varies over time; it is dependent on earning volatility which depends on industry characteristics, financial leverage, and operating leverage. Q. What do you think the beta of General Motors is? What about a high-tech stock such as Cisco Systems? GM would have high beta of about 1.8-2. The reason is that in good economic conditions they will see their sales increasing, while people buy more cars. Cisco systems would have a low beta of 1.1-1.3. Explain why? Q. What number would you use for the market risk premium? Would use historical premium of 6.8% for US. Q. What number would you use for the risk-free rate? If forecasts are for 10 years then 10 year t bill rate. Q. How do you calculate the Gordon Growth Model or Perpetuity Model for the second Terminal Value? FCF(1+g)/(r-g)

Q. What are some of the advantages and disadvantages of DCF? Advantages - Looks for fundamentals that drive value rather than what market perceptions are. - If stock prices rise disproportionately relative to the underlying earnings and cash flows, DCF models are likely to find stocks to be overvalued, and the opposite. Disadvantages: - DCF valuations can be manipulated to generate estimates of value that have no relationship to intrinsic value due to the vast amount of assumptions that are needed - Need substantially more information to value a company with DCF models, since estimates of cash flows, growth rates, and discount rates are needed. - DCF may find every stock in a sector or even a market to be overvalued if market perceptions have run ahead of fundamentals. Q. What is NOPLAT? Net operating profits less adjusted taxes, same as EBIT(1-T). Removes the effects of capital structure. Q. Is a DCF valuation the value of equity or the enterprise value of a company? Can be either depending if you use unlevered or levered cash flows Q. Reconcile Free Cash Flow from Net Income? Are they asking for free cash flow to firm/equity? Net income + depreciation increase in wc Q. How do you find diluted shares outstanding? Total common shares + any convertible shares Q. What is the Treasury Stock Method? When would you use it? How do you calculate it? Check in accounting book The component of the diluted earnings per share denominator that includes the net of new shares potentially created by unexercised in-the-money warrants and options. This method assumes that the proceeds that a company receives from an in-the-money option exercise are used to repurchase common shares in the market. Q. How do you get the Enterprise Value (or known as firm value, total capitalization, transaction value, aggregate value, adjusted market value)? Can do market cap (equity) + net debt + preferred shares + minority interest Can do DCF with unlevered cash flows

Comparable Questions:

Understand equity and enterprise multiples. Know them backwards and forwards and when you apply them, what companies would use equity multiples vs. enterprise multiples, how it is related to debt, etc. Q. What are the difference between public comparables and acquisition comparables? Acquisition comparables are used to derive the relative value of a company based on precedent transactions in a given industry. Acquisition comparables will be higher due to premium paid and synergies to be derived from the merger/acquisition Public comparables are derived from public company 10-K/10-Qs Q. Why dont you compare Net Income to Enterprise Value? Q. What is difference between Enterprise Value and Equity Value? Enterprise value is the value of the firms total debt and market value of equity, while equity value is just the market value of equity

Public or Trading Comparables Questions: Q. Pick a company. What multiples would you use for that company? What if it was a start-up? What if it had high CAPEX that was unusual? Q. What determining factors would you use to find comparable companies for a public comp?

Q. How would you do a public comparable? Q. How do you find the appropriate market value for a company?

Q. You are interested in company X, what multiples would you use to compare it to its peers? Q. How would you find information for a comp? Capital IQ, 10-K/10-Q of companies Q. When do you use public vs. acquisition? Q. You said you were interested in health care, what is an average P/E multiple in this area. Acquistion or Transaction Comparables Questions: Q. What are the key factors in determining your comparable transactions? Q. What is included in the price paid for an acquisition? Control premium and synergies to be derived from the deal

Q. What is the difference between offer value and equity value? Same thing? Q. What is the difference between transaction value and enterprise value? Same thing? Q. How would you determine the deal list for acquisition comps? Q. What are some shortcomings of acquisition comps? Q. What multiples would you use for acquisition comps? Random Questions: Q. Company A and B are in the restaurant business. Company A is buying company B. What things would company A want to know? Q. What is an option? You're talking to a CEO about how he could use options. What would you say? Q. How would you value and compare a private all equity company vs. a public company with equity and debt? Q. How do you calculate the cost of debt for a private company? Q. If valuing an all-equity company, how would you calculate the cost of equity? Q. If you were advising a client on an acquisition and your client was willing to pay between $800M - $1B and you knew a PE outfit was about to make a bid for $850M, what would you offer to preempt their bid? Q. If company A owned its stores and company B leased its stores, which would have the higher EBITDA? Q. Its 10pm and you have a pitch to prepare for morning what would you do to prepare a valuation for the client company? Q. If a target company has a higher P/E than the acquirer in an all-stock deal, will the acquisition be accretive or dilutive? Q. What are the benefits of pooling versus purchase method in an acquisition? Q. You said you were interested in technology, what's the average debt load for a technology company? Q. What is an LBO and how is it structured?

Q. What make a company a good candidate for an LBO? Q. How do you ref out a model? (more geared towards former analysts). When a model blows up, what are the three ways to fix it? Q. In a secondary offering, if you could only choose one method of valuation, which one would you use? Why? Q. What is operating leverage? Q. Tell me how you have modeled with equations in the past? Q. Do you have an analytical mind? Show me. Q. What are the benefits of pooling versus purchase method in an acquisition? Q. Heres a whiteboard. Stand in front of it and present a chapter from your favorite finance textbook. You have five minutes. Q. Do you know the relationship between the price and yield on the bond? Q. How you developed your core finance skills (analytical ability, good communication skills, strong work ethic)? Q. What is an option? You're talking to a CEO about how he could use options. What would you say? Q. Tell me about the stock a stock that you follow? (what are we suppose to say) Q. What does liquidity allow an investor? Q. If you worked for the finance division of our company, how would you decide whether or not to invest in a project? Q. Why might a technology company be more highly valued in the market in terms of P/E than a steel company? Q. When should a company raise money via equity? Q. When should a company raise funds using debt? Q. How would one price the different elements of a convertible bond? (not as likely of a question)

Q. Your client wants to buy one of two banks. One is trading at 12xP/E and the other trades at a 16xP/E. Which should your client try to buy? Do you even have enough information to determine this? Q. What are some ways to determine if a company might be a credit risk? Q. How does compounding work? Would I be better off with 10% annually, semiannually or daily? Q. For a bond, what is duration? Why is duration important? Q. What is the difference between preferred stock and regular stock? Q. How can a company raise its stock price? Q. What is a leveraged buyout? Why lever up? Q. Your boss uses the DCF model for high growth company with low earnings. What do you think of this strategy? Q. Can I apply CAPM in Latin America markets? Q. How do you value a company with NOLS (Net Operating Losses)? Q. Why would a company do a share repurchase or buyback? Q. What are the pros and cons of a company going public? Q. Why would a company decide to issue a convertible bond or equity or debt?

Valuation

What are the three main valuation methodologies?

The three main valuation methodologies are (1) comparable company analysis, (2) precedent transaction analysis and (3) discounted cashflow (DCF) analysis.

Of the three main valuation methodologies, which ones are likely to result in higher/lower value?
Firstly, the Precedent Transactions methodology is likely to give a higher valuation than the Comparable Company methodology. This is because when companies are purchased, the targets shareholders are typically paid a price that is higher than the targets current stock price. Technically speaking, the purchase price includes a control premium. Valuing companies based on M&A transactions (a control based valuation methodology)

will include this control premium and therefore likely result in a higher valuation than a public market valuation (minority interest based valuation methodology). The Discounted Cash Flow (DCF) analysis will also likely result in a higher valuation than the Comparable Company analysis because DCF is also a control based methodology and because most projections tend to be pretty optimistic. Whether DCF will be higher than Precedent Transactions is debatable but is fair to say that DCF valuations tend to be more variable because the DCF is so sensitive to a multitude of inputs or assumptions.

How do you use the three main valuation methodologies to conclude value?
The best way to answer this question is to say that you calculate a valuation range for each of the three methodologies and then triangulate the three ranges to conclude a valuation range for the company or asset being valued. You may also put more weight on one or two of the methodologies if you think that they give you a more accurate valuation. For example, if you have good comps and good precedent transactions but have little faith in your projections, then you will likely rely more on the Comparable Company and Precedent Transaction analyses than on your DCF.

What are some other possible valuation methodologies in addition to the main three?
Other valuation methodologies include leverage buyout (LBO) analysis, replacement value and liquidation value.

What are some common valuation metrics?

Probably the most common valuation metric used in banking is Enterprise Value (EV)/EBITDA. Some others include EV/Sales, EV/EBIT, Price to Earnings (P/E) and Price to Book Value (P/BV).

Why cant you use EV/Earnings or Price/EBITDA as valuation metrics?

