Investment Banking 400 Questions Latest

Investment Banking 400 Questions Latest Update - Actual Exam Questions and 100% Verified Correct Answers Guaranteed A+

• Could a company have a negative Enterprise Value? What would that mean? -

CORRECT ANSWER: Yes. It means that the company has an extremely large cash

balance, or an extremely

low market capitalization (or both). You see it with:

• Companies on the brink of bankruptcy.
• Financial institutions, such as banks, that have large cash balances.

These days, there's a lot of overlap in these 2 categories...

A buyer pays $100 million for the seller in an all-stock deal, but a day later the

market decides it's only worth $50 million. What happens? - CORRECT ANSWER: The

buyer's share price would fall by whatever per-share dollar amount corresponds to the $50 million loss in value. Note that it would not necessarily be cut in half.Depending on how the deal was structured, the seller would effectively only be receiving half of what it had originally negotiated.This illustrates one of the major risks of all-stock deals: sudden changes in share price could dramatically impact valuation.

A company has 1 million shares outstanding at a value of $100 per share. It also has $10 million of convertible bonds, with par value of $1,000 and a conversion price

of $50. How do I calculate diluted shares outstanding? - CORRECT ANSWER: This

gets confusing because of the different units involved. First, note that these convertible bonds are in-the-money because the company's share price is $100, but the conversion price is $50. So we count them as additional shares rather than debt.Next, we need to divide the value of the convertible bonds - $10 million - by the par

value - $1,000 - to figure out how many individual bonds we get:

$10 million / $1,000 = 10,000 convertible bonds.Next, we need to figure out how many shares this number represents. The number of

shares per bond is the par value divided by the conversion price:

$1,000 / $50 = 20 shares per bond.So we have 200,000 new shares (20 * 10,000) created by the convertibles, giving us 1.2 million diluted shares outstanding.We do not use the Treasury Stock Method with convertibles because the company is not "receiving" any cash from us.

A company has a high debt load and is paying off a significant portion of its

principal each year. How do you account for this in a DCF? - CORRECT ANSWER:

Trick question. You don't account for this at all in a DCF, because paying off debt principal shows up in Cash Flow from Financing on the Cash Flow Statement - but we only go down to Cash Flow from Operations and then subtract Capital Expenditures to get to Free Cash Flow. 1 / 4

If we were looking at Levered Free Cash Flow, then our interest expense would decline in future years due to the principal being paid off - but we still wouldn't count the principal repayments themselves anywhere.

A company has had positive EBITDA for the past 10 years, but it recently went bankrupt. How could this happen? - CORRECT ANSWER: Several possibilities:

• The company is spending too much on Capital Expenditures - these are not

reflected at all in EBITDA, but it could still be cash-flow negative.

• The company has high interest expense and is no longer able to afford its debt.
• The company's debt all matures on one date and it is unable to refinance it due to

a "credit crunch" - and it runs out of cash completely when paying back the debt.

• It has significant one-time charges (from litigation, for example) and those are

high enough to bankrupt the company.Remember, EBITDA excludes investment in (and depreciation of) long-term assets, interest and one-time charges - and all of these could end up bankrupting the company.

A company with a higher P/E acquires one with a lower P/E - is this accretive or dilutive? - CORRECT ANSWER: Trick question. You can't tell unless you also know that it's an all-stock deal. If it's an all-cash or all-debt deal, the P/E multiples of the buyer and seller don't matter because no stock is being issued.Sure, generally getting more earnings for less is good and is more likely to be accretive but there's no hard-and-fast rule unless it's an all-stock deal.

