Breaking Into Wall Street – Lbo Exam Questions With Correct Answers

BREAKING INTO WALL STREET – LBO EXAM QUESTIONS WITH CORRECT ANSWERS "Depreciation Expense found in the SG&A line of the income statement for a manufacturing firm would most likely be attributable to which of the following - CORRECT ANSWER computers used by the accounting department" "If a company has projected revenues of $10 billion, a gross profit margin of 65%, and projected SG&A expenses of $2billion, what is the company's operating (EBIT) margin? - CORRECT ANSWER 45%" "A company has the following information, 1. 2014 revenues of $5 billion,2013 Accounts receivable of $400 million, 2014 accounts receivable of $600 million, what are the days sales outstanding - CORRECT ANSWER 36.5" "Which of the following is true - CORRECT ANSWER Coca Cola's brand name is not reflected as an intangible asset on its balance sheet" "A company has the following information: • 2014 share repurchase plan of $4 billion • Average share price of $60 for the year 2013 • Expected EPS growth for 2014 of 10% What should the number of shares repurchased by the company be in your financial model? - CORRECT ANSWER 60.6 million" "A debt holder would be primarily concerned with which of the following multiples? I. Enterprise (Transaction) Value / EBITDA II. Price/Earnings III. Enterprise (Transaction) Value / Sales - CORRECT ANSWER 1 and 3 only" "On January 1, 2014, shares of Company X trade at $6.50 per share, with 400 million shares outstanding. The company has net debt of $300 million. After building an earnings model for Company X, you have projected free cash flow for each year through 2014 as follows: Year Free Cash Flow 250 280 You estimate that the weighted average cost of capital (WACC) for Company X is 10% and assume that free cash flows grow in perpetuity at 3.0% annually beyond 2020, the final projected year. According to the discounted cash flow valuation method, Company X shares are: - CORRECT ANSWER .13 per share overvalued" "An acquisition creates shareholder value: - CORRECT ANSWER when a company acquires a business whose fundamental value is higher than the purchase price" "• Acquirer purchases 100% of target by issuing additional stock to purchase target shares • No premium is offered to the current target share price • Acquirer share price at announcement is $30 • Target share price at announcement is $50 • Acquirer EPS next year is $3.00 • Target EPS next year is $2.00 • Acquirer has 4 thousand shares outstanding • Target has 2 thousand shares outstanding What is the exchange ratio for the deal? - CORRECT ANSWER 1.7x" "• Acquirer purchases 100% of target by issuing additional stock to purchase target shares • No premium is offered to the current target share price • Acquirer share price at announcement is $30 • Target share price at announcement is $50 • Acquirer EPS next year is $3.00 • Target EPS next year is $2.00 • Acquirer has 4 thousand shares outstanding • Target has 2 thousand shares outstanding Assuming a 40% tax rate, what are the necessary pre-tax synergies needed to break-even? - CORRECT ANSWER " "Use the following information to answer the question below: • Acquisition takes place on July 1, 2013 • Acquirer FYE - June 30 • Target FYE - December 31 • Acquirer expected EPS for FYE June 2014 is $2.40 • Target consensus EPS for FYE Dec 2013 is $1.12 • Target consensus EPS for FYE Dec 2014 is $1.78 Assuming 360 days in a year for simplicity, calculate target EPS adjusted to acquirer FYE in the transaction year (FYE June 2014) - CORRECT ANSWER $1.45" " "When an LBO sponsor wishes to exit its investment in 5 years, one way to find the equity value of a company at the LBO sponsor's exit year is to: - CORRECT ANSWER Use an Enterprise Value/Sales multiple to find Enterprise Value and then subtract net debt Use an Enterprise Value/EBITDA multiple to find Enterprise Value and then subtract net debt Use a Price/Earnings multiple to find Equity Value" "Under recapitalization accounting - CORRECT ANSWER The purchase price is reflected as a reduction to equity" "which of the following is true about senior debt - CORRECT ANSWER None of the Below. Has the least restrictive covenants because it is secured by the company's assets Since it is secured by the company's assets, lenders prefer to have the debt outstanding over time in order to generate more interest Usually uses PIK securities or come with warrants like mezzanine debt" "On December 30, 2013: • Company Y trades at $10 per share • Enterprise Value / EBITDA multiple of 5.0x • Leverage ratio of 0.6x (Net debt/EBITDA) • 2013 EBITDA = $2.0 billion • Assume no cash on company Y's balance sheet On December 31, 2013: • Company Y undergoes an LBO and is recapitalized • The company's new leverage ratio becomes 5.0x • Financial sponsor exit is planned for Year 5. Assume that the EV/ EBITDA multiple