Key Technical Questions for Finance Interviews

Technical Interview Questions Overview

Technical interview questions are an integral facet of all finance interviews, be they for investment banking, private equity, corporate, S&T, or equity
research roles. Technicals will seldom win you the offer outright (though can if you perform exceptionally well) but can easily cost you it, despite how
excellent a conversationalist you may be. They help the interviewer learn a few things about you. The first is explicit; your technical acumen tells the
interviewer how quickly you’ll be able to “ramp up” when on the job and whether they’d have to spend months teaching you the ropes before you
started being useful if they hired you. The second and third, intellectual horsepower and commitment, are implicit. Your intellectual bandwidth will
become apparent when your interviewer asks a question you haven’t prepared for; seeing how someone uses, or fails to use, the limited information
available to them (the technicals you have memorized) to find an answer, draw a conclusion, or make an inference is revealing. The third point,
commitment, is maybe less obvious. Learning technicals and internalizing finance concepts is not fun by any stretch of the word. No one wants to spend
their free-time in college committing abstract cashflow theories to memory or mastering the DCF walk through. You know this, I know this, and your
interviewer knows this. A robust technical skillset is indicative of serious time commitment during a time when the opportunity cost to your personal
utility is high. Stated more simply: if you know your stuff it means you skipped drinking with friends to study technicals. The better you are, the more
time you must’ve spent. As explained in the qualitative interview guide, interviewers need to know you’ll be committed to the job. A deep technical
understanding will help your commitment shine through and validate the story you told during the qualitative portion of the interview. Technicals aren’t
fun, but don’t ever believe someone who tells you they’re just a “check the box” exercise; they allow you to show your interviewer you will be a useful,
intelligent, and committed employee.

Key components of good technical answers

1) Accuracy. Obviously. The people you’re talking to do this every day and know the correct answer and, if they’re listening, will immediately know
whether what you’ve said is right or wrong.
2) Confidence. It is critical that you not only giving the right answer but deliver it in such a way that it’s clear to your interviewer that you know what
you said is the right answer. A little piece of insider info: interviewers aren’t always listening that closely when you give an answer. They may check
their emails, think about an email they forgot to check, or mentally count the days until their first vacation in a year. This is more often the case
during phone / Zoom interviews. You may get away with a minor slip up so long as you sound like you’re absolutely certain what you said is correct.
The inverse is also true; if you ramble, equivocate, or say “uh” every other word, you may articulate what is objectively the correct answer but your
interviewer will remember the weak delivery and could mentally score it as wrong / partially correct when reflecting on your interview four hours
and seven candidates later. When studying, practice giving the answers aloud, not just writing them on paper, to get accustomed to the cadence of
delivering technical responses.
3) Agility. Being able to think on your feet. Your interviewer prepped for the same interviewers and has a good idea of what you should and shouldn’t
know. They may give curve-ball questions that are more complicated variants of the ones you should know, so blindly memorizing answers to
specific questions won’t work. You need to ensure you understand the foundational concepts behind the technicals detailed on the following pages.
Whenever you read an answer to a question / commit one to memory, ask yourself, “Do I know why this is the right answer and that it can’t be
something else?”. If you don’t, you should do some addt’l research or engage in vigorous internal cogitation until you actually understand the why
of the answer. Once you have this, you’ll be more equipped to answer variants of that question on the fly and sound more confident as you do so.

Study hard, study aloud, and know why something is the answer. Do these three things and Goldman will come crawling to you.

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Table of Contents

Accounting Questions & Answers 4

Valuation Questions & Answers 9

Transaction Questions & Answers 22

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Accounting Questions & Answers

