Wall Street Investment Banking
Technical Questions and Answers32
How would an asset write-up or write-down affect an LBO model? / Walk me though how you
adjust the Balance Sheet in an LBO Model - ANSWERS-1. Calculate Goodwill, Other Intangibles,
and the rest of the write-ups
2. Balance Sheet Adjustments: subtract cash, add in cap. financing fees, write-up assets, wiping
out goodwill, adjust deferred tax assets/liabilities, add new debt, etc
Differences:
1. SE is replace with PE equity ; add in preferred stock, management rollover, or rollover from
Options Holders
2. Add more tranches of debt
3. do not combine balance sheets
tell me about all the different kinds of debt you could use in an LBO and the differences
between everything - ANSWERS-CHART
How would a dividend recap impact the 3 financial statements? - ANSWERS-No changes in
Income
Balance sheet - debt goes up and SE goes down
Cash Flow - Financing: new debt cancels out cash paid to investors
,Why would a PE firm choose to do a dividend recap of one of its portfolio companies? -
ANSWERS-Boost returns - more leverage means a higher return to the firm
The recap would be paying the firm back some of its investors equity
Cost of Equity tells us what kind of return an equity investor can expect for investing in a given
company - but what about dividends? Shouldn't we factor dividend yield into the formula? -
ANSWERS-Dividends are already factored into Beta because Beta describes returns in excess of
the market as a whole - and those returns include dividends
Two companies are exactly the same, but one has debt and one does not - which one will have
the higher WACC - ANSWERS-The one without debt will have a higher WACC up to a certain
point because equity is more expensive than debt
Why?
1. interest on debt is tax-deductable
2. Debt is senior to equity in company's capital structure
3. Interest Rates on debt are lower than Cost of Equity Numbers
Once debt is high enough the Interest rates will increase and cause risk to increase
U-shape curve where debt decreases WACC unit a point where it starts to increase it
When you are calculating WACC, let's say that the company has convertible debt. Do you count
this as debt when calculating Levered Beta for the company? - ANSWERS-1. If it is in the money
then you do not count it but assume it contributes to dilution and increases Equity Value
2. If it is out of the money the you count it as debt and use the interest rate on the convertible
for Cost of Debt
,Walk me though a concrete example of how to calculate revenue synergies - ANSWERS-1. Yahoo
makes $0.10 per search
2. Microsoft acquires Yahoo and makes an additional $0.02 per search
3. multiple $0.02 by the total number of searches and decide on a margin of how much goes
into Operating Income
What are some examples of incurrence covenants? Maintenance covenants? - ANSWERS-
Incurrence
1. company cannot pay more than$2B of total debt
2. Sale os assets goes to paying off debt
3. no acquisitions over $200M
4. no CapEx over $100M
Maintenance
1. Total Debt/EBITDA cannot exceed 3x
2. Senior Debt / EBITDA cannot exceed 2x
3. (Total Cash Payable Debt + Capitalized Leases)/EBIDTAR cannot exceed 4x
4. EBITDA/Interest Expense cannot fall below 5x
5. EBITDA/Cash Interest Expense cannot fall below 3x
6. (EBITDA - CapEx)/Interest Expense cannot fall below 2x
Most of the time, increased leverage means an increased IRR. Explain how increasing the
leverage could reduce the IRR. - ANSWERS-If the increased leverage increases interest payments
or debt repayments to very high levels, preventing the use of cash flow in other areas
1. relative lack of cash flow / EBITDA growth
2. High-interest payments and principal repayments relative to cash flow
3. High purchase premium to make it hard to get high IRR
, Walk me through a future share price analysis - ANSWERS-Project a company's share price 1-2
years from now and discount it back to the PV
1. get median historical P/E of comps
2. Apply this P/E to the 1 and 2 year forward projected EPS to get implied future share price
3. discount back to PV with discount rate in-line with the company's Cost of Equity
Both M&A premium analysis and precedent transactions involve looking at previous M&A
transaction. What is the different in how we select them? - ANSWERS-1. All sellers in M&A
premium analysis must be public
2. Use a broader set of transactions for M&A premiums
Walk me through a Sum-of-the-Parts analysis - ANSWERS-Evaluate each division of the company
using separate comps and transactions, get to separate multiples, and the add up each division's
value to get the total value of the company
How do you value Net Operating Losses and take them into account in a valuation? - ANSWERS-
Value NOLs based on how much they will save a company in taxes in the future and then find
the PV of these savings
2 ways to assess the tax savings in future years
1. Use NOLs to completely offset its taxable income until the NOLs run out