at exit year is the same as the current multiple. • Required rate of return is 25% • Exit year EBITDA projected to be $3.0 billion • The company's year-end leverage ratio is 1.6x What is the initial Equity Value? - CORRECT ANSWER 8.8 billion" "On December 30, 2013: • Company Y trades at $10 per share • Enterprise Value / EBITDA multiple of 5.0x • Leverage ratio of 0.6x (Net debt/EBITDA) • 2013 EBITDA = $2.0 billion • Assume no cash on company Y's balance sheet On December 31, 2013: • Company Y undergoes an LBO and is recapitalized • The company's new leverage ratio becomes 5.0x • Financial sponsor exit is planned for Year 5. Assume that the EV/ EBITDA multiple at exit year is the same as the current multiple. • Required rate of return is 25% • Exit year EBITDA projected to be $3.0 billion • The company's year-end leverage ratio is 1.6x How much debt is paid down by the exit year (since the LBO announcement)? - CORRECT ANSWER 5.2 billion" "On December 30, 2013: • Company Y trades at $10 per share • Enterprise Value / EBITDA multiple of 5.0x • Leverage ratio of 0.6x (Net debt/EBITDA) • 2013 EBITDA = $2.0 billion • Assume no cash on company Y's balance sheet On December 31, 2013: • Company Y undergoes an LBO and is recapitalized • The company's new leverage ratio becomes 5.0x • Financial sponsor exit is planned for Year 5. Assume that the EV/ EBITDA multiple at exit year is the same as the current multiple. • Required rate of return is 25% • Exit year EBITDA projected to be $3.0 billion • The company's year-end leverage ratio is 1.6x What is the initial equity necessary to achieve the rate of return required by the financial sponsors? - CORRECT ANSWER 3.34 billion" "A debt holder would be primarily concerned with which of the following multiples? I. Enterprise (Transaction) Value / EBITDA II. Price/Earnings III. Enterprise (Transaction) Value / Sales - CORRECT ANSWER one and three only" "Company A shares are currently trading at $20 per share. A survey of Wall Street analysts reveals that EPS expectations for Company A for the full year 2014 are $1.50 per share. Company A has 200 million diluted shares outstanding. Company A's major competitors are trading at an average share price / 2014 Expected EPS of 15.0x. Using the comparable company analysis valuation method, Company A shares are: - CORRECT ANSWER 2.5 per share undervalued" "When looking to do a transaction comp analysis, some of the merger-related filings that should be looked at include each of the following except: - CORRECT ANSWER Form s-1" "when determining value for a company based on transaction rather than trading comps, one of the key differences that will affect the value is - CORRECT ANSWER premium paid for control of the business" What's an LBO? - CORRECT ANSWER " "Typical capital structure of an LBO? - CORRECT ANSWER Is a range; could see 40% debt and 60% equity, up to around 70% debt and 30% equity depending on the deal" "Why does leverage boost returns? - CORRECT ANSWER - Allows a pe firm to buy a bigger business with less capital upfront - interest expense is tax deductible -" "Things that boost returns in an LBO? - CORRECT ANSWER - multiple expansion - amount of leverage used - deleveraging: as this happens, it increases the pe firm's amount of equity in the firm - EBITDA growth" "Is B2B or B2C better for LBO? - CORRECT ANSWER B2B demand in B2B markets tends to less volatile and more sticky than in B2C markets" "What subsections in tech offer good candidates for an LBO? - CORRECT ANSWER - enterprise software (SaaS, recurring rev, contracts, software businesses can't easily stop using) - Cyber security" "Two types of synergies in an acqusition - CORRECT ANSWER - Revenue: when you combine two businesses and the whole has more revenue than the parts (occurs cuz cross selling, upselling) - Cost: when combining two businesses reduces cost (vertical integration)" "Cross selling - CORRECT ANSWER " "Management buyout (aka Equity Roll Over) - CORRECT ANSWER special type of LBO where the firm's top management continues to run the firm and has substantial equity position in the reorganized firm" "How does a pe firm decide between issuing a term loan or bond? - CORRECT ANSWER - by analyzing the assets of the company - term loan is preferred to a bond cuz it has low interest expense and is higher on the cap structure" "How does a pe firm create value for a company? - CORRECT ANSWER By providing its business expertise in that specific niche" "PE waterfall effect - CORRECT ANSWER - first: pe funds must return LPs initial investment - second: LPs need to reach a hurtle rate of return (usually 7-8% (return you'd get in S&P)) - Third: pe firms usually have a 'catch up clause'; after that hurtle return is met, GPs start getting the 80/20 split OR they'll get a return equal to the LPs, then returns will be split 80/20 afterwards" "Capital Call - CORRECT