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Accounting Questions & Answers
1) Walk me through the 3 financial statements.
I. The 3 financial statements are the income statement (“I/S”), balance sheet (“B/S”) and statement of cashflows (“CFS”).
II. The income statement is a statement that illustrates the profitability of the company. It begins with the revenue line and, after subtracting
various expenses, arrives at net income. The types of expenses vary by company (for example a toy manufacturer would likely have lines
for COGS and gross profit, while a consultancy might not have a line for gross profit at all since the cost of their service could be accounted
for in a payroll or employee expense line). The income statement covers a specified period, like quarter or year.
III. The balance sheet shows the company’s Assets – its resources – such as cash, inventory and property, plant, and equipment (“PP&E”), as
well as its Liabilities – such as debt and accounts payable – and shareholders’ equity. Assets must equal Liabilities plus Shareholders’ Equity.
Unlike the I/S, the balance sheet does not account for the entire period; it is a snapshot of how much the company owns and owes at a
specific point in time (e.g. an end-of-year balance sheet would be as of 12/31/2020).
IV. The statement of cashflows is broken into three parts: cashflow from operations, cashflow from investing, and cashflow from financing.
Cashflow from operations, in its most basic form, is calc’d as net income + D&A +/- the change in net working capital. Cashflow from
investing is, in its most basic form, just CapEx. Finally, there’s cashflow from financing which, in its most basic form, is just the change in
debt: did the business raise debt during the period (positive cashflow from financing) or did the business paydown debt (negative cashflow
from financing)? To summarize, the statement of cashflows details everywhere the business saw capital come in and leave during a period,
then sums it all to see if there was an increase or a decrease in cash.

2) How do the 3 statements link together?

I. To tie the statements together, net income from the income statement flows into shareholders’ equity on the balance sheet, and into the
top line of the statement of cashflows (which is also the first line of cashflow from operations). Changes to current assets on the balance
sheet appear as changes in delta net working capital on the statement of cashflows, cashflow from operations, and investing and financing
activities (CapEx, debt raising/repayment, and equity raising) affect Balance Sheet items such as PP&E, debt and shareholders’ equity. The
cash and shareholders’ equity items on the B/S act as “plugs,” with cash flowing in from the final line on the statement of cashflows (this
line is called “change in cash” and is the sum of the cashflow from operations, cashflow from investing, and cashflow from financing lines).

3) Walk me through the major line items on a cash flow statement.

I. The three segments are cashflow from operations, investing, and financing. Cashflow from operations tells the reader how much cash the
core business generated during a period by taking net income, adding back non-cash expenses like D&A and PIK interest, and adding or
subtracting the change in networking capital. Cashflow from investing covers expenditures that don’t affect the income statement (i.e.
CapEx), and cashflow from financing shows how much debt the business raised (positive CFF) or how much debt it paid down (negative CFF)
during the period. Note to the reader: cashflow from financing does not include interest expense, just the amount of debt principal that was
raised / paid down. Including interest expense in cashflow from financing would be double counting since interest expense is already
embedded in net income.

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Accounting Questions & Answers (Cont’d)
4) Walk me through how depreciation going up by $10, assuming a tax rate of 40%, would flow through the three financial statements.
I. Income Statement: Operating Income would decline by $10 and, assuming a 40% tax rate, Net Income would go down by $6.
II. Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so
overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4.
III. Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from
the changes on the Cash Flow Statement.
IV. Overall, Assets are down by $6. Since Net Income fell by $6 as well, Shareholders’ Equity on the Liabilities & Shareholders’ Equity side is
down by $6 and both sides of the Balance Sheet balance.
V. *PFF Tip* Answer this question starting by going through the income statement, then cash flow statement, then balance sheet. This way,
you can check yourself at the end and make sure the balance sheet balances.
VI. *PFF Tip* Remember that an asset going up decreases your cash flow, whereas a liability going up increases your cash flow. Think about
why this is – if you get an asset, you must’ve paid for it; that’s a cash outflow, or a “use”. If your liabilities increase, that means someone
gave you cash and all you had to give back was an IOU; that means, when you increased the liability, cash flowed into your business without
anything leaving in return. This increase in liability was a “source” of cash.

5) What is net working capital, and what does it mean if this is negative?
I. Working capital = current assets – cash – current liabilities.
II. If it’s negative, it means a company does not have enough short-term assets to pay off its short-term liabilities.
III. It is used as a measure of liquidity.
IV. *PFF Tip* Negative working capital is not necessarily a bad sign. It depends on the type of company and specific situation, i.e.:
i. Companies with subscriptions or longer-term contracts often have negative working capital because of high deferred revenue
balances.
ii. Retail and restaurant companies like Amazon and McDonald’s often have negative working capital because customers pay upfront,
so they can use the cash generated to pay off their accounts payable rather than keeping a large cash balance on hand, actually a
sign of business efficiency.
iii. In other cases, negative working capital could point to financial trouble or possible bankruptcy (for example, when customers don’t
pay quickly and upfront, and the company is simultaneously carrying a high debt balance).