Enterprise Value (EV) equals the value of the operations of the company attributable to all providers of capital. That is to say, because EV incorporates all of both debt and equity, it is NOT dependant on the choice of capital structure (i.e. the percentage of debt and equity). If we use EV in the numerator of our valuation metric, to be consistent (apples to apples) we must use an operating or capital structure neutral (unlevered) metric in the denominator, such as Sales, EBIT or EBITDA. These such metrics are also not dependant on capital structure because they do not include interest expense. Operating metrics such as earnings do include interest and so are considered leveraged or capital structure dependant metrics. Therefore EV/Earnings is an apples to oranges comparison and is considered inconsistent. Similarly Price/EBITDA is inconsistent because Price (or equity value) is dependant on capital structure (levered) while EBITDA is unlevered. Again, apples to oranges. Price/Earnings is fine (apples to apples) because they are both levered.

Enterprise Value and Equity Value

What is the difference between enterprise value and equity value?

Enterprise Value represents the value of the operations of a company attributable to all providers of capital. Equity Value is one of the components of Enterprise Value and represents only the proportion of value attributable to shareholders.

What is the formula for Enterprise Value?

The formula for enterprise value is: market value of equity (MVE) + debt + preferred stock + minority interest - cash.

How do you calculate the market value of equity?

A companys market value of equity (MVE) equals its share price multiplied by the number of fully diluted shares outstanding.

What is the difference between basic shares and fully diluted shares?
Basic shares represent the number of common shares that are outstanding today (or as of the reporting date). Fully diluted shares equals basic shares plus the potentially dilutive effect from any outstanding stock options, warrants, convertible preferred stock or convertible debt. In calculating a companys market value of equity (MVE) we always want to use diluted shares. Implicitly the market also uses diluted shares to value a companys stock.

How do you calculate fully diluted shares?

To calculate fully diluted shares, we need to add the basic number of shares (found on the cover of a companys most recent 10Q or 10K) and the dilutive effect of employee stock options. To calculate the dilutive effect of options we typically use the Treasury Stock Method. The options information can be found in the companys latest 10K. Note that if the company has other potentially dilutive securities (e.g. convertible preferred stock or convertible debt) we may need to account for those as well in our fully diluted share count.

How do we use the Treasury Stock Method to calculate diluted shares?

To use the Treasury Stock Method, we first need a tally of the companys issued stock options and weighted average exercise prices. We get this information from the companys most recent 10K. If our calculation will be used for a control based valuation methodology (i.e. precedent transactions) or M&A analysis, we will use all of the options outstanding. If our calculation is for a minority interest based valuation methodology (i.e. comparable companies) we will use only options exercisable. Note that options exercisable are options that have vested while options outstanding takes into account both options that have vested and that have not yet vested.

Once we have this option information, we subtract the exercise price of the options from the current share price (or per share purchase price for an M&A analysis), divide by the share price (or purchase price) and multiply by the number of shares outstanding. We repeat this calculation for each subset of options reported in the 10K (usually companies will report several line items of options categorized by exercise price). Aggregating the calculations gives us the amount of diluted shares. If the exercise price of an option is greater than the share price (or purchase price) then the options are out-of-the-money and have no dilutive effect. The concept of the treasury stock method is that when employees exercise options, the company has to issue the appropriate number of new shares but also receives the exercise price of the options in cash. Implicitly, the comp any can use this cash to offset the cost of issuing new shares. This is why the diluted effect of exercising one option is not one full share of dilution, but a fraction of a share equal to what the company does NOT receive in cash divided by the share price.

Why do you subtract cash in the enterprise value formula?

Cash gets subtracted when calculating Enterprise Value because (1) cash is considered a non-operating asset AND (2) cash is already implicitly accounted for within equity value. Note that when we subtract cash, to be precise, we should say excess cash. However, we will typically make the assumption that a companys cash balance (including cash equivalents such as marketable securities or short-term investments) equals excess cash.

What is Minority Interest and why do we add it in the Enterprise Value formula?
When a company owns more than 50% of another company, U.S. accounting rules state that the parent company has to consolidate its books. In other words, the parent company reflects 100% of the assets and liabilities and 100% of financial performance (revenue, costs, profits, etc.) of the majority-owned subsidiary (the sub) on its own financial statements. But since the parent company does not 100% of the sub, the parent company will have a line item called minority interest on its income statement reflecting the portion of the subs net income that the parent is not entitled to (the percentage that it does not own). The parent companys balance sheet will also contain a line item called minority interest which reflects the percentage of the subs book value of equity that the parent does NOT own. It is the balance sheet minority interest figure that we add in the Enterprise Value formula. Now, keep in mind that the main use for Enterprise Value is to create valuation ratios/metrics (e.g. EV/Sales, EV/EBITDA, etc.) When we take, say, sales or EBITDA from the parent companys financial statements, these figures due to the accounting consolidation, will contain 100% of the subs sales or EBITDA, even though the parent does not own 100%. In order to counteract this, we must add to Enterprise Value, the value of the sub that the parent company does not own (the minority interest). By doing this, both the numerator and denominator of our valuation metric account for 100% of the sub, and we have a consistent (apples to apples) metric.

One might ask, instead of adding minority interest to Enterprise Value, why dont we just subtract the portion of sales or EBITDA that the parent does NOT own. In theory, this would indeed work and may in fact be more accurate. However, typically we do not have enough information about the sub to do such an adjustment (minority owned subs are rarely, if ever, public companies). Moreover, even if we had the financial information of the sub, this method is clearly more time consuming. Discounted Cash Flow (DCF) Walk me through a Discounted Cash Flow (DCF) analysis In order to do a DCF analysis, first we need to project free cash flow for a period of time (say, five years). Free cash flow equals EBIT less taxes plus D&A less capital expenditures less the change in working capital. Note that this measure of free cash flow is unlevered or debt-free. This is because it does not include interest and so is independent of debt and capital structure. Next we need a way to predict the value of the company/assets for the years beyond the projection period (5 years). This is known as the Terminal Value. We can use one of two methods for calculating terminal value, either the Gordon Growth (also called Perpetuity Growth) method or the Terminal Multiple method. To use the Gordon Growth method, we must choose an appropriate rate by which the company can grow forever. This growth rate should be modest, for example, average long-term expected GDP growth or inflation. To calculate terminal value we multiply the last years free cash flow (year 5) by 1 plus the chosen growth rate, and then divide by the discount rate less growth rate. The second method, the Terminal Multiple method, is the one that is more often used in banking. Here we take an operating metric for the last projected period (year 5) and multiply it by an appropriate valuation multiple. This most common metric to use is EBITDA. We typically select the appropriate EBITDA multiple by taking what we concluded for our comparable company analysis on a last twelve months (LTM) basis. Now that we have our projections of free cash flows and terminal value, we need to present value these at the appropriate discount rate, also known as weighted average cost of capital (WACC). For discussion of calculating the WACC, please read the next topic. Finally, summing up the present value of the projected cash flows and the present value of the terminal value gives us the DCF value. Note that because we used unlevered cash flows and WACC as our discount rate, the DCF value is a representation of Enterprise Value, not Equity Value.

What is WACC and how do you calculate it?

The WACC (Weighted Average Cost of Capital) is the discount rate used in a Discounted Cash Flow (DCF) analysis to present value projected free cash flows and terminal value. Conceptually, the WACC represents the blended opportunity cost to lenders and investors of a company or set of assets with a similar risk profile. The WACC reflects the cost of each type of capital (debt (D), equity (E) and preferred stock (P)) weighted by the

respective percentage of each type of capital assumed for the companys optimal capital structure. Specifically the formula for WACC is: Cost of Equity (Ke) times % of Equity (E/E+D+P) + Cost of Debt (Kd) times % of Debt (D/E+D+P) times (1-tax rate) + Cost of Preferred (Kp) times % of Preferred (P/E+D+P). To estimate the cost of equity, we will typically use the Capital Asset Pricing Model (CAPM) (see the following topic). To estimate the cost of debt, we can analyze the interest rates/yields on debt issued by similar companies. Similar to the cost of debt, estimating the cost of preferred requires us to analyze the dividend yields on preferred stock issued by similar companies.

How do you calculate the cost of equity?

To calculate a companys cost of equity, we typically use the Capital Asset Pricing Model (CAPM). The CAPM formula states the cost of equity equals the risk free rate plus the multiplication of Beta times the equity risk premium. The risk free rate (for a U.S. company) is generally considered to be the yield on a 10 or 20 year U.S. Treasury Bond. Beta (See the following question on Beta) should be levered and represents the riskiness (equivalently, expected return) of the companys equity relative to the overall equity markets. The equity risk premium is the amount that stocks are expected to outperform the risk free rate over the long-term. Today, most banks tend to use an equity risk premium of between 4% and 5%.

What is Beta?
Beta is a measure of the riskiness of a stock relative to the broader market (for broader market, think S&P500, Wilshire 5000, etc). By definition the market has a Beta of one (1.0). So a stock with a Beta above 1 is perceived to be more risky than the market and a stock with a Beta of less than 1 is perceived to be less risky. For example, if the market is expected to outperform the risk-free rate by 10%, a stock with a Beta of 1.1 will be expected to outperform by 11% while a stock with a Beta of 0.9 will be expected to outperform by 9%. A stock with a Beta of -1.0 would be expected to underperform the risk-free rate by 10%. Beta is used in the capital asset pricing model (CAPM) for the purpose of calculating a companys cost of equity. For those few of you that remember your statistics and like precision, Beta is calculated as the covariance between a stocks return and the market return divided by the variance of the market return.

