Investment Banking 100 Questions and Answers Final Exam

Investment Banking 100 Questions and Answers 2024- 2025 Final Exam Where does Depreciation usually show up on the Income Statement? It could be in a separate line item, or it could be embedded in Cost of Goods Sold or Operating Expenses - every company does it differently. Note that the end result for Accounting questions is the same: Depreciation always reduces Pre-Tax Income. What happens when Accrued Compensation goes up by $10? For this question, confirm that the accrued compensation is now being recognized as an Expense (as opposed to just changing non-accrued to accrued compensation). Assuming that's the case, Operating Expenses on the Income Statement go up by $10, Pre-Tax Income falls by $10, and Net Income falls by $6 (assuming a 40% tax rate). On the Cash Flow Statement, Net Income is down by $6, and Accrued Compensation Will increase Cash Flow by $10, so overall Cash Flow from Operations is up by $4 and the Net Change in Cash at the bottom is up by $4. On the Balance Sheet, Cash is up by $4 as a result, so Assets are up by $4. On the Liabilities & Equity side, Accrued Compensation is a liability so Liabilities are up by $10 And Retained Earnings are down by $6 due to the Net Income, so both sides balance. What happens when Inventory goes up by $10, assuming you pay for it with cash? No changes to the Income Statement. On the Cash Flow Statement, Inventory is an asset so that decreases your Cash Flow from Operations - it goes down by $10, as does the Net Change in Cash at the bottom. On the Balance Sheet under Assets, Inventory is up by $10 but Cash is down by $10, so The changes cancel out and Assets still equals Liabilities & Shareholders' Equity. Why is the Income Statement not affected by changes in Inventory? This is a common interview mistake - incorrectly stating that Working Capital changes Show up on the Income Statement. In the case of Inventory, the expense is only recorded when the goods associated with it Are sold - so if it's just sitting in a warehouse, it does not count as a Cost of Goods Sold or Operating Expense until the company manufactures it into a product and sells it. Let's say Apple is buying $100 worth of new iPod factories with debt. How are all 3 statements affected at the start of "Year 1," before anything else happens? At the start of "Year 1," before anything else has happened, there would be no changes On Apple's Income Statement (yet). On the Cash Flow Statement, the additional investment in factories would show up Under Cash Flow from Investing as a net reduction in Cash Flow (so Cash Flow is down By $100 so far). And the additional $100 worth of debt raised would show up as an Addition to Cash Flow, canceling out the investment activity. So the cash number stays The same. On the Balance Sheet, there is now an additional $100 worth of factories in the Plants, Property & Equipment line, so PP&E is up by $100 and Assets is therefore up by $100. On the other side, debt is up by $100 as well and so both sides balance. Now let's go out 1 year, to the start of Year 2. Assume the debt is high-yield so no Principal is paid off, and assume an interest rate of 10%. Also assume the factories Depreciate at a rate of 10% per year. What happens? After a year has passed, Apple must pay interest expense and must record the Depreciation. Operating Income would decrease by $10 due to the 10% depreciation charge each year, And the $10 in additional Interest Expense would decrease the Pre-Tax Income by $20 Altogether ($10 from the depreciation and $10 from Interest Expense). Assuming a tax rate of 40%, Net Income would fall by $12. On the Cash Flow Statement, Net Income at the top is down by $12. Depreciation is a Non-cash expense, so you add it back and the end result is that Cash Flow from Operations is down by $2. That's the only change on the Cash Flow Statement, so overall Cash is down by $2. On the Balance Sheet, under Assets, Cash is down by $2 and PP&E is down by $10 due To the depreciation, so overall Assets are down by $12. On the other side, since Net Income was down by $12, Shareholders' Equity is also Down by $12 and both sides balance. Remember, the debt number under Liabilities does not change since we've assumed None At the start of Year 3, the factories all break down and the value of the equipment Is written down to $0. The loan must also be paid back now. Walk me through the 3 Statements. After 2 years, the value of the factories is now $80 if we go with the 10% depreciation per Year assumption. It is this $80 that we will write down in the 3 statements. First, on the Income Statement, the $80 write-down shows up in the Pre-Tax Income line. With a 40% tax rate, Net Income declines by $48. On the Cash Flow Statement, Net Income is down by $48 but the write-down is a noncash Expense, so we add it back - and therefore Cash Flow from Operations increases by $32. There are no changes under Cash Flow from Investing, but under Cash Flow from Financing there is a $100 charge for the loan payback - so Cash Flow from Investing falls By $100. Overall, the Net Change in Cash falls by $68. On the Balance Sheet, Cash is now down by $68 and PP&E is down by $80, so Assets Have decreased by $148 altogether. On the other side, Debt is down $100 since it was paid off, and since Net Income was Down by $48, Shareholders' Equity is down by $48 as well. Altogether, Liabilities & Shareholders' Now let's look at a different scenario and assume Apple is ordering $10 of Additional iPod inventory, using cash on hand. They order the inventory, but them Have not manufactured or sold anything yet - what happens to the 3 statements? No changes to the Income Statement. Cash Flow Statement - Inventory is up by $10, so Cash Flow from Operations decreases By $10. There are no further changes, so overall Cash is down by $10. On the Balance Sheet, Inventory is up by $10 and Cash is down by $10 so the Assets Number stays the same and the Balance Sheet remains in balance. Now let's say they sell the iPods for revenue of $20, at a cost of $10. Walk me Through the 3 statements under this scenario. Income Statement: Revenue is up by $20 and COGS is up by $10, so Gross Profit is up by $10 and Operating Income is up by $10 as well. Assuming a 40% tax rate, Net Income is Up by $6. Cash Flow Statement: Net Income at the top is up by $6 and Inventory has decreased by $10 (since we just manufactured the inventory into real iPods), which is a net addition to Cash flow - so Cash Flow from Operations is up by $16 overall. These are the only changes on the Cash Flow Statement, so Net Change in Cash is up by $16. On the Balance Sheet, Cash is up by $16 and Inventory is down by $10, so Assets is up By $6 overall. On the other side, Net Income was up by $6 so Shareholders' Equity is up by $6 and Both sides balance. Could you ever end up with negative shareholders' equity? What does it mean? Yes. It is common to see this in 2 scenarios: 1. Leveraged Buyouts with dividend recapitalizations - it means that the owner of The company has taken out a large portion of its equity (usually in the form of Cash), which can sometimes turn the number negative. 2. It can also happen if the company has been losing money consistently and Therefore has a declining Retained Earnings balance, which is a portion of Shareholders' Equity. It doesn't "mean" anything in particular, but it can be a cause for concern and possibly Demonstrate that the company is struggling (in the second scenario).