6) When do you capitalize a purchase and when do you expense it?

I. If the asset has a useful life of over 1 year, it is capitalized (put on the Balance Sheet rather than shown as an expense on the Income
Statement). Then it is depreciated (tangible assets) or amortized (intangible assets) over a certain number of years.
II. Purchases like factories, equipment and land all last longer than a year and therefore show up on the Balance Sheet. Employee salaries and
the cost of goods sold (“COGS”) only cover a short period of operations and therefore show up on the Income Statement as normal
expenses instead.

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Accounting Questions & Answers (Cont’d)
7) What’s the difference between accounts receivable, accounts payable, and deferred revenue?
I. Accounts receivable (“AR”):
i. Current asset on the balance sheet until payment is received from customers for goods or services.
ii. Example: products sold on credit; I sell you a $10 hat and you’re going to pay tomorrow – until you pay me, I have an AR balance of
$10 in my current assets.
iii. Revenue has been earned, but not received in cash.
iv. *PFF Tip*: Receivables may be offset by an allowance for doubtful accounts, while payables have no such offset.
1. Management’s best estimate of amount of accounts receivable that will not be paid by customers.
2. Allowance is subtracted from accounts receivable to produce a net AR value.
II. Accounts payable:
i. Current liability on the balance sheet until payment is made to suppliers for goods/services.
ii. Example: Inventory purchased from supplier on credit.
III. Deferred revenue:
i. Classified on a company’s balance sheet as a liability rather than an asset.
ii. Refers to payments receive in advance of services or goods that have not yet been delivered.
iii. Payment has been received in cash, but not earned.
iv. Example: annual subscriptions; I sell magazines and you pay me $120 for 12 magazines on January 1st, 2021, and I send you one
magazine a month. Each month I send you a magazine, I get to debit my deferred revenue liability by $10 and credit my revenue
line $10. Once I’ve sent the last magazine on 12/31/2021, I’ll have recognized $120 of revenue and eliminated the entire deferred
revenue liability from my balance sheet.
IV. In short, Accounts receivable represents how much revenue the company is waiting on, whereas deferred revenue represents how much it
is waiting to record as revenue. Accounts payable is a current liability and represents cash owed by the company for goods or services have
received.

8) What does pro forma mean?

I. When financials are pro forma, it means they’re incorporating certain projections or presumptions that occurred in the past and/or may
occur in the future to project the most likely outcome for financial results.
II. Often, pro forma financials are not GAAP compliant, but can be issued to highlight certain items for potential investors. They are also used
internally by management for business decisions.
III. Companies may also design pro forma statements to assess the potential earnings value of a proposed business change, such as an
acquisition or a merger.
IV. Easiest example is COVID; if you’re looking at buying a business that has generated $10m of EBITDA for each of the last three years but only
generated $5m of EBITDA this year because it couldn’t do as much business, you might accept that the business performed poorly this year
but it was clearly due to COVID, so you’d pro forma adjust EBITDA by $5m and believe that the 2020 EBITDA would have been $10m had it
not been for the pandemic; you would refer to this as 2020 PF Adj. EBITDA.

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Accounting Questions & Answers (Cont’d)
9) What is goodwill and how is it treated? How is it different than Other Intangible Assets?
I. Goodwill is created when a company is acquired at a value higher than the sum of the net fair value of assets and liabilities assumed in the
acquisition. E.g. the company had $100 in assets, owed $50 to the village loan shark, yet you paid $200 for the business. You got something
that was worth net $50 but paid $200, so the $150 excess is identified as goodwill.
II. Goodwill typically stays the same over many years and is not amortized. It changes only if there is goodwill impairment or another
acquisition.
III. Other Intangible Assets, by contrast, are amortized over several years and affect the Income Statement by hitting the Pre-Tax Income line.
IV. Key point to note (and one that will really impress your interviewers): while Goodwill created by an acquisition is not amortized for GAAP
reporting, the IRS does allow businesses to amortize it. This means that the company gets to recognize a non-cash expense when reporting
their taxes, which lowers the net income that company reports to the IRS, which means the company gets taxed less. When a company gets
acquired for a price that, at first glance, seem over-priced, a component of the Buyer’s rationale for paying so much could be that they pay
a lot up front, but the large amount of goodwill creates a tax shield for the next 15 years (the annual tax shield is calculated as the tax rate *
goodwill created / 15 years).