When using the CAPM for purposes of calculating WACC, why do you have to unlever and then relever Beta?
In order to use the CAPM to calculate our cost of equity, we need to estimate the appropriate Beta. We typically get the appropriate Beta from our comparable companies (often the mean or median Beta). However before we can use this industry Beta we must first unlever the Beta of each of our comps. The Beta that we will get (say from Bloomberg or Barra) will be a levered Beta. Recall what Beta is: in simple terms, how risky a stock is relative to the market. Other things being equal, stocks of companies that have debt are somewhat more risky that stocks of companies without debt (or that have less debt). This is because even a small

amount of debt increases the risk of bankruptcy and also because any obligation to pay interest represents funds that cannot be used for running and growing the business. In other words, debt reduces the flexibility of management which makes owning equity in the company more risky. Now, in order to use the Betas of the comps to conclude an appropriate Beta for the company we are valuing, we must first strip out the impact of debt from the comps Betas. This is known as unlevering Beta. After unlevering the Betas, we can now use the appropriate industry Beta (e.g. the mean of the comps unlevered Betas) and relever it for the appropriate capital structure of the company being valued. After relevering, we can use the levered Beta in the CAPM formula to calculate cost of equity.

What are the formulas for unlevering and levering Beta?

Unlevered Beta = Levered Beta / (1 + ((1 - Tax Rate) x (Debt/Equity))) Levered Beta = Unlevered Beta x (1 + ((1 - Tax Rate) x (Debt/Equity)))

Which is less expensive capital, debt or equity?

Debt is less expensive for two main reasons. First, interest on debt is tax deductible (i.e. the tax shield). Second, debt is senior to equity in a firms capital structure. That is, in a liquidation or bankruptcy, the debt holders get paid first before the equity holders receive anything. Note, debt being less expensive capital is the equivalent to saying the cost of debt is lower than the cost of equity. Mergers and Acquisitions

Walk me through an accretion/dilution analysis

The purpose of an accretion/dilution analysis (sometimes also referred to as a quick-anddirty merger analysis) is to project the impact of an acquisition to the acquirors Earnings Per Share (EPS) and compare how the new EPS (proforma EPS) compares to what the companys EPS would have been had it not executed the transaction. In order to do the accretion/dilution analysis, we need to project the combined companys net income (proforma net income) and the combined companys new share count. The proforma net income will be the sum of the buyers and targets projected net income plus/minus certain transaction adjustments. Such adjustments to proforma net income (on a post-tax basis) include synergies (positive or negative), increased interest expense (if debt is used to finance the purchase), decreased interest income (if cash is used to finance the purchase) and any new intangible asset amortization resulting from the transaction. The proforma share count reflects the acquirors share count plus the number of shares to be created and used to finance the purchase (in a stock deal). Dividing proforma net income by proforma shares gives us proforma EPS which we can then compare to the acquirors original EPS to see if the transaction results in an increase to EPS (accretion) or a decline in EPS (dilution). Note also that we typically will perform this analysis

using 1-year and 2-year projected net income and also sometimes last twelve months (LTM) proforma net income.

What factors can lead to the dilution of EPS in an acquisition?

A number of factors can cause an acquisition to be dilutive to the acquirors earnings per share (EPS), including: (1) the target has negative net income, (2) the targets Price/Earnings ratio is greater than the acquirors, (3) the transaction creates a significant amount of intangible assets that must be amortized going forward, (4) increased interest expense due to new debt used to finance the transaction, (5) decreased interest income due to less cash on the balance sheet if cash is used to finance the transaction and (6) low or negative synergies.

If a company with a low P/E acquires a company with a high P/E in an all stock deal, will the deal likely be accretive or dilutive?
Other things being equal, if the Price to Earnings ratio (P/E) of the acquiring company is lower than the P/E of the target, then the deal will be dilutive to the acquirors Earnings Per Share (EPS). This is because the acquiror has to pay more for each dollar of earnings than the market values its own earnings. Hence, the acquiror will have to issue proportionally more shares in the transaction. Mechanically, proforma earnings, which equals the acquirors earnings plus the targets earnings (the numerator in EPS) will increase less than the proforma share count (the denominator), causing EPS to decline.

What is goodwill and how is it calculated?

Goodwill, a type of intangible asset, is created in an acquisition and reflects the value (from an accounting standpoint) of a company that is not attributed to its other assets and liabilities. Goodwill is calculated by subtracting the targets book value (written up to fair market value) from the equity purchase price paid for the company. This equation is sometimes referred to as the excess purchase price. Accounting rules state that goodwill no longer should be amortized each period, but must be tested once per year for impairment. Absent impairment, goodwill can remain on a companys balance sheet indefinitely.

Why might one company want to acquire another company?

There are a variety of reasons why companies do acquisitions. Some common reasons include:

- The Buyer views the Target as undervalued. - The Buyers own organic growth has slowed or stalled and needs to grow in other ways (via acquiring other companies) in order to satisfy the growth expectations of Wall Street. - The Buyer expects the deal to result in significant synergies (see the next post for a discussion of synergies). - The CEO of the Buyer wants to be CEO of a larger company, either because of ego, legacy or because he/she will get paid more.

Explain the concept of synergies and provide some examples.

In simple terms, synergy occurs when 2 + 2 = 5. That is, when the sum of the value of the Buyer and the Target as a combined company is greater than the two companies valued apart. Most mergers and large acquisitions are justified by the amount of projected synergies. There are two categories of synergies: cost synergies and revenue synergies. Cost synergies refer to the ability to cut costs of the combined companies due to the consolidation of operations. For example, closing one corporate headquarters, laying off one set of management, shutting redundant stores, etc. Revenue synergies refer to the ability to sell more products/services or raise prices due to the merger. For example, increasing sales due to cross-marketing, co-branding, etc. The concept of economies of scale can apply to both cost and revenue synergies. In practice, synergies are easier said than done. While cost synergies are difficult to achieve, revenue synergies are even harder. The implication is that many mergers fail to live up to expectations and wind up destroying shareholder value rather than create it. Of course, this last fact never finds its way into a bankers M&A pitch.

Leveraged Buyout (LBO) Analysis Walk me through an LBO analysis First, we need to make some transaction assumptions. What is the purchase price and how will the deal be financed? With this information, we can create a table of Sources and Uses (where Sources equals Uses). Uses reflects the amount of money required to effectuate the transaction, including the equity purchase price, any existing debt being refinanced and any transaction fees. The Sources tells us from where the money is coming, including the new debt, any existing cash that will be used, as well as the equity contributed by the private equity firm. Typically, the amount of debt is assumed based on the state of the capital markets and other factors, and the amount of equity is the difference between the Uses (total funding required) and all of the other sources of funding. The next step is to change the existing balance sheet of the company to reflect the transaction and the new capital structure. This is known as constructing the proforma balance sheet. In addition to the changes to debt and equity, intangible assets such as goodwill and capitalized financing fees will likely be created. The third, and typically most substantial step is to create an integrated cashflow model for the company. In other words, to project the companys income statement, balance sheet and cashflow statement for a period of time (say, five years). The balance sheet must be projected based on the newly created proforma balance sheet. Debt and interest must be projected based on the post-transaction debt. Once the functioning model is created, we can make assumptions about the private equity firms exit from its investment. For example, a typical assumption is that the company is sold after five years at the same implied EBITDA multiple at which the company was

purchased. Projecting a sale value for the company allows us to also calculate the value of the private equity firms equity stake which we can then use to analyze its internal rate of return (IRR). Absent dividends or additional equity infusions, the IRR equals the average annual compounded rate at which the PE firms original equity investment grows (to its value at the exit). While the private equity firms IRR is usually the most important piece of information that comes out of an LBO analysis, the analysis also has other uses. By assuming the PE firms required IRR (amongst other things), we can back into a purchase price for the company, thus using the analysis for valuation purposes. In addition, we can utilize the LBO model to analyze the trend of credit statistics (such as the leverage ratio and interest coverage ratio) which is especially important from a lenders perspective.

Why do private equity firms use leverage when buying a company?

By using significant amounts of leverage (debt) to help finance the purchase price, the private equity firm reduces the amount of money (the equity) that it must contribute to the deal. Reducing the amount of equity contributed will result in a substantial increase to the private equity firms rate of return upon exiting the investment (e.g. selling the company five years later).

Lets say you run an LBO analysis and the private equity firms return is too low. What drivers to the model will increase the return?
Some of the key ways to increase the PE firms return (in theory, at least) include:

- reduce the purchase price that the PE firm has to pay for the company - increase the amount of leverage (debt) in the deal - increase the price for which the company sells when the PE firm exits its investment (i.e. increase the assumed exit multiple) - increase the companys growth rate in order to raise operating income/cashflow/EBITDA in the projections decrease the companys costs in order to raise operating income/cashflow/EBITDA in the projections

What are some characteristics of a company that is a good LBO candidate?