ANSWER When a GP requests money from an LP to make an investment" "Clawback - CORRECT ANSWER When an LP requests its investments back early" "LBO 'Sensitivity Analysis' - CORRECT ANSWER Table that shows different exit scenarios based on the company's EBITDA and an exit multiple to find IRR" "Other ways to look at returns other than IRR - CORRECT ANSWER MOIC - multiples on invested capital" "How can a fund have a high IRR but low MOIC? - CORRECT ANSWER " "What's MOIC also known as? - CORRECT ANSWER Cash on cash return" "J-curve effect - CORRECT ANSWER Capital outflows from the fund + management fee payments cause negative returns for a portion of a fund's life" "Walk me through a basic LBO model - CORRECT ANSWER Step 1: make assumption ab purchase price, debt/equity ratio, interest on debt; may also make assumptions ab the company's operations like rev growth or margins Step 2: Sources and uses section - shows hoe transaction is financed and what the capital is used for (also indicates how much investor equity is required) Step 3: adjust company's BS for new debt and equity figures; also add goodwill/other intangibles on assets side to make everything balance Step 4: project company financial statements (IS, BS, and CFS) - determine how much debt is paid off per year which is based on cash flow and required interest payments Step 5: after several years, make assumptions ab the exit - usually assuming an EBITDA exit multiple using a 'Sensitivity Analysis' table" "Why use leverage when buying a company? - CORRECT ANSWER To boost returns and also gives the firm access to more capital to purchase other or larger companies" "What variables impact an LBO model the most? - CORRECT ANSWER - Purchase and exit multiples have the biggest impact on the returns of a model. - the amount of leverage (debt) used also has a significant impact - operational characteristics such as revenue growth and EBITDA margins." "How would a dividend recap impact the 3 financial statements in an LBO? - CORRECT ANSWER - IS: no changes - CFS: under CFF, addititional cash from debt raise would cancel with cash paid out to investors no change to cash - BS: Debt would go up, shareholder's equity goes down (cus retained earnings), cancelling out" "Why would a PE firm choose to do a dividend recap of one of its portfolio companies? - CORRECT ANSWER Primarily to boost returns" "What's meant by the tax shield in an LBO? - CORRECT ANSWER - refers to that the interest paid by a firm is tax deductible" "How could a PE firm boost its return in an LBO? - CORRECT ANSWER 1) Reduce purchase price in the model 2) Increase exit multiple and exit price 3) Increase leverage used 4) Increase company's growth rate 5) Increase margins by reducing expenses" "What's bank debt? - CORRECT ANSWER - Revolvers and term loans - floating rate - typically will have a minimum yield that comes into play if rates fall below that - secured by collateral" "Difference between bank debt and high yield debt? - CORRECT ANSWER Simplification, but broadly 2 types of debt. 1. high yield has higher interest rates 2. high yield debt interest rates usually fixed, bank debt interest rates floating (change on LIBOR or Fed) 3. high yield debt more incurrence covenants, bank debt more maintenance covenants. 4. Bank debt usually amortized (principal paid off over time) whereas high yield has entire principal due at end (bullet maturity)." "Let's say we're analyzing how much debt a company can take on, and what the terms of the debt should be. What are reasonable leverage and coverage ratios? - CORRECT ANSWER - mostly dependent on the company, industry and leverage and coverage ratios of comparable LBO transactions - look at the types and terms of debt similar sized companies in the industry have recently used - Some general rules: i.e., wouldn't lever a company to 50x EBITDA, rare to see leveraged above 5-10x EBITDA" "How is the BS adjusted in an LBO model? - CORRECT ANSWER - new debt is added to liabilities, shareholder's equity is typically wiped out and replaced by however much equity the pe firm contributes - cash is adjusted for any cash used to finance the transactions and goodwill is used as a plug to make the BS balance - other changes: capitalized financing fees added to assets side" "Capitalized Financing Fees definition - CORRECT ANSWER " “What is generally not considered to be a pre-tax non-recurring (unusual or infrequent) item? - CORRECT ANSWER Extraordinary gains/losses" "what is false about depreciation and amortization - CORRECT ANSWER D&A may be classified within interest expense" "Company X's current assets increased by $40 million from while the companies current liabilities increased by $25 million over the same period. the cash impact of the change in working capital was - CORRECT ANSWER a decrease of 15 million" "the final component of an earnings projection