10) What is preferred stock?

I. Preferred stock is an instrument that gives its holders a higher claim on distributions (e.g. dividends) than common stockholders.
II. Preferred stockholders usually have no or limited, voting rights in corporate governance.
III. In the event of a liquidation, preferred stockholders’ claim on assets is greater than common stockholders but less than bondholders.
IV. When valuing a company, preferred stock is treated as debt and it typically accrues PIK interest.

11) What is retained earnings and how can it be negative?

I. a. Retained earnings is an equity account that represents the amount of net income left for the business after it has paid out dividends to
shareholders.
II. b. Retained earnings = beginning period retained earnings + net income (loss) – dividends.
III. c. If a company has negative net income for an extended period of time, it can result in a negative retained earnings balance.

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Valuation Questions & Answers

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Valuation Questions & Answers
1) What do you actually use a valuation for?
I. First response is to specify the context, whether it’s from an investment banker’s perspective or a Buyer’s (e.g. PE firm).
II. Investment Banking: Early in a process, when still trying to win the mandate to sell a company, there typically isn’t just one valuation but a
range of valuations generated by comps, precedent transaction, DCF, and LBO valuation methodologies. Typically, you first shows this
range in pitch books and in client presentations when you’re providing updates and telling them what they should expect for their own
valuation. It’s also used right before a deal closes in a Fairness Opinion, a document a bank creates that “proves” the value their client is
paying or receiving is “fair” from a financial point of view.
III. PE Firm: Determine what you believe the TEV of the business, almost always with an LBO model, and use this to inform what capital
structure you should seek to optimize returns (i.e. how much debt can you burden the business with in order to minimize your equity
check, which maximizes returns, without putting the business in an untenable position). This is the TEV, and, subsequently, the structure,
you use when negotiating with both the sellers and prospective lenders.

2) How do you calculate enterprise value?

I. TEV = Equity Value + Debt + Preferred Stock + Minority Interest – Cash.

3) Why do you subtract cash from TEV?

I. Cash is subtracted because it’s considered a non-operating asset and because Equity Value implicitly accounts for it.
II. In an acquisition, the buyer would “get” the cash of the seller, so it effectively pays less for the company based on how large its cash
balance is. Remember, Enterprise Value tells us how much you’d really have to “pay” to acquire another company.
III. *PFF Tip*: It’s not always accurate to subtract total cash because technically you should be subtracting only excess cash – the amount of
cash a company has above the minimum cash it requires to operate, but this is a technicality that likely won’t come up in interviews.

4) What is the difference between enterprise value and equity value and why does it matter?
I. Enterprise Value represents the value of the company that is attributable to all investors. Equity Value also only represents the portion
available to shareholders (equity investors). You look at both because Equity Value is the number the public-at-large sees, while Enterprise
Value represents its true value.
II. Another, more abstract, way to think of this is in terms of cashflows. At the end of the day, what makes a business worth anything is the
belief that it will be able to generate cash in the future. Which stakeholders can lay claim to those future cashflows and how likely / unlikely
(price of risk) it is that the cashflows will actually materialize for them is what determines the value of their position. The TEV is the sum of
the present value of each stakeholder’s position.

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Valuation Questions & Answers (Cont’d)
5) What is the difference between equity value and shareholders’ equity?
I. Equity Value is the market value and Shareholders’ Equity is the book value. Equity Value can never be negative because shares outstanding
and share prices can never be negative, whereas Shareholders’ Equity could be any value. For healthy companies, Equity Value usually far
exceeds Shareholders’ Equity.

6) How do you calculate fully diluted shares?

I. Take the basic share count and add in the dilutive effect of stock options and any other dilutive securities, such as warrants, convertible
debt or convertible preferred stock.
II. To calculate the dilutive effect of options, you use the Treasury Stock Method.

7) Explain the treasury stock method.

I. The TSM assumes that all tranches of in-the-money options and warrants are exercised at their weighted average strike price with the
resulting option proceeds used to repurchase outstanding shares of stock at the company's current share price. In-the-money options and
warrants are those that have an exercise price lower than the current market price of the underlying company's stock. As the strike price is
lower than the current market price, the number of shares repurchased is less than the additional shares outstanding from exercised
options. This results in a net issuance of shares, which is dilutive.