Notwithstanding the recent LBO boom where nearly all companies were considered to be possible LBO candidates, characteristics of a good LBO target include steady cashflows, limited business risk, limited need for ongoing investment (e.g. capital expenditures or working capital), strong management, opportunity for cost reductions and a high asset base (to use as debt collateral). The most important trait is steady cashflows, as the company must have the ability to generate the cashflow required to support relatively high interest expense. Accounting

If a company incurs $10 (pretax) of depreciation expense, how does that affect the three financial statements?
The most common version of this type of question. Note that the amount of depreciation may be a number other than $10. To answer this question, take the three statements one at a time. First, the income statement: depreciation is an expense so operating income (EBIT) declines by $10. Assuming a tax rate of 40%, net income declines by $6. Second, the cash flow statement: net income decreased $6 and depreciation increased $10 so cash flow from operations increased $4. Finally, the balance sheet: cumulative depreciation increases $10 so Net PP&E decreases $10. We know from the cashflow statement that cash increased $4. The $6 reduction of net income caused retained earnings to decrease by $6. Note that the balance sheet is now balanced. Assets decreased $6 (PP&E -10 and Cash +4) and shareholders equity decreased $6. You may get the follow-up question: If depreciation is non-cash, explain how this transaction caused cash to increase $4. The answer is that because of the depreciation expense, the company had to pay the government $4 less in taxes so it increased its cash position by $4 from what it would have been without the depreciation expense.

A company makes a $100 cash purchase of equipment on Dec. 31. How does this impact the three statements this year and next year?
First Year: Lets assume that the companys fiscal year ends Dec. 31. The relevance of the purchase date is that we will assume no depreciation the first year. Income Statement: A purchase of equipment is considered a capital expenditure which does not impact earnings. Further, since we are assuming no depreciation, there is no impact to net income, thus no impact to the income statement. Cash Flow Statement: No change to net income so no change to cash flow from operations. However weve got a $100 increase in capex so there is a $100 use of cash in cash flow from investing activities. No change in cash flow from financing (since this is a cash purchase) so the net effect is a use of cash of $100. Balance Sheet: Cash (asset) down $100 and PP&E (asset) up $100 so no net change to the left side of the balance sheet and no change to the right side. We are balanced. Second Year: Here lets assume straightline deprec iation over 5 years and a 40% tax rate. Income Statement: Just like the previous question: $20 of depreciation, which results in a $12 reduction to net income. Cash Flow Statement: Net income down $12 and depreciation up $20. No change to cash flow from investing or financing activities. Net effect is cash up $8. Balance Sheet: Cash (asset) up $8 and PP&E (asset) down $20 so left side of balance sheet doen $12. Retained earnings (shareholders equity) down $12 and again, we are balanced.

Same question as the previous but the company finances the purchase of equipment by issuing debt rather than paying cash.
First Year: Income Statement: No depreciation and no interest expense so no change. Cash Flow Statement: No change to net income so no change to cash flow from

operations. Just like the previous question, weve got a $100 increase in capex so there is a $100 use of cash in cash flow from investing activities. Now, however, in our cash flows from financing section, weve got an increase in debt of $100 (source of cash). Net effect is no change to cash. Balance Sheet: No change to cash (asset), PP&E (asset) up $100 and debt (liability) up $100 so we balance. Second Year: Same depreciation and tax assumptions as previously. Lets also assume a 10% interest rate on the debt and no debt amortization. Income Statement: Just like the previous question: $20 of depreciation but now we also have $10 of interest expense. Net result is a $18 reduction to net income ($30 x (1 - 40%)). Cash Flow Statement: Net income down $18 and depreciation up $20. No change to cash flow from investing or financing activities (if we assumed some debt amortization, we would have a use of cash in financing activities). Net effect is cash up $2. Balance Sheet: Cash (asset) up $2 and PP&E (asset) down $20 so left side of balance sheet down $18. Retained earnings (shareholders equity) down $18 and voila, we are balanced.

Continuing with the last question, on Jan. 1 of Year 3 the equipment breaks and is deemed worthless. The bank calls in the loan. What happens in Year 3?
Now the company must writedown the value of the equipment down to $0. At the beginning of Year 3, the equipment is on the books at $80 after one years depreciation. Further, the company must pay back the entire loan. Income statement: The $80 writedown causes net income to decline $48. There is no further depreciation expense and no interest expense. Cash Flow Statement: Net income down $48 but the writedown is non-cash so add $80. Cash flow from financing decreases $100 when we pay back the loan. Net cash is down $68. Balance Sheet: Cash (asset) down $68, PP&E (asset) down $80, Debt (liability) down $100 and Retained Earnings (shareholders equity) down $48. Left side of the balance sheet is down $148 and right side is down $148 and were good!

Valuation Methods
Here's a common question: "How do you value a company?" There are a ton of ways to answer this. I'll just list a few ways to do it: 1. Discounted Cash Flow 2. Comparable Transactions 3. Comparable Companies 4. LBO valuation

5. Sum-of-the-parts 6. Liquidation value There are even more but usually if you list five or six that is enough to sound smarter than the average American (one of many things that you could say to sound smarter than the average American I guess). Question about depreciation
Another classic question that I've gotten a few times is something like this: "Imagine that you have a company and suddenly you find out that you reported your depreciation expense incorrectly. You now have an additional $10 million in depreciation. How would this change be reflected in all three financial statements?" I've actually received some form of this question about six times as I've interviewed. As always, you want to keep things simple and just go through everything methodically. Here's how I might go about answering this: "I'll start with the income statement. Your depreciation expense will increase by $10 million, which will decrease your operating income by $10 million. Assuming (to make life easier) that you have a 40% tax rate, then your net income will decrease by $6 million after accounting for the tax shield you get from added depreciation expense. "This net income will flow onto the statement of cash flows, so the net income will be decreased by $6 million. But, you will add back the $10 mm in depreciation so your net change in operating cash flows will be a positive $4 million. "On the balance sheet, your accumulated depreciation increases by $10mm, so your net PP&E will decrease by $10mm. The cash balance increases by $4 million (from the cash flow statement), so the asset side of the balance sheet nets to a negative $6mm. No cash is actually paid out, but in essence your tax shield increases by $4mm so your cash position increases. On the liability/equity side, your net income, which decreased by $6mm, flows into retained earnings and therefore balances with your assets." One time at Lazard I was asked, "You have been depreciating your assets using a doubledeclining method, but you now change to a straight-line method. What does this do to the

financial statements?" This question is similar but there's just one more little caveat. Can you think of it? I've got a pretty cool pdf file that shows how all of the financial statements are connected. I'll post it on here soon. The past week has been one for the ages. We will probably never see another span of carnage on Wall Street like we have seen for the past 10 days. With Fannie and Freddie going under, followed by Lehman, Merrill, and now AIG, the entire finance world is changing. And with Morgan Stanley and Goldman down well over 20% today, who knows if they will even outlast this crazy time. With all of this turmoil, it becomes even more necessary to have a great resume and be ready for interviews. A quick update - my kidney stone is no longer in my body, but the effects of the little rock are still being felt today. Kidney stones suck!! Also, I got some offers - one at another bulge bracket bank and one from a top boutique. So that was GREAT news given the other things going on this week. Now the tough part is deciding where to go. I am definitely blessed to have options this year. So I thought I would write about some of the other interview questions I've faced over the past few months, as well as some of the ways I've answered these questions. Keep in mind that I'm not an expert and could very well miss some things. That said, I've received an offer from every firm with which I've interviewed, both for internships or full-time, so I feel like I can at least take a crack at some of these questions. The most common technical question I've gotten at every bank I've interviewed with is "walk me through a DCF." I think everybody knows in their mind what a discounted cash flow model does, but what I've found is that there's a certain way to answer this question that makes your life easier. When I first started interviewing I really wanted to show people that I know what I'm talking about, and I went into great detail about every part of a DCF calc. What happened though was that I would get bogged down in the details and end up not sounding very smart. Now when I answer this question, I like to begin with a very simple answer and allow the interviewer to drill down however he/she would like to. For example I might say something like this:

"The goal of a DCF model is to derive the enterprise value of the firm. I do this by calculating the unlevered free cash flows of the firm, then project them forward for about five years (or whatever time horizon you are looking at). I then calculate a terminal value (TV), and discount the TV and the FCFs back to the present value at the cost of capital to get my enterprise value." Done. At this point, the interviewer knows that I understand the DCF, and they are free to ask me deeper questions. Some interviewers I've had will stop me as I go along to ask questions, but most let me go to this point and then say something like, "Ok great. Can you tell me how you would calculate the free cash flow of a company?" "Sure. Starting with EBITDA, you subtract D&A, then multiply by (1-tax rate) to get rid of the tax cash, then add back D&A, take out CAPEX and the change in net working capital, and you have free cash flows." "And what is net working capital?" "Current assets less current liabilities." "Great. How do you calculate a terminal value?" "Well it depends on the deal. If it's a strategic deal, you'll probably use a perpetuity model since they want the asset for the long term. If it's a financial deal the sponsor will want to sell in the terminal year and you'll use a multiple, like EV/EBITDA." You get the picture. I just give the answers in a way that shows that I know what I'm saying but I don't try to tell it all at once. They might ask you about how to calculate a discount rate (use
WACC), how to calculate WACC, how to get CAPM, and even how to unlever/relever beta.