All else being equal, which method would a company prefer to use when acquiring

another company - cash, stock, or debt? - CORRECT ANSWER: Assuming the buyer

had unlimited resources, it would always prefer to use cash when buying another company. Why?• Cash is "cheaper" than debt because interest rates on cash are usually under 5% whereas debt interest rates are almost always higher than that. Thus, foregone interest on cash is almost always less than additional interest paid on debt for the same amount of cash/debt.• Cash is also less "risky" than debt because there's no chance the buyer might fail to raise sufficient funds from investors.• It's hard to compare the "cost" directly to stock, but in general stock is the most "expensive" way to finance a transaction - remember how the Cost of Equity is almost always higher than the Cost of Debt? That same principle applies here.• Cash is also less risky than stock because the buyer's share price could change dramatically once the acquisition is announced.

Are revenue or cost synergies more important? - CORRECT ANSWER: No one in M&A takes revenue synergies seriously because they're so hard to predict.Cost synergies are taken a bit more seriously because it's more straightforward to see how buildings and locations might be consolidated and how many redundant employees might be eliminated.That said, the chances of any synergies actually being realized are almost 0 so few take 2 / 4

them seriously at all.

Are there any problems with the Enterprise Value formula you just gave me? - CORRECT ANSWER: Yes - it's too simple. There are lots of other things you need to add into the formula with

real companies:

• Net Operating Losses - Should be valued and arguably added in, similar to cash.• Long-Term Investments - These should be counted, similar to cash.• Equity Investments - Any investments in other companies should also be added in, similar to cash (though they might be discounted).• Capital Leases - Like debt, these have interest payments - so they should be added in like debt.• (Some) Operating Leases - Sometimes you need to convert operating leases to capital leases and add them as well.• Pension Obligations - Sometimes these are counted as debt as well.So a more "correct" formula would be Enterprise Value = Equity Value - Cash + Debt + Preferred Stock + Minority Interest - NOLs - Investments + Capital Leases + Pension Obligations...In interviews, usually you can get away with saying "Enterprise Value = Equity Value - Cash + Debt + Preferred Stock + Minority Interest" I mention this here because in more advanced interviews you might get questions on this topic.

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. - CORRECT ANSWER: 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' Equity are down by $148 and both sides balance.

• / 4

Both M&A premiums analysis and precedent transactions involve looking at previous M&A transactions. What's the difference in how we select them? - CORRECT

ANSWER: • All the sellers in the M&A premiums analysis must be public.

• Usually we use a broader set of transactions for M&A premiums - we might use fewer than 10 precedent transactions but we might have dozens of M&A premiums. The industry and financial screens are usually less stringent.• Aside from those, the screening criteria is similar - financial, industry, geography, and date.

Can you explain how the Balance Sheet is adjusted in an LBO model? - CORRECT ANSWER: First, the Liabilities & Equities side is adjusted - the new debt is added on, and the Shareholders' Equity is "wiped out" and replaced by however much equity the private equity firm is contributing.On the Assets side, Cash is adjusted for any cash used to finance the transaction, and then Goodwill & Other Intangibles are used as a "plug" to make the Balance Sheet balance.Depending on the transaction, there could be other effects as well - such as capitalized financing fees added to the Assets side.

Can you give examples of major line items on each of the financial statements? - CORRECT ANSWER: Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General & Administrative Expenses); Operating Income; Pretax Income; Net Income.Balance Sheet: Cash; Accounts Receivable; Inventory; Plants, Property & Equipment (PP&E); Accounts Payable; Accrued Expenses; Debt; Shareholders' Equity.

Cash Flow Statement: Net Income; Depreciation & Amortization; Stock-Based

Compensation; Changes in Operating Assets & Liabilities; Cash Flow From Operations; Capital Expenditures; Cash Flow From Investing; Sale/Purchase of Securities; Dividends Issued; Cash Flow From Financing.

Can you use private companies as part of your valuation? - CORRECT ANSWER: Only

in the context of precedent transactions - it would make no sense to include them for public company comparables or as part of the Cost of Equity / WACC calculation in a DCF because they are not public and therefore have no values for market cap or Beta.

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? - CORRECT ANSWER: Trick question. Dividend yields are already factored into Beta, because Beta describes returns in excess of the market as a whole - and those returns include dividends.

• / 4