8) Let’s say a company has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each –
what is its fully diluted equity value?
I. Its basic equity value is $1,000 (100 * $10 = $1,000). To calculate the dilutive effect of the options, first you note that the options are all “in-
the-money” – their exercise price is less than the current share price.
II. When these options are exercised, there will be 10 new shares created – so the share count is now 110 rather than 100.
III. However, that doesn’t tell the whole story. In order to exercise the options, the option holders had to “pay” the company $5 for each
option (the exercise price).
IV. As a result, it now has $50 in additional cash, which it now uses to buy back 5 of the new shares the exercised options created.
V. So the fully diluted share count is 105, and the fully diluted equity value is $1,050.

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Valuation Questions & Answers (Cont’d)
9) Can a business have a negative TEV? If so, how?
I. Yes. It means that the company has an extremely large cash balance, or an extremely low market capitalization (or both). You see it with:
i. Companies on the brink of bankruptcy.
ii. Financial institutions, such as banks, that have large cash balances.
II. *PFF Tip*: it is NOT possible for a public company to have a negative equity value because you cannot have negative share count and you
cannot have a negative share price.

10) Walk me through how you conduct a DCF / comps / precedent transaction / LBO valuation and tell me about the merits and downsides of each.
I. DCF: A DCF values a company based on the Present Value of its future cash flows + the Present Value of its Terminal Value. First, you
project out a company’s financials using assumptions for revenue growth, expenses and working capital; then you get down to Free Cash
Flow for each year, which you then sum up and discount to a Net Present Value, based on your discount rate – usually the Weighted
Average Cost of Capital (“WACC”). Once you have the present value of the cash flows, you determine the company’s Terminal Value, using
either the Multiples Method or the Gordon Growth Method, and then also discount that back to its Net Present Value using WACC. Finally,
you add the two together to determine the company’s Enterprise Value.

*PFF Tip*: The above paragraph is how high-level you want to be when first walking through the DCF; don’t feel obligated to explain how to
calculate WACC, define what terminal value is, and/or opine on the merits of the Gordon Growth Method vs. the Multiples Method (the answer is
bankers / investors always use the Multiple Method). That is not to say you don’t need to know the answer to these questions – you do – but wait
for your interviewer to ask you. There are numerous advantages to this strategy:
I. Waiting for your interviewer to ask more detailed questions runs down the clock on the interview as the they have to think about
what to ask next rather than you just spraying it all out at once (the longer you can go in an interview without getting a question
wrong, the better).
II. It is way more impressive when a candidate confidently answers a question after being asked than when they preempt the answer
to a question they think they’re going to be asked.
III. Interviewers often have a set time in their head for how long they want the technical session to be. If the full interview is supposed
to be 30 minutes, they might want to spend 15 minutes on technicals, for some people maybe it’s 10 minutes, for others maybe it’s
20 minutes. Regardless, the point is, if you expectorate everything you know about the DCF in five minutes, your interviewer is going
to want to keep asking you technicals for another 5 – 15 minutes, and since you just answered the next nine technical questions
your interviewer had planned when responding to their first question, the interviewer is just going to start making up questions that
are inevitably going to be way harder than anything you’re prepared for and you will look like a fool. This was a long-winded way of
saying: Don’t give away the farm when responding to a DCF (or any technical question). Be succinct and accurate, but not too
detailed – keep some facts to yourself until asked.

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Valuation Questions & Answers (Cont’d)
10) Walk me through how you conduct a DCF / comps / precedent transaction / LBO valuation and tell me about the merits and downsides of each
(Cont’d).
i. DCF Merits
1. Cash flow-based – reflects value of projected FCF, which represents a more fundamental approach to valuation than using
multiples-based methodologies.
2. Market independent – more insulated from market aberrations such as bubbles and distressed periods.
3. Self-sufficient – does not rely entirely upon comparable companies or transactions, which may or may not exist, to frame
valuation; a DCF is particularly important when there are limited or no “pure play” public comparables to the company
being valued.
4. Flexibility – allows the banker to run multiple financial performance scenarios, including improving or declining growth
rates, margins, CapEx requirements, and working capital efficiency.
ii. DCF Downsides
1. Dependence on financial projections – accurate forecasting of financial performance is challenging, especially as the
projection period lengthens.
2. Sensitivity to assumptions – relatively small changes in key assumptions, such as growth rates, margins, WACC, or exit
multiple, can produce meaningfully different valuation ranges.
3. Terminal value – the present value of the terminal value can represent as much as three-quarters or more of the DCF
valuation, which decreases the relevance of the projection period's annual FCF.
4. Assumes constant capital structure – basic DCF does not provide flexibility to change the company's capital structure over
the projection period.