Whatever it is, just be ready for it, but start basic and work your way into the nitty gritty. One more question about accretion/dilution that I got this summer was something like this: "If you own a company and want to do a quick back-of-the-envelope calculation of acc/dil, how would you do it given a particular target? In other words, what information would you need to do a quick calc?" "Well a P/E ratio would be great."

"That's right. So lets say your company has a P/E of 18 and the target's P/E is 21. Will the deal be accretive or dilutive? Why?" "Dilutive because their P/E is higher than mine. In essence I would have to pay more per dollar of earnings than my own company is worth, so the EPS would decline." Here are a few more random interview questions: "What's the square root of 2,025?" (The answer doesn't have to be right on - it's 45 - but you just have to be close. They want to see how you can out loud reason through some mental math) "What is 2/3 + 3/4?" (Just take a deep breath and think back to seventh grade - you can do this!) "So you worked a little in a fund. Pitch me a stock." (On this one I pretty much always go with my favorite stock that I've bought - PARL - because it's an interesting company to talk about. I would suggest that you are ready to talk about a few investment ideas, and also that you pick companies that the interviewers have never heard of. You don't want to say "GM" and then find out that you're talking to the MD on that account) "If you had $1 Billion to invest for your school, how would you do it?" (Again you can pretty much say whatever you want, but don't be stupid and say 'Short Goldman with the whole fund because I don't believe in the pure play model!' Just be rational with how you answer most questions and you'll be fine) I'll be posting more questions/answers in the next little while. Sorry again for the long delay. I'm working at Treasury so you can all imagine what a week it's been around here with Fannie, Freddie, Lehman, Merrill, and AIG all blowing up. Anyway, keep the comments coming about the types of posts you'd like to see.

Ouch
Well as if things couldn't get any weirder, check this out. And, by the way, I'll be posting later on today about resumes. Sorry for the long breaks between posts.

So on Thursday night I took a bus from DC to New York because I had final rounds at a bank. I stayed with a good friend who just started at a bulge bracket bank and has been working like crazy. He didn't even get home till after 3am and that has been par for the course for him since he's started. I guess that's what you have to expect. The amazing thing is that in addition to all the work he's doing, he's made time to build some sweet models in preparation for private equity interviews coming in a few months. Props to him! So I had the final rounds on Friday. It was pretty standard - there were six interviews of about a half an hour each. Three of them were with managing directors, one with a principal, and two with associates. Like other places, the associates and the principal gave me pretty technical interviews, and the managing directors just wanted to hear about my life, talk about their past experiences, and answer questions about the firm. The technical stuff was actually pretty challenging - probably the toughest I've ever had. They based a lot of the questions off of what's on my resume, so one of the first things an associate asked me about was accretion/dilution. This girl was sharp - she worked at Miller Buckfire doing restructuring, then went to Goldman's sponsers group for two years, then went to McKinsey for two years advising on corporate finance, then finally went to Harvard Business School and on to her current job. Nice background. She had me walk her through different scenarios such as 100% cash, 50/50, and 100% stock, and asked me to talk about what would make the deal accretive or dilutive in each scenario. The only thing I needed her help on was remembering how assets are written up or down in a purchase and how that can affect accretion or dilution. She then asked me about a DCF model I built over the summer. Usually I've just been asked how to walk through a DCF, which I did for her. But along the way she would ask me things like, "So on this deal, what were the COGS? What were the revenue drivers? What kind of operating expenses were there? When talking about discounting, she wanted to know what discount rate I used and why/how I got to that rate. She asked if we discounted at beginning/end of year or if we used the mid-year convention. I said mid-year because cash flows don't all come at the beginning or end of the year, so mid-year tends to smooth it out. She said that was right and said, "What about the terminal value?" I answered, "Well that one you discount from the end of year because you want to discount the full last year before you sell." She responded, "Exactly right - that's a very common mistake so good job." Whew!

The other associate I interviewed with gave me a case study. He said something like, "Assume you have a company that owns 15 coal refineries in North America, the rights to build more refineries in 10 other places, and then you own an electrical power plant in South Africa where the price of electricity swings 1000% percent a day. How would you value this company?" I said I would do a sum-of-the-parts, which was correct, but then he wanted to know how I would value each piece. The coal refineries are pretty solid so I said I would use a traditional DCF with steady-state assumptions. The rights to build were dependent on how rare they are, so I said I would have to use some comps and decide what the real estate was worth, as well as finding out how feasible it would be to build. Lastly, the South African asset could be valued using a DCF, but you would have to use a really high discount rate to account for the swings in value. I also said you could use comps to see what other people are discounting similar assets at.

Brainteasers/Math Questions (1) let's say you have 6 tennis balls in front of you and an old-fashioned legal scale. One of the six balls is lighter than the other but they all appear exactly the same. How would you go about determining which ball is the lightest in just two weighings? You can weigh the ball in any way you want. (2) Let's say you have 3 light switches which correspond to three light bulbs inside a room with no windows. Each switch corresponds to exactly one bulb. You can turn the switches on and off in any combination and as many times as you want to, but you can only go inside the room once (to inspect the bulbs). How do you figure out which switch corresponds to which bulb? Q. What is 6/7ths ? A. Answer like the last one. 1/7th is approximately 0.14, and six times 14 is 84, so the answer is approximately .84. Getting the answer right to the fifth decimal place is not what they are testing. Make sure you know all the 8ths and 16ths too (ie 1/8th is .125). 1. Brain Teaser: Say you are driving 2 miles on a 1-mile track. You do one lap at 30 miles per hour. How fast do you need to go to average 60 miles an hour. 2. Give me the sum of all the numbers between 1 and 100.

3. You have a painting that is $320 that is selling for 20 percent off. Howmuch is the discounted price? 4. What is 4 cubed? 5. What is 6 cubed? 6. What is 7 cubed? 7. What is 8 cubed? 8. What is 9 cubed? 9. What is 2/3 + 3/4? 10. What is 1% of one million? 11. What is 10,000 x 10,000? 12. What is larger 3^4 or 4^3? 13. What is larger 3^5 or 4^4? 14. What is 100*100? 15. What is 10,000/8? 16. What is 40% of 1250? 17. What is 3/16 in a decimal? 18. What is 7/16 in a decimal?

Market Questions Q. What is a stock you follow and why should I buy it? Q. What is the current unemployment rate? Q. What was the lead story on the front page of the WSJ summary section today? Q. What kind of effect will the rise in oil prices have on the U.S. economy? Q. Can you describe the shape of the yield curve currently?

Q. Where are the Dow, Nasdaq, and S&P 500 trading currently? Q. Where are 10-year Treasurys trading? Q. Where is the Federal Funds rate? Q. Where is 3-month LIBOR? Q. Where is the dollar versus the Yen and Euro?

Behavioral Questions Q. Tell me about a time you had to persuade a group of people and how you did it."

Q. can ethical standards be too high in a firm?" Q. if you were running the bank, where would you take it right now?" Q. Usually the bank's career website will have some resources to help you prepare and it lists characteristics that they are looking for in a candidate... try to find these if you havent yet and match them up with separate team, academic, work experiences you've had... often the characteristics include teamwork, adaptability, initiative, etc... Q. tell me the full names of the three people who interviewed you before me and how you prepared for this day." I got this one as I was walking into the office, before even sitting down. Q. tell me about a time you displayed leadership. Q. tell me about a time when you worked on a team and there was someone who wasn't pulling their weight. how did you deal with the situation? Q. Give an example of when you've been required to pay particular attention to detail; Q. Why investment banking? (this seems like an obvious one...but a lot of people don't answer it properly) Q. What characteristics do you possess that would make you a successful IB analyst/SA? Q. Why our company? Why this particular group (if you interview for regional positions you'll be interviewing with a specific group within the IBD)? Q. What do you do in your free time? Do not be the guy that claims to follow the market every second of every day.

