Key Technical Questions For Finance Interviews
Key Technical Questions For Finance Interviews
Key Technical Questions For Finance Interviews
Study hard, study aloud, and know why something is the answer. Do these three things and Goldman will come crawling to you.
5) What is net working capital, and what does it mean if this is negative?
I. Working capital = current assets – cash – current liabilities.
II. If it’s negative, it means a company does not have enough short-term assets to pay off its short-term liabilities.
III. It is used as a measure of liquidity.
IV. *PFF Tip* Negative working capital is not necessarily a bad sign. It depends on the type of company and specific situation, i.e.:
i. Companies with subscriptions or longer-term contracts often have negative working capital because of high deferred revenue
balances.
ii. Retail and restaurant companies like Amazon and McDonald’s often have negative working capital because customers pay upfront,
so they can use the cash generated to pay off their accounts payable rather than keeping a large cash balance on hand, actually a
sign of business efficiency.
iii. In other cases, negative working capital could point to financial trouble or possible bankruptcy (for example, when customers don’t
pay quickly and upfront, and the company is simultaneously carrying a high debt balance).
4) What is the difference between enterprise value and equity value and why does it matter?
I. Enterprise Value represents the value of the company that is attributable to all investors. Equity Value also only represents the portion
available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise
Value represents its true value.
II. Another, more abstract, way to think of this is in terms of cashflows. At the end of the day, what makes a business worth anything is the
belief that it will be able to generate cash in the future. Which stakeholders can lay claim to those future cashflows and how likely / unlikely
(price of risk) it is that the cashflows will actually materialize for them is what determines the value of their position. The TEV is the sum of
the present value of each stakeholder’s position.
8) Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each –
what is its fully diluted equity value?
I. Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all “in-
the-money” – their exercise price is less than the current share price.
II. When these options are exercised, there will be 10 new shares created – so the share count is now 110 rather than 100.
III. However, that doesn’t tell the whole story. In order to exercise the options, the option holders had to “pay” the company $5 for each
option (the exercise price).
IV. As a result, it now has $50 in additional cash, which it now uses to buy back 5 of the new shares the exercised options created.
V. So the fully diluted share count is 105, and the fully diluted equity value is $1,050.
10) Walk me through how you conduct a DCF / comps / precedent transaction / LBO valuation and tell me about the merits and downsides of each.
I. DCF: A DCF values a company based on the Present Value of its future cash flows + the Present Value of its Terminal Value. First, you
project out a company’s financials using assumptions for revenue growth, expenses and working capital; then you get down to Free Cash
Flow for each year, which you then sum up and discount to a Net Present Value, based on your discount rate – usually the Weighted
Average Cost of Capital (“WACC”). Once you have the present value of the cash flows, you determine the company’s Terminal Value, using
either the Multiples Method or the Gordon Growth Method, and then also discount that back to its Net Present Value using WACC. Finally,
you add the two together to determine the company’s Enterprise Value.
*PFF Tip*: The above paragraph is how high-level you want to be when first walking through the DCF; don’t feel obligated to explain how to
calculate WACC, define what terminal value is, and/or opine on the merits of the Gordon Growth Method vs. the Multiples Method (the answer is
bankers / investors always use the Multiple Method). That is not to say you don’t need to know the answer to these questions – you do – but wait
for your interviewer to ask you. There are numerous advantages to this strategy:
I. Waiting for your interviewer to ask more detailed questions runs down the clock on the interview as the they have to think about
what to ask next rather than you just spraying it all out at once (the longer you can go in an interview without getting a question
wrong, the better).
II. It is way more impressive when a candidate confidently answers a question after being asked than when they preempt the answer
to a question they think they’re going to be asked.
III. Interviewers often have a set time in their head for how long they want the technical session to be. If the full interview is supposed
to be 30 minutes, they might want to spend 15 minutes on technicals, for some people maybe it’s 10 minutes, for others maybe it’s
20 minutes. Regardless, the point is, if you expectorate everything you know about the DCF in five minutes, your interviewer is going
to want to keep asking you technicals for another 5 – 15 minutes, and since you just answered the next nine technical questions
your interviewer had planned when responding to their first question, the interviewer is just going to start making up questions that
are inevitably going to be way harder than anything you’re prepared for and you will look like a fool. This was a long-winded way of
saying: Don’t give away the farm when responding to a DCF (or any technical question). Be succinct and accurate, but not too
detailed – keep some facts to yourself until asked.
IV. LBO: In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt and other variables;
you might also assume something about the company’s operations, such as Revenue Growth or Margins, depending on how much
information you have. Step 2 is to create a Sources & Uses section, which shows how you finance the transaction and what you use the
capital for; this also tells you how much Investor Equity is required. Step 3 is to adjust the company’s Balance Sheet for the new Debt and
Equity figures, and also add in Goodwill & Other Intangibles on the Assets side to make everything balance. In Step 4, you project out the
company’s Income Statement, Balance Sheet and Cash Flow Statement, and determine how much debt is paid off each year, based on the
available Cash Flow and the required Interest Payments. Finally, in Step 5, you make assumptions about the exit after several years, usually
assuming an EBITDA Exit Multiple, and calculate the return based on how much equity value is returned to the firm vs. how much they
originally invested.
i. LBO Merits:
1. An excellent means to establish a “floor” valuation—i.e., an LBO analysis will determine the amount that a financial buyer
(sponsor) would be willing to pay for the company, thereby determining the value that a strategic bidder will have to
exceed.
