BREAKING INTO WALL STREET INVESTMENT BANKING
TECHNICAL QUESTIONS AND ANSWERS GUARANTEED 100% PASS
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? - 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 - 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? - 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 - 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? - 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. - 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 - 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? - 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 - 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? - 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
2. In an acquisition scenario, multiple the adjusted long-term rate by the equity purchase price of the
seller to determine the maximum NOLs per year that can be used
Do not usually use this in a valuation but they could be treated like cash and be subtracted from Equity
Value to get Enterprise value
I have a set of public company comps and need to get the projections from equity research. How do I
select which report to use? - 1. Pick the report with the most detailed info
, 2. Pick the report with the numbers in the middle of the range
I have a set of precedent transactions but I'm missing info like EBITDA for a lot of the companies - how
can I find it if it's not available via public sources? - 1. Look online for press releases or articles in the
financial press with these numbers
2. Look in equity research for the buyer around the time of the transaction and see if any of the
analysts estimate the seller's numbers
3. Look at Capital IQ and Factset
How far back and forward do we usually go for public company comparable and precedent transaction
multiples - Back TTM
Forward 1-2 years
Longer for comps sometimes
I have a company with a 40% EBITDA margin trading at 8x EBITDA, and another company with 10%
EBITDA margin trading at 16x EBITDA. WHat's the problem with comparing these 2 valuations directly?
- It can be misleading to compare companies with dramatically different margins
Screen based on margins an remove outliers
Walk me through how we might value an oil and gas company and how it's different from a "standard"
company - 1. Use industry-specific multiples like P/MCFE and P/NAV in addition to standard ones
2. Project the prices of commodities like oil and natural gas, and also the company's reserves to
determine revenue and future cash flows
3. Use a NAV Model - everything flows from the company's reserves rather than simple revenue
growth / EBITDA margin projections
There are special accounting policies
Walk me through how you would value a REIT and how it differs from a normal company - 1. Look at
Price/FFO , Price/AFFO which adds back Depreciation and subtracts gains of sales, and NAV
2. Value properties by dividing Net Operating Income (Property Gross Income - Operating Expenses) by
the capitalization rate
3. Replacement Valuation - estimate cost of buying new land and building new properties
4. DCF can be used flowing from specific properties
Walk me through a DCF - It values a company based on the PV of its Cash Flows and the PV of its
TECHNICAL QUESTIONS AND ANSWERS GUARANTEED 100% PASS
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? - 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 - 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? - 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 - 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? - 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. - 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 - 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? - 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 - 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? - 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
2. In an acquisition scenario, multiple the adjusted long-term rate by the equity purchase price of the
seller to determine the maximum NOLs per year that can be used
Do not usually use this in a valuation but they could be treated like cash and be subtracted from Equity
Value to get Enterprise value
I have a set of public company comps and need to get the projections from equity research. How do I
select which report to use? - 1. Pick the report with the most detailed info
, 2. Pick the report with the numbers in the middle of the range
I have a set of precedent transactions but I'm missing info like EBITDA for a lot of the companies - how
can I find it if it's not available via public sources? - 1. Look online for press releases or articles in the
financial press with these numbers
2. Look in equity research for the buyer around the time of the transaction and see if any of the
analysts estimate the seller's numbers
3. Look at Capital IQ and Factset
How far back and forward do we usually go for public company comparable and precedent transaction
multiples - Back TTM
Forward 1-2 years
Longer for comps sometimes
I have a company with a 40% EBITDA margin trading at 8x EBITDA, and another company with 10%
EBITDA margin trading at 16x EBITDA. WHat's the problem with comparing these 2 valuations directly?
- It can be misleading to compare companies with dramatically different margins
Screen based on margins an remove outliers
Walk me through how we might value an oil and gas company and how it's different from a "standard"
company - 1. Use industry-specific multiples like P/MCFE and P/NAV in addition to standard ones
2. Project the prices of commodities like oil and natural gas, and also the company's reserves to
determine revenue and future cash flows
3. Use a NAV Model - everything flows from the company's reserves rather than simple revenue
growth / EBITDA margin projections
There are special accounting policies
Walk me through how you would value a REIT and how it differs from a normal company - 1. Look at
Price/FFO , Price/AFFO which adds back Depreciation and subtracts gains of sales, and NAV
2. Value properties by dividing Net Operating Income (Property Gross Income - Operating Expenses) by
the capitalization rate
3. Replacement Valuation - estimate cost of buying new land and building new properties
4. DCF can be used flowing from specific properties
Walk me through a DCF - It values a company based on the PV of its Cash Flows and the PV of its