Personal Tell me about yourself. Walk me through your resume. Tell me why banking/ Finance? I havent had time to read your resume, fill me in What do you want me to know about you and your background? You are a career-changer. What makes you want to do banking? You have never done banking/ finance before. Why now? What makes you think you can do banking/ finance? What are you most proud of on your resume? What are your career and educational goals? What is the greatest risk we face in hiring you? How did you prepare for this interview? Why you? There are many qualified candidates. What motivates you? Give me three words to describe you. How would your friends describe you? Where do you see yourself in 5/10 years? What are the three most important events in your life? What new goals have you established for yourself recently? If you could do it all over again, what would you do differently? What were you doing during this gap of time I see here on your resume? Tell me about a decision you have made that you later regretted. What are the three best ideas youve had in the past five years? Did you get an offer from the firm you worked for this summer? Do you have other offers? Why would/wouldnt you take our offer over one of the others? What do you enjoy doing outside of work in your free time? If you had six months ahead with no obligations and no financial constraints, what would you do? If you could invite anyone you would like to a dinner party (famous or historical figures, dead or alive), which ten people would you invite? If you could trade places with someone for a week, who would it be? What is your favorite book/movie/song/painting or author/actor/singer/artist? Which magazines/newspapers do you read regularly? Which books have you read recently? What would you do if you overheard a junior analyst discuss a confidential pitch/process with his friend at other firm? What if you overheard the managing director doing the same? Do you see yourself as a trader or a salesman? Leadership Style Define leadership. Tell me about a time when you successfully resolved a conflict. Give me an example of a leadership role you have held when not everything went as planned. How would you define your leadership style? What is an example of an experience in which you took on a leadership role? How have you demonstrated initiative? What are some key lessons you have learned about motivating people? Tell me about a time you led a team/project. Do you consider yourself a team player? Tell me about your past experience working in teams.

 Have you ever worked with a difficult group? Strengths/Weaknesses and Skills What kind of financial modeling have you done in the past? Tell us about three of your strengths and three of your weaknesses. Are you creative? Give me an example. What is your biggest weakness? What can you do for us that someone else cannot do? Name one thing you learned from your previous experience/internship? Give me an example of one of your successes. Give me an example of one of your failures. Have you ever failed at anything? Describe the accomplishment of which you are most proud. What has been your greatest challenge? What makes you different from the other candidates interviewing for this position? What types of tasks and responsibilities motivates you the most? What are the attributes of an ideal job for you? Why should we hire you? Tell me about a situation where you disappointed your boss and why. Interpersonal Style/Skills How competitive are you? How do you work under pressure? What types of people seem to rub you the wrong way? Define cooperation. In what kind of work environment do you do your best work? With what kind of people do you like to work? Describe a team situation you were in where things did not work out for you. What three adjectives would your: a. peers; b. superiors; c. subordinates use to describe you? What are your greatest team and personal achievements? Name three traits you would want to have in a friend and show how you have those too. Do you consider yourself a risk-taker? Education What have you learned at business school that will help you on this job? Tell me about a project you did. What activities are you involved in? Do you hold any leadership positions? What electives have you taken? Which class did you enjoy the most? Why did you choose Goizueta? What other B-schools did you apply to and get in? Do your grades reflect your abilities? Describe the course that has had the greatest impact on your thinking. How did you become involved in your extracurricular activities? If you could make a major policy change at your school, what would it be? What non-finance and accounting electives have you taken? What is your favorite class and why? Describe what you learned in class this morning What are your undergraduate GPA, GMAT and SAT scores? What are your class-byclass B-school grades?

Job/Company/Industry What do you know about the industry? What do you know about us? Why us? What do you think you have to offer us? Why are you pursuing this field? What skills does Investment Banking requirewhat in your background shows you can do it? What do Investment Banks do? Tell me what you have learned from your previous jobs and how that is going to benefit our firm. Given that you have no background in this field, why are you interested in it? What do you predict is going to happen in this industry in the next 5 years? What do you know about our company? Do you know who our competitors are? What interests you most about this position? What parts of the job do you think you would find least satisfying? What other types of jobs are you interviewing for and why? What other investment banks are you interviewing with? If you got offers from all of them, where would you go? You have 5 minutes to describe the most relevant and specific items in your background that show you are uniquely qualified for this position. What would you add to our firm? Where would you like to be in ten years? What do you like about our company? Which divisions are you interested in? Do you know what the responsibilities of the position are? What do you think differentiates our firm from the others? What do you think you would like least about this job/company/field? What industry publications do you normally read? What company in the market do you admire most and why? Wrap-Up What would you like me to know about you that is not on your resume? What would you like your lasting impression to be? Do you have a final statement? Do you have any questions youd like to ask? What is your favorite quote? Whos your idol/mentor? Tell me a joke. Sell me this highlighter. What three things would you want stranded on a desert island? Whats your personal discount rate? What do you do for fun? Suppose everyone has a chip on his shoulder, big or small. Whats yours? What are you passionate about? What would cohort mates, other than your study group, say about you? Company - General Why would we not have given you an offer at the end of the summer? You would take an offer from us over them, right?

Would you take an offer from us now on the spot? What dont you like about banking? Would you rather be on the buy-side or sell-side of a transaction? What about your background will make you a good investment banker? Of my colleagues who have interviewed you to this point, whom would you hire and why? How many of your classmates are truly qualified to do this job? How do you feel about taking orders from a VP or MD who is younger than you? Tell me about some recent deals that have piqued your interest. If you were the interviewer, what are the three most important criteria for hiring someone into this position? How would you deal with an angry client? Why Banking/ S&T/ AM/ Corp Fin? Why did you decide to go to Goizueta if you wanted to do IB in NY? Who else have you spoken to at our bank (or in our division)? What other banks are you interviewing with? What books have you read to familiarize yourself with the industry? (e.g. Liars Poker, Monkey Business, Den of Thieves) What have you done to learn about investment banking? What kind of skills do investment bankers need? What product or industry groups are you interested in working with? How well do you function under pressure? Why do you want to work on Wall Street? What qualifications will help you do well at this job? Are you a smart person? Who is your best friend? Would you lie for them? How do you know you will be able to handle the hours required of an investment banker

Company Specific Questions Why Bank XX? Compare Bank XX and YY? What is the market cap, current price, 52-week high and low, and expected EPS and next earnings date for Bank XX? Name 3 major news items related to Bank XX in the last 2 months. What is Bank XX known for? Who are Bank XXs competitors? What is the structure of Bank XX? Who is the CEO of Bank XX? What is his background? What would you ask him?

Personal Questions Q. Spend 5 minutes and walk me through your resume. A. The first question you will most likely be asked. On the surface it seems like an easy question, but you will need to be clear and concise with your response. This is something you will need to practice repeatedly so that you can SUCCINCTLY talk about yourself and relate your background to the job. Try to start after you finished undergrad. and talk about: Each position you have held, your role and responsibilities (try to highlight ones that match the job), and what you liked about that work. You want to work your way up to attending Emory.

Q. Why do you want to work in Investment Banking/Sales & Trading / Research/ PCS? A. Probably the second question you will be asked. This is probably the most important question you will have to answer. You should be able to relate experiences in your job and interests that match the job you are interviewing for. This is a question that you need to have a rehearsed 2-minute response. Your answer should end along the line "and thats why I want to go into Investment Banking." How can you relate your background if you didnt used to work in the industry? Be creative! Interviewers dont care if you didnt work in this field before. Questions to ask yourself: Did your company ever get bought out or did your company ever buy another? Did you read an article about a merger in the Wall Street Journal? Work that into your answer. Here is what a second year student who came from different backgrounds said: DAVID RICHARDS- Manager at HBOC McKesson (Internship: SunTrust) I spent my time focusing on the things I had done that were related to Banking. P&L responsibilities I had & my motivation/track record of being profit focused The transactional work that I have done before and liking the work Leveraging grades/GMAT as a way to show my quant. orientation Client centric management (more a corporate banking plus) I also spent some time talking about the two years of night school and preparation to come back to business school specifically for banking. Q. Why did you decide to go to Emory? No standard answer, but people usually mention: Small Class Size Need to be in a big city (if you want to work in NYC- don't say you like living where its warmer) The diversity of students (33% International). Do not say something like: "I didnt get into Harvard." You need to stay positive. Q. Why do you want to work for Company X? A. Try to tell them about your interests and how it relates to the strengths they provide. For example: I would like to work at Chase because I'm interested in working in leveraged finance and Chase is a leader in debt financing through syndicated loans and high yield offerings. I think SG Cowen would be a great place for me because I'm interested in doing healthcare banking, which is a particular strength of the firm. Q. What other companies are you considering? A. Don't just say that their company is the only one. You can be honest. They don't expect you to put all your eggs in one basket. I think the key to this question is to mention firms that may be similar to the reasons you gave for wanting to work at the company

you are interviewing with. Using the Chase example from above, you might want to tailor your answer around other banks known for fixed income, such as B of A, Lehman, the Big Three(Merrill, Goldman, MSDW) or Bear. The thing not to say is someone like Robertson Stephens ( a fine institution, just not known for fixed-income). If you would want to work for a niche firm, don't say you are considering Merrill or some type of bulge bracket firm. The person interviewing you is trying to see if you are really interested in a certain type of work/environment or are you just bullshitting. Q. What specific area are you interested in? A. Obviously you want to display an interest in some area, but also need to be able to talk in detail about that subject area so they don't think you are trying to bullshit them. If you want to work in equity research covering telecommunications you should be able to talk now (as of 12/15/2000) about how telecomm. firms are struggling and what are some of the problems they face. Q. In 1 sentence, tell me why we should hire you? A. Don't just blurt out an answer. Take your time and use commas. Q. Look outside my office. Down the right side of the building are offices of bankers that all went to Harvard Business School. Down the left side are all bankers that went to Wharton. I get hundreds of resumes every year - mostly from Harvard, Wharton, Chicago, and Columbia. There's a long track record of success here from those schools - if I take a chance on an HBS grad, and it doesn't work out, nobody will second-guess me. However, in your case, if I take a chance and you don't work out, I'll have some explaining to do about my judgment. How are you going to convince me to hire you over the hundreds of resumes I get every fall? Q. Is there anything else, that is not your resume that I should know about? A. Try to highlight personality traits. You could talk about work ethic, being a team player, and how you are an easy-going person who is great to work with.