2. LBO valuation is realistic, as it does not require synergies to achieve (sponsors usually do not have synergy opportunities).
ii. LBO Downsides:
i. Ignoring synergies could result in an underestimated valuation, particularly for a well-fitting strategic buyer.
ii. The valuation obtained is very sensitive to operating assumptions (growth rate, operating working capital assumptions,
profit margins, etc.) and financing cost assumptions (and thus LBO valuation is dependent upon the quality of the prevailing
financing market conditions).
14) Do you factor in taxes when calculating cost of debt? Why or why not?
I. Yes, because interest expense is deductible.
II. That being said, cost of debt can be calculated pre-tax (total interest cost incurrent/total debt*100).
17) Would you expect a tech company or a manufacturing company to have a higher beta?
I. A tech company, because tech is viewed as a “riskier”, more volatile industry than manufacturing.
18) How do you select the companies for a comps analysis? Look at (1) business profile and (2) financial profile.
I. Business profile:
i. Industry/sector
ii. Products/services
iii. Customers and end markets
iv. Distribution channels
v. Geography
II. ii. Financial profile
i. Size
ii. Profitability
iii. Growth profile
iv. Return on investment
v. Credit profile
III. *PFF Tip* The best precedent transactions analyses typically involve companies similar to the target on a fundamental level. As a general
rule, the most recent transactions (i.e., those that have occurred within the previous two to three years) are the most relevant as they likely
took place under similar market conditions to the contemplated transaction. Potential buyers and sellers look closely at the multiples that
have been paid for comparable acquisitions. As a result, bankers and investment professionals are expected to know the transaction
multiples for their sector focus areas.
21) What value is being determined when using levered and unlevered FCF, respectively?
I. Levered FCF: Equity value
II. Unlevered FCF: Enterprise value
23) What are the two ways to calculate a terminal value? Which is more commonly used, and why?
I. You can either apply an exit multiple to the company’s Year 5 EBITDA, EBIT or Free Cash Flow (Multiples Method) or you can use the
Gordon Growth method to estimate its value based on its growth rate into perpetuity.
II. The formula for Terminal Value using Gordon Growth is: Terminal Value = Year 5 Free Cash Flow * (1 + Growth Rate) / (Discount Rate –
Growth Rate).
i. Growth rate is normally the country’s long-term GDP growth rate, the rate of inflation, or something similarly conservative.
ii. For companies in mature economies, a long-term growth rate over 5% would be quite aggressive since most developed economies
are growing at less than 5% per year.
III. In banking, you almost always use the Multiples Method to calculate Terminal Value in a DCF. It’s much easier to get appropriate data for
exit multiples since they are based on Comparable Companies – picking a long-term growth rate, by contrast, is always a shot in the dark.
IV. However, you might use Gordon Growth if you have no good Comparable Companies or if you have reason to believe that multiples will
change significantly in the industry several years down the road. For example, if an industry is very cyclical you might be better off using
long-term growth rates rather than exit multiples.
24) How do you select an appropriate exit multiple when calculating Terminal Value?
I. Normally you look at the Comparable Companies and pick the median of the set, or something close to it.
II. As with almost anything else in finance, you always show a range of exit multiples and what the Terminal Value looks like over that range
rather than picking one specific number.
III. So if the median EBITDA multiple of the set were 8x, you might show a range of values using multiples from 6x to 10x.
26) Rank the valuation methodologies from highest to lowest expected valuation.
I. Trick question – there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to
the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it’s best to say that it’s more variable than other
methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions. Assuming
your DCF has reasonable assumptions then the LBO model will, in general, have the lowest TEV since the banker and / or the PE firm are
back solving TEV for the highest possible IRR.
II. *PFF Tip*: It’s important that you note that the TEV in an LBO is assumed, not explicitly solved for. An LBO model doesn’t work unless you
plug in an assumed capital structure, and you can’t determine a capital structure without a TEV. What you can do, however, is solve for the
IRR and use a sensitivity table to see how returns to the buyer change as the TEV the business is purchased at goes up or down.
2) What is EBITDA?
I. EBITDA stands for earnings before interest, taxes, depreciation and amortization.
II. It effectively represents how much cash the core business generates (business makes a gross profit on its sales, you have to deduct the cash
expenses associated w/ running the business such as rent, payroll, shipping, etc., and what you’re left with is EBITDA).
3) When [insert asset] goes up is that a source or use of cash? When [insert liability] goes down is that a source or use of cash?
I. Assets are inversely related: Assets go up, cash goes down.
II. Liabilities are directly related: Liability goes up, cash goes up.
10) Two identical companies are identical in earnings, growth prospects, leverage, returns on capital, and risk. Company A is trading at a 15x P/E
multiple, while Company B trades at 10x P/E. What would you prefer as an investment?
I. Company B. Investors would rather pay less per unit of ownership.
14) Why might a strategic acquirer in the target’s industry pay more for a business than a private equity firm?
I. Because the strategic acquirer can underwrite revenue and cost synergies that the private equity firm cannot unless it combines the
company with a complementary portfolio company. Those synergies allow the strategic to justify paying a higher price for the target
company.
17) In an LBO, if you buy a company for a dollar and sell a company for a dollar can you make a return?
I. Yes, by paying down debt or taking out dividends.
18) What if you sold the company with the same debt/equity split? Could you still make a return?
I. Yes, you could take out a dividend during your hold.