II. Public Company Comparables

i. Trading comps: Comparable companies provides a market benchmark against which a banker can establish valuation for a private
company or analyze the value of a public company at a given point in time. Common metrics compared are EV/EBITDA, P/E, Net
debt/EBITDA, etc.
ii. Public Company Comparables Merits:
i. Market-based – information used to derive valuation for the target is based on actual public market data, thereby
reflecting the market's growth and risk expectations, as well as overall sentiment.
ii. Relativity – easily measurable and comparable versus other companies.
iii. Quick and convenient – valuation can be determined on the basis of a few easy-to-calculate inputs.
iv. Current – valuation is based on prevailing market data, which can be updated on a daily (or intraday) basis.

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Valuation Questions & Answers (Cont’d)
10) Walk me through how you conduct a DCF / comps / precedent transaction / LBO valuation and tell me about the merits and downsides of each
(Cont’d).
i. Public Company Comparables Downsides
1. Market-based – valuation that is completely market-based can be skewed during periods of irrational exuberance or
bearishness.
2. Absence of relevant comparables – “pure play” comparables may be difficult to identify or even non-existent, especially if
the target operates in a niche sector, in which case the valuation implied by trading comps may be less meaningful.
3. Potential disconnect from cash flow – valuation based on prevailing market conditions or expectations may have significant
disconnect from the valuation implied by a company's projected cash flow generation (e.g., DCF analysis).
4. Company-specific issues – valuation of the target is based on the valuation of other companies, which may fail to capture
target-specific strengths, weaknesses, opportunities, and risks.

III. Precedent Transactions

i. Employs a multiples-based approach to derive an implied valuation range for a given company, division, business, or collection of
assets (“target”). It is premised on multiples paid for comparable companies in prior M&A transactions.
1. E.g. your competitor was acquired for 8.0x EBITDA last week and your businesses are very similar. Transaction comps logic
would imply your business is also probably worth 8.0x.
ii. Under normal market conditions, transaction comps tend to provide a higher multiple range than trading comps for two principal
reasons. First, buyers generally pay a “control premium” when purchasing another company. In return for this premium, the
acquirer receives the right to control decisions regarding the target's business and its underlying cash flows. Second, strategic
buyers often have the opportunity to realize synergies, which supports the ability to pay higher purchase prices. Synergies refer to
the expected cost savings, growth opportunities, and other financial benefits that occur as a result of the combination of two
businesses.
iii. Precedent Transactions Merits:
i. Market-based – analysis is based on actual acquisition multiples and premiums paid for similar companies.
ii. Current – recent transactions tend to reflect prevailing M&A, capital markets, and general economic conditions.
iii. Relativity – multiples approach provides straightforward reference points across sectors and time periods.
iv. Simplicity – key multiples for a few selected transactions can anchor valuation.
v. Objectivity – precedent-based and, therefore, avoids making assumptions about a company's future performance.

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Valuation Questions & Answers (Cont’d)
10) Walk me through how you conduct a DCF / comps / precedent transaction / LBO valuation and tell me about the merits and downsides of each
(Cont’d).
i. Precedent Transactions Downsides
1. Market-based – multiples may be skewed depending on capital markets and/or economic environment at the time of the
transaction.
2. Time lag – precedent transactions, by definition, have occurred in the past and, therefore, may not be truly reflective of
prevailing market conditions (e.g., the LBO boom in the mid-2000s vs. the ensuing credit crunch).
3. Existence of comparable acquisitions – in some cases it may be difficult to find a robust universe of precedent transactions.
4. Availability of information – information may be insufficient to determine transaction multiples for many comparable
acquisitions.
5. Acquirer's basis for valuation – multiple paid by the buyer may be based on expectations governing the target's future
financial performance (which is typically not publicly disclosed) rather than on reported LTM financial information).