Walk me through your resume

The majority of interviews will start out with you being asked to introduce yourself and your background or walk me through your resume. There are two reasons for this. First, the interviewer wants to hear your story and second, it gives the interviewer a chance to quickly read over your resume while you are talking. More often than not, he or she hasnt had the time to read it before you walked in the interview room. The opportunity to walk through your resume is your chance to talk about your background and to make your case why you want to be an investment banker. The most important thing is that you tell a story that makes sense to the interviewer and shows a progression leading up to you being a banker. Even if the choices that youve made (schools, degrees, jobs) dont follow a natural progression, you need to describe your experiences in a manner that flows convincingly. Now, that isnt to say that you

necessarily need to find commonality in everything youve done, or weave a thread through each job, as long as you can demonstrate some sensible flow. For example, highlight how each job enabled you to take more responsibility or required more finance knowledge than the one before it. Even if youve switched careers or reversed directions, talk about what youve learned from those decisions that make you a good investment banking candidate. Remember, this is your opportunity to make a first impression and perhaps your only opportunity to make your case as you see fit, so dont underestimate the importance of this part of the interview.

If I am asked to walk through my resume, where (when) should I start?

Its really up to you and whatever you think tells the best story. Some people start with where they grew up. Others start with college or their first job out of college while more experienced or older individuals might start with Business School or other graduate program. Just keep in mind that your most recent experiences are going to be more relevant so dont get bogged down with stories of your first lemonade stand or how well you invested your Bar Mitzvah money.

How long should I spend walking through my resume?

You should plan on spending 3 - 5 minutes talking about your background. If you notice that the interviewer looks bored, then speed it up. If the interviewer looks engaged, then be more detailed. Some interviewers will let you finish your story before asking questions and others will interrupt you repeatedly.

While walking through my resume, can I refer to the copy of the resume in front of me?
No. Even if you have a copy of your resume in front of you, you should be able to talk about your background and experiences without referring to your resume. Referring to, or worse, reading off of your resume makes it seem like you dont even know your own history.

Why do you want to be an investment banker?

As someone trying to break into the industry, this is the most important question that you can be asked. And even if you are not asked this explicitly, other questions will likely try to elicit from you the same information. Most people trying to get a banking job have the intellectual abilities to be a banker. The question is do they have the attitude, the mindset, the willingness to sacrifice and the attention to detail. There are a range of answers that will help you portray that you have both the ability and attitude to be a banker. Here are a few: - Ive always enjoyed the aspects of my past jobs/classes in school that involve corporate finance. - I like the fast paced environment of banking as Ive always excelled in pressure

situations. - I am excited to be able to work on many projects at the same time and the fact that Ill never be bored. - I cant wait to be in an environment where Ill always be learning. - Even though I know Ill be playing a junior role for a number of years, I like that ultimately I will be able to help advise senior management of companies. - I enjoy reading about M&A transactions in the newspaper. - All of the bankers that I have met are really smart and I want the opportunity to work with them and learn from them (just make sure you say this one with a straight face) Whatever responses you give, make sure that you can back them up with actual stories and details from your experiences.

How NOT to answer the question, Why do you want to be an investment banker?
I want to make a lot of money/I want a house in the Hamptons/I want to date models, etc. Yes, everyone in banking is in it for the money. Anyone who says otherwise is delusional or lying. But, you still cant say it in an interview. I love working all night Yes, you can say you want to be challenged. But NOBODY likes working on pitchbooks at 3:00 am and you wont either. I want to learn how businesses work so I can advise CEOs. Two issues here. First, the typical banker knows (a little about) finance but nothing about operations and how businesses really operate. Second, as an Analyst or Associate, it will be years before you will be advising CEOs, if ever.

Why do you want to work at our bank?

This is your opportunity to (1) show you know a little about the bank and (2) kiss the ass a bit of the person with whom you are interviewing. Just dont go overboard with #2. If you have friends that work for this bank, say so, and mention that they are really enjoying their experiences. If you are interviewing with a bulge bracket bank, mention how you are excited about the prospect of getting a broad experience and learning about different products or industries. If you are interviewing with a boutique, talk about how you like the idea of a smaller firm, where you might have more responsibility and more interaction with clients and senior bankers. Without a doubt (unless this is the first person with whom youve ever met), state how youve really liked all of the people from this bank that youve met before. If you have previously had the opportunity (for example, in prior interviews or at recruiting receptions) to ask other bankers from this firm (or better yet, this particular interviewer) why they like working at this bank, then by all means recycle these answers! If they say the culture is great, you say you want to work here because the culture is great. If they say dealflow is strong, you say you want to work here because the dealflow is strong. You get the idea

What do you know about our bank?

Somewhat similar to the last question (Why do you want to work here?), you need to demonstrate your knowledge of the bank. You might talk about a deal or two that youve heard or read with which the bank has been involved. Or, if you know the bank is strong is certain product areas (such as M&A or leveraged finance) or industry coverage, then mention that. Perhaps the bank focuses on cross-border deals or deals in emerging markets. By no means will you be expected to be an expert but you should be able to talk about a few things. If you dont know anything, rather than make something up and sound stupid, be honest. Say something like, I really dont know many specifics, and one of the reasons that Im really excited to interview with you is to learn more. If you can ask the interviewer about the bank, then you can learn some things for your next interview, for when you are asked the same question.

What are your strengths?

This is one of those generic interview questions that you are less likely to get in banking interviews. If you do get this question, this is one of your best opportunities to make your case that youd be a good banker. Some of the skills that you probably want to highlight include your analytical/quantitative skills (especially for an Analyst), communication skills (especially for an Associate), ability to learn quickly, detail orientedness and ability to work really hard. You should definitely be prepared to back up what you state as your strengths, using one or two concrete examples from past jobs or school.

What are your weaknesses?

Even more so than the question about strengths, its unusual to be asked about your weaknesses. There is no good way to answer this question so the best advice is to try to move on as quickly as possible. Obviously you dont want mention real weaknesses (Im dumb, Im lazy, I require 12 hours of sleep a night). You also dont want to say things that make you look silly like I work too hard and you cant say you dont have any weaknesses because youll come off as too arrogant. So try to think of something relatively innocuous that also might highlight a strength. For example, I can get occasionally get impatient wit h peers/coworkers who dont have the same abilities as me or dont show the same commitment that I do. Or, Sometimes I can be so focused with or driven by the task on hand that I wind up tuning out other aspects of my life. You can also usually say so mething like, I think my skills are very good compared with my peers but, of course, Im new to investment banking, and I obviously need more experience. Experience which Im confident Ill get working for you

What are your long-term plans?

This is a bit of a tricky question. You obviously want to demonstrate you are committed to investment banking but you dont want to come across as obviously disingenuous by stating that banking is the only job youll ever want to do. If you are interviewing for an Analyst position, I dont think you need to be committed to banking for the long -term

(since being an Analyst position is a 2-year position). I would mention that you are really excited about and committed to becoming an Analyst and that you want to learn as much as possible, get as much experience, etc. while you are an Analyst. But I think its okay to say that youll see what happens after your Analyst position is up (i.e. going to business school, moving on to other jobs like private equity or hedge funds, etc.) If you are interviewing for an Associate position, then you need to demonstrate a little bit more commitment to banking. I would definitely recommend stating that you see yourself as a banker for the foreseeable future (call it 3-5 years). However, I dont think that you need to state that you are certain to be a banker for the rest of your life but I wouldnt say that that is out of the question either.

With what other banks are you interviewing?

Interviewing is about marketing yourself and you do want to give them impression that you are desired by other banks. On the other hand, you dont want to lie. Always keep in mind that banking is a small industry where bankers know bankers at other banks. If you are interviewing with other investment banks say so. If they are prestigious or comparable to this firm, name them. If they are less prestigious, then just mention that you are interviewing with a number of boutiques. If they ask you to name them, then mention one or two. If you have no interviews lined up, state that you are talking to a number of banks and try to move the conversation along.

Are you interviewing for jobs other than investment banking?

This can be another tricky one. If you are interviewing out of undergrad or B-School, I would emphasize that you are only interviewing with investment banks or at least that banking is by far your main focus. If you are trying to switch careers, interviewers are going to understand that getting a job in banking is more difficult and that you may need to cast a wider net. In these instances, I think that as long as you state that banking is your top choice, its okay to mention that you ar e interviewing with other institutions, provided that they are in finance and require similar skill-sets (e.g. equity research, corporate banking, etc.) Whatever you do, dont state (even if it is true) that you are looking at banking, consulting, hedge funds, private equity and also considering going to cooking school. Youll come across as unfocused and not serious about being an investment banker.