model is calculating interest expense. the calculation may create a circular reference because - CORRECT ANSWER interest expense affects net income, which affects FCF, which affects the amount of debt a company pays down, which, in turn affects the interest expense, hence the circular reference" "a 10-q financial filing has all of the following characteristics except - CORRECT ANSWER issued four times a year." "A company has the following information: • 2014 Revenues of $8 billion • 2014 COGS of $5 billion • 2013 Accounts receivable of $400 million • 2014 Accounts receivable of $600 million • 2013 Inventories of $1 billion • 2014 Inventories of $800 million • 2013 Accounts payable of $250 million • 2014 Accounts payable of $300 million What are the inventory days for the company? - CORRECT ANSWER 65.7 days" "non-controlling interest - CORRECT ANSWER is an expense on the income statement and equity o the balance sheet" "A company has the following information: • 2013 retained earnings balance of $12 billion • Net income of $3.5 billion in 2014 • Capex of $200 million in 2014 • Preferred dividends of $100 million in 2014 • Common dividends of $400 million in 2014 What is the retained earnings balance at the end of 2014? - CORRECT ANSWER 15 billion" "in order to find out how much cash is available to pay down short term debt, such as revolving credit line, you must take - CORRECT ANSWER beginning cash balance + pre-debt cash flows - min. cash balance - required principal payments of LT and other debt" "to calculate interest expense in the future, you should do which of the following - CORRECT ANSWER apply a weighted average interest rate times the average debt balance over the course of the year" "enterprise (transaction) value represents the: - CORRECT ANSWER value of all capital invested in a business" "On January 1, 2014, shares of Company X trade at $6.50 per share, with 400 million shares outstanding. The company has net debt of $300 million. After building an earnings model for Company X, you have projected free cash flow for each year through 2020 as follows: Year Free Cash Flow 250 280 You estimate that the weighted average cost of capital (WACC) for Company X is 10% and assume that free cash flows grow in perpetuity at 3.0% annually beyond 2020, the final projected year. Estimate the present value of the projected free cash flows through 2020, discounted at the stated WACC. Assume all cash flows are generated at the end of the year (i.e., no mid-year adjustment): - CORRECT ANSWER 837 million" "On January 1, 2014, shares of Company X trade at $6.50 per share, with 400 million shares outstanding. The company has net debt of $300 million. After building an earnings model for Company X, you have projected free cash flow for each year through 2014 as follows: Year Free Cash Flow 250 280 You estimate that the weighted average cost of capital (WACC) for Company X is 10% and assume that free cash flows grow in perpetuity at 3.0% annually beyond 2020, the final projected year. Calculate Company X's implied Enterprise Value by using the discounted cash flow method: - CORRECT ANSWER 2951.2 million" "the formula for discounting any specific period cash flow in period "t"is: - CORRECT ANSWER cash flow from period "t" divided by (1+discount rate raised exponentially to "t"" "the terminal value of a business that grows indefinitely is calculated as follows - CORRECT ANSWER cash flow from period "t+1" divided by (discount rate-growth rate)" "the two-stage DCF model is: - CORRECT ANSWER where stage 1 is an explicit projection of free cash flows (generally for 5-10 years), and stage 2 is a lump-sum estimate of the cash flows beyond the explicit forecast period" "disadvantages of a DCF do not include - CORRECT ANSWER free cash flows over the first 5-10 year period represent a significant portion of value and are highly sensitive to valuation assumptions" "the typical sell-side process - CORRECT ANSWER shorter than the buy side, buyer secures financing, and doesn't involve id'ing potential issues to address such as ownership and unusual equity structures, liabilities, etc." "the following happened in a recent M&A transaction: 1. PP&E of the target company was increased from its original book basis of $600 million to $800 million to reflect fair market value for book purposes in accordance with the purchase method of accounting. 2. no "step-up" for tax purposes. 