Technical Questions and Answers32
How would an asset write-up or write-down affect an LBO model? / Walk me though how you
adjust the Balance Sheet in an LBO Model - ANSWERS-1. Calculate Goodwill, Other Intangibles,
and the rest of the write-ups
2. Balance Sheet Adjustments: subtract cash, add in cap. financing fees, write-up assets, wiping
out goodwill, adjust deferred tax assets/liabilities, add new debt, etc
Differences:
1. SE is replace with PE equity ; add in preferred stock, management rollover, or rollover from
Options Holders
2. Add more tranches of debt
3. do not combine balance sheets
tell me about all the different kinds of debt you could use in an LBO and the differences
between everything - ANSWERS-CHART
How would a dividend recap impact the 3 financial statements? - ANSWERS-No changes in
Income
Balance sheet - debt goes up and SE goes down
Cash Flow - Financing: new debt cancels out cash paid to investors
,Why would a PE firm choose to do a dividend recap of one of its portfolio companies? -
ANSWERS-Boost returns - more leverage means a higher return to the firm
The recap would be paying the firm back some of its investors equity
Cost of Equity tells us what kind of return an equity investor can expect for investing in a given
company - but what about dividends? Shouldn't we factor dividend yield into the formula? -
ANSWERS-Dividends are already factored into Beta because Beta describes returns in excess of
the market as a whole - and those returns include dividends
Two companies are exactly the same, but one has debt and one does not - which one will have
the higher WACC - ANSWERS-The one without debt will have a higher WACC up to a certain
point because equity is more expensive than debt
Why?
1. interest on debt is tax-deductable
2. Debt is senior to equity in company's capital structure
3. Interest Rates on debt are lower than Cost of Equity Numbers
Once debt is high enough the Interest rates will increase and cause risk to increase
U-shape curve where debt decreases WACC unit a point where it starts to increase it
When you are calculating WACC, let's say that the company has convertible debt. Do you count
this as debt when calculating Levered Beta for the company? - ANSWERS-1. If it is in the money
then you do not count it but assume it contributes to dilution and increases Equity Value
2. If it is out of the money the you count it as debt and use the interest rate on the convertible
for Cost of Debt
,Walk me though a concrete example of how to calculate revenue synergies - ANSWERS-1. Yahoo
makes $0.10 per search
2. Microsoft acquires Yahoo and makes an additional $0.02 per search
3. multiple $0.02 by the total number of searches and decide on a margin of how much goes
into Operating Income
What are some examples of incurrence covenants? Maintenance covenants? - ANSWERS-
Incurrence
1. company cannot pay more than$2B of total debt
2. Sale os assets goes to paying off debt
3. no acquisitions over $200M
4. no CapEx over $100M
Maintenance
1. Total Debt/EBITDA cannot exceed 3x
2. Senior Debt / EBITDA cannot exceed 2x
3. (Total Cash Payable Debt + Capitalized Leases)/EBIDTAR cannot exceed 4x
4. EBITDA/Interest Expense cannot fall below 5x
5. EBITDA/Cash Interest Expense cannot fall below 3x
6. (EBITDA - CapEx)/Interest Expense cannot fall below 2x
Most of the time, increased leverage means an increased IRR. Explain how increasing the
leverage could reduce the IRR. - ANSWERS-If the increased leverage increases interest payments
or debt repayments to very high levels, preventing the use of cash flow in other areas
1. relative lack of cash flow / EBITDA growth
2. High-interest payments and principal repayments relative to cash flow
3. High purchase premium to make it hard to get high IRR
, Walk me through a future share price analysis - ANSWERS-Project a company's share price 1-2
years from now and discount it back to the PV
1. get median historical P/E of comps
2. Apply this P/E to the 1 and 2 year forward projected EPS to get implied future share price
3. discount back to PV with discount rate in-line with the company's Cost of Equity
Both M&A premium analysis and precedent transactions involve looking at previous M&A
transaction. What is the different in how we select them? - ANSWERS-1. All sellers in M&A
premium analysis must be public
2. Use a broader set of transactions for M&A premiums
Walk me through a Sum-of-the-Parts analysis - ANSWERS-Evaluate each division of the company
using separate comps and transactions, get to separate multiples, and the add up each division's
value to get the total value of the company
How do you value Net Operating Losses and take them into account in a valuation? - ANSWERS-
Value NOLs based on how much they will save a company in taxes in the future and then find
the PV of these savings
2 ways to assess the tax savings in future years
1. Use NOLs to completely offset its taxable income until the NOLs run out