Do you have any questions for me?

At the end of almost every interview, you will be asked if you have any questions. This is your opportunity to learn more about the job and the firm. By asking good questions, it is also a chance for you to open up the interview into more of a conversation. However, even if you have little interest in the job, or if youve already had all of your questions answered by the other 8 people with whom you interviewed that day, you should always be prepared with 3-4 questions that you can ask an interviewer. Heres a few examples:

- How long have you been with the bank and how has your experience been? - What do you like best about working here. Worst? - How do you compare working here with other banks at which you have worked? - How is the dealflow? - On what types of deals are you currently working? - What kind of responsibility does the typical Analyst/Associate receive? - Can you tell me about your training program? - How do Analysts/Associates get staffed?

What NOT to ask

How much money did you make last year?/How much money will I make?/How were bonuses last year?/How much vacation will I get? No explanation neededI hope. What is the lifestyle like?/How many hours will I be expected to work?/Is there face time at this bank? Any questions regarding lifestyle and hours, risk giving the interviewer the impression that you are not willing to work hard. Now, if you are interviewing at a boutique and the interviewer has already talked about how good the lifestyle is here, then it may be okay to ask these things. But if you are interviewing at a bulge bracket bank or the like, dont ask about lifestyle.

Interviewing - Brainteasers
What is the sum of numbers from 1 to 100?
The trick here is that you have 50 pairs which each sum to 101 (e.g. 1+100, 2+99, 3+98, etc.). So, 50 times 101 = 5050.

What is the angle between the hour-hand and minute-hand of a clock at 3:15?
At quarter past the hour, the minute-hand is exactly at 3:00 but the hour-hand has moved 1/4 of the way between 3:00 and 4:00. Therefore 1/4 times 1/12 = 1/48 of the clock. With the clock having 360 degrees, 360/48 = 7.5 degrees.

Youve got a 10 x 10 x 10 cube made up of 1 x 1 x 1 smaller cubes. The outside of the larger cube is completely painted red. On how many of the smaller cubes is there any red paint?
First, note that the larger cube is made up of 1000 smaller cubes. The easiest way to think about this is how many cubes are NOT painted? 8 x 8 x 8 inner cubes are not painted which equals 512 cubes. Therefore, 1000 - 512 = 488 cubes that have some paint. Alternatively, we can calculate this by saying that two 10 x 10 sides are painted (200) plus two 10 x 8 sides (160) plus two 8 x 8 sides (128). 200 + 160 + 128 = 488.

A car travels a distance of 60 miles at an average speed of 30 mph. How fast would the car have to travel the same 60 mile distance home to average 60 mph over the entire trip?
Most people say 90 mph but this is actually a trick question! The first leg of the trip covers 60 miles at an average speed of 30 mph. So, this means the car traveled for 2 hours (60/30). In order for the car to average 60 mph over 120 miles, it would have to travel for exactly 2 hours (120/60). Since the car has already traveled for 2 hours, it is impossible for it to average 60 mph over the entire trip.

You are given a 3-gallon jug and a 5-gallon jug. How do you use them to get 4 gallons of liquid?
Fill the 5-gallon jug completely. Pour the contents of the 5-gallon jug into the 3-gallon jug, leaving 2 gallons of liquid in the 5-gallon jug. Next, dump out the contents of the 3gallon jug and pour the contents of the 5-gallon jug into the 3-gallon jug. At this point, there are 2 gallons in the 3-gallon jug. Fill up the 5-gallon jug and then pour the contents of the 5-gallon jug into the 3-gallon jug until the 3-gallon jug is full. You will have poured 1 gallon, leaving 4 gallons in the 5-gallon jug.

You are given 12 balls and a scale. Of the 12 balls, 11 are identical and 1 weighs slightly more. How do you find the heavier ball using the scale only three times?
First, weigh 5 balls against 5 balls (1st Use of Scale). If the scale is equal, then discard those 10 balls and weigh the remaining 2 balls against each other (Second Use of Scale). The heavier ball is the one you are looking for. If on the first weighing (5 vs 5), one group is heavier, then of the heavier group weigh 2 against 2 (2nd Use of Scale). If they are equal, then the 5th ball from the heavier group (the one not weighed) is the one you are looking for. If one of the groups of 2 balls is heaver, then take the heaver group of 2 balls and weigh them against each other (Third Use of Scale). The heavier ball is the one you are looking for.

You are given 12 balls and a scale. Of the 12 balls, 11 are identical and 1 weighs EITHER slightly more or less. How do you find the ball that is different using the scale only three times AND tell if it is heavier or lighter than the others?
Significantly harder than the last question! Weigh 4 vs 4 (1st Weighing). If they are identical then you know that all of 8 of these are normal balls. Take 3 normal balls and weigh them against 3 of the unweighed balls (2nd Weighing). If they are identical, then the last ball is different. Take 1 normal ball and weigh against the different one (3rd Weighing). Now you know if the different ball is heavier or lighter. If, on the 2nd weighing, the scales are unequal then you now know if the different ball is heavier (if the 3 non-normal balls were heavier) or lighter (if the 3 non-normal balls were lighter). Take the 3 non-normal balls and weigh 1 against the other (3rd Weighing). If they are equal then the third ball not weighed is the different one. If

they are not equal then either the heavier or lighter ball is different depending on if the 3 non-normal balls were heavier or lighter in the 2nd Weighing. If, on the 1st Weighing, the balls were not equal then at least you know that the 4 balls not weighed are normal. Next, take 3 of the normal balls and 1 from the heavier group and weigh against the 1 ball from the lighter group plus the 3 balls you just replaced from the heavier group (2nd Weighing). If they are equal then you know that the different ball is lighter and is 1 of the 3 not weighed. Of these 3, weigh 1 against 1 (3rd Weighing) If one is lighter, that is the different ball, otherwise, the ball not weighed is different and lighter. If, on the 2nd weighing from the preceding paragraph, the original heavier group (containing 3 normal balls) is still heavier, then either one of the two balls that were NOT replaced are different. Take the one from the heavier side and weigh against a normal ball (3rd Weighing). If it is heavier, it is different, and heavier otherwise the ball not weighed is different and lighter. If, on the 2nd weighing, the original lighter side is now heavier, then we know that one of the 3 balls we replaced is different. Weigh one of these against the other (3rd Weighing). If they are equal, the ball not weighed is different and heavier. Otherwise, the heavier ball is the different one (and is heavier). If you get this right and can answer within the 30 minutes alloted for the interview, then you probably do deserve the job.

A windowless room has 3 lightbulbs. You are outside the room with 3 switches, each controlling one of the lightbulbs. If you can only enter the room one time, how can you determine which switch controls which lightbulb?
Turn on two switches (call them A and B) on and leave them on for a few minutes. Then turn one of them off (switch B) and enter the room. The bulb that is lit is controlled by switch A. Touch the other two bulbs (they should be off). The one that is still warm is controlled by switch B. The third bulb (off and cold) is controlled by switch C.

Four investment bankers need to cross a bridge at night to get to a meeting. They have only one flashlight and 17 minutes to get there. The bridge must be crossed with the flashlight and can only support two bankers at a time. The Analyst can cross in 1 minute, the Associate can cross in 2 minutes, the VP can cross in 5 minutes and the MD takes 10 minutes to cross. How can they all make it to the meeting in time?
First, the Analyst takes the flashlight and crosses the bridge with the Associate. This takes 2 minutes. The Analyst then returns across the bridge with the flashlight taking 1 more minute (3 minutes passed so far). The Analyst gives the flashlight to the VP and the VP and MD cross together taking 10 minutes (13 minutes passed so far). The VP gives the flashlight to the Associate, who recrosses the bridge taking 2 minutes (15 minutes passed so far). The Analyst and Associate now cross the bridge together taking 2

more minutes. Now, all are across the bridge at the meeting in exactly 17 minutes. Note, that instead of investment bankers, youll often see the same question using members of musical bands (usually either the Beatles or U2).

Three envelopes are presented in front of you by an interviewer. One contains a job offer, the other two contain rejection letters. You pick one of the envelopes. The interviewer then shows you the contents of one of the other envelopes, which is a rejection letter. The interviewer now gives you the opportunity to switch envelope choices. Should you switch?
The answer is yes. Say your original pick was envelope A. Originally, you had a 1/3 chance that envelope A contained the offer letter. There was a 2/3 chance that the offer letter was either in envelope B or C. If you stick with envelope A, you still have the same 1/3 chance. Now, the interviewer eliminated one of the envelopes (say, envelope B), which contained a rejection letter. So, by switching to envelope C, you now have a 2/3 chance of getting the offer and youve doubled your chances. Note that you will often get this same question but referring to playing cards (as in 3Card Monte) or doors (as in Monte Hall/Lets Make a Deal) instead of envelopes.