3. original tax basis of $650 million. assuming a corporate tax rate of 35% for book purposes, the company should record the following - CORRECT ANSWER A deferred tax liability equal to $52.5 million" "Pushdown accounting: - CORRECT ANSWER Refers to the establishment of a new accounting and reporting basis in an acquired company's separate financial statements" "Use the following information to answer the question below:• Acquirer purchases 100% of target by issuing $100 million in new debt to purchase target shares, carrying an interest rate of 10% • Excess cash is used to help pay for the acquisition • Acquirer expects to be able to close down several of the target company's old manufacturing facilities and save an estimated $2 million in the first year • Target PP&E is written up by $25 million to fair market value • Investment bankers, accountants, and consultants on the deal earned $30 million in fees Which of the following adjustments would be made to the pro forma income statement? - CORRECT ANSWER Advisory fee expense of $30 million Depreciation expense increase due to PP&E write-up Pre-tax synergies of $2 million" A 338(h)(10) election: - CORRECT ANSWER Requires that both buyer and seller must jointly elect to have the IRS deem the acquisition an asset sale for tax purposes" "A good LBO candidate has which of the following characteristics? - CORRECT ANSWER Little to no existing leverage, steady cash flows and little investment in business through capex and working capital" "Which of the following is NOT a disadvantage of performing an LBO analysis? - CORRECT ANSWER Stand-alone LBO may overestimate strategic sale value by ignoring synergies with acquirer" "While equity contribution went as low as the single digits in the 1980's, the current split between equity and debt in an LBO deal is best characterized as: - CORRECT ANSWER Equity - 35%; Debt 65%" "Non-equity claims that should be deducted from Enterprise Value to find Equity Value include all of the following EXCEPT: - CORRECT ANSWER Minority interest, preferred stock, capitalized leases" "LTM (Last Twelve Months) is calculated as follows - CORRECT ANSWER Latest completed fiscal year results + Latest reported stub period results - Same stub period results from one year ago" "Company A shares are currently trading at $50 per share. A survey of Wall Street analysts reveals that EPS expectations for Company A for the full year 2014 are $2.50 per share. Company A has 300 million diluted shares outstanding. Company A's major competitors are trading at an average share price / 2014 Expected EPS of 23.0x. Using the comparable company analysis valuation method, Company A shares are: - CORRECT ANSWER 7.5 per share undervalued" "Garth's Micro Brewery, whose shares are currently trading at $40 per share, is considering acquiring Wayne's Beer Bottling Co. You have compiled a group of comparable transactions within the beer bottling space and have calculated that since 2014, acquisitions similar (or comparable!) to the one Garth's is currently considering have had transaction values (offer value of target plus any target debt, net of cash) that are, on average, 8.0x target's EBITDA. • Wayne's shares currently trade at $34 per share • Wayne's has 50 million diluted shares outstanding • Wayne's LTM EBITDA was $250 million • Wayne's Net Debt was $200 million What is the offer value per share and the offer premium? - CORRECT ANSWER $36.00 per share; 5.9%" "How to determine maximum leverage in an LBO? - CORRECT ANSWER - want to see what the company's asset base can cover - look at leverage ratios, interest coverage ratios (company needs enough EBITDA to cover interest expense) - Rule of thumb: wouldn't want to put over 5-6x EBITDA in terms of leverage - remember to discount things: $X bn of intangibles isn't as secure as $X bn of cash = discount cash by 100%, discount accounts receivable by 90%, discount PP&E and inventory by ~70-80%" "How could a company go about expanding multiples? - CORRECT ANSWER - acquisitions to expand revenue base or create cost synergies - cutting non-core business segments - getting better management team" "Why would a PE firm buy a company in a "risky" industry, such as technology? - CORRECT ANSWER - even in marketds that are more risky, there will be cash flow-stable companies - further, some PE firms specialize in strategies like: - industry consolidation: buying competitors to increase efficiency - Turnarounds: taking struggling companies and making them function properly - divestitures: selling divisions of a company or taking a division and turning it into a strong stand along entity" "Why would a PE firm prefer high-yield debt instead? - CORRECT ANSWER If the pe firm intends to refinance the debt or they don't think their returns are too sensitive to higher interest payments, they may use high yield debt. (Further, if they don't have plans for major expansion or selling off the company's assets, they may choose to use high yield debt)" "Why might you use bank debt rather than high-yield debt in an LBO? - CORRECT ANSWER If the pe firm is concerned about meeting interest payments and wants a lower-cost option, they'll typically use banks debt; (also, if they're planning a major expansion or high capex and don't want to be restricted by incurrence covenants, they'll use bank debt)"