IV. LBO: In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt and other variables;
you might also assume something about the company’s operations, such as Revenue Growth or Margins, depending on how much
information you have. Step 2 is to create a Sources & Uses section, which shows how you finance the transaction and what you use the
capital for; this also tells you how much Investor Equity is required. Step 3 is to adjust the company’s Balance Sheet for the new Debt and
Equity figures, and also add in Goodwill & Other Intangibles on the Assets side to make everything balance. In Step 4, you project out the
company’s Income Statement, Balance Sheet and Cash Flow Statement, and determine how much debt is paid off each year, based on the
available Cash Flow and the required Interest Payments. Finally, in Step 5, you make assumptions about the exit after several years, usually
assuming an EBITDA Exit Multiple, and calculate the return based on how much equity value is returned to the firm vs. how much they
originally invested.
i. LBO Merits:
1. An excellent means to establish a “floor” valuation—i.e., an LBO analysis will determine the amount that a financial buyer
(sponsor) would be willing to pay for the company, thereby determining the value that a strategic bidder will have to
exceed.
2. LBO valuation is realistic, as it does not require synergies to achieve (sponsors usually do not have synergy opportunities).
ii. LBO Downsides:
i. Ignoring synergies could result in an underestimated valuation, particularly for a well-fitting strategic buyer.
ii. The valuation obtained is very sensitive to operating assumptions (growth rate, operating working capital assumptions,
profit margins, etc.) and financing cost assumptions (and thus LBO valuation is dependent upon the quality of the prevailing
financing market conditions).

Jefferies LLC / January 2020 15

Valuation Questions & Answers (Cont’d)
11) How do you calculate WACC?
I. WACC = [Cost of Equity * (% Equity)] + [Cost of Debt * (% Debt) * (1 – Tax Rate)] + [Cost of Preferred * (% Preferred)].
II. In all cases, the percentages refer to how much of the company’s capital structure is taken up by each slug of capital.

12) How do you calculate the cost of equity?

I. Cost of Equity = Risk-Free Rate + Beta * Equity Risk Premium.
II. The risk-free rate represents how much a 10-year or 20-year US Treasury should yield; Beta is calculated based on the “riskiness” of
Comparable Companies and the Equity Risk Premium is the % by which stocks are expected to out-perform “risk-less” assets.

13) How do you calculate the cost of debt?

I. A company's cost of debt reflects its credit profile at the target capital structure, which is based on a multitude of factors including size,
sector, outlook, cyclicality, credit ratings, credit statistics, cash flow generation, financial policy, and acquisition strategy, among others.
II. Assuming the company is currently at its target capital structure, cost of debt is generally derived from the blended yield on its outstanding
debt instruments, which may include a mix of public and private debt.
III. Post-tax cost of debt = (total interest cost incurrent*(1 – effective tax rate))/total debt*100.
IV. *PFF Tip*: When you’ve finished walking through the above, show that you’ve actually networked with people by saying: “That being said,
my understanding is that on the job, an analyst would just check the Bloomberg terminal or send an email to the debt capital markets
team.”

14) Do you factor in taxes when calculating cost of debt? Why or why not?
I. Yes, because interest expense is deductible.
II. That being said, cost of debt can be calculated pre-tax (total interest cost incurrent/total debt*100).

15) How do you get to beta in the Cost of Equity calculation?

I. You look up the Beta for each Comparable Company (usually on Bloomberg, CapIQ, or FactSet), un-lever each one, take the median of the
set and then lever it based on your company’s capital structure.
II. Then you use this Levered Beta in the Cost of Equity calculation.

Jefferies LLC / January 2020 16

Valuation Questions & Answers (Cont’d)
16) How do you lever and un-lever beta? Why is it necessary?
I. Un-Levered Beta = Levered Beta / (1 + ((1 - Tax Rate) x (Total Debt/Equity))).
II. Levered Beta = Un-Levered Beta x (1 + ((1 - Tax Rate) x (Total Debt/Equity))).
III. When you look up betas, they will be levered to reflect the debt already assumed by each company. But each company’s capital structure is
different, and we want to look at how “risky” a company is regardless of what % debt or equity it has. To get that, we need to un-lever Beta
each time. But at the end of the calculation, we need to re-lever it because we want the Beta used in the cost of equity calculation to
reflect the true risk of the company, taking into account its capital structure this time.

17) Would you expect a tech company or a manufacturing company to have a higher beta?
I. A tech company, because tech is viewed as a “riskier”, more volatile industry than manufacturing.

18) How do you select the companies for a comps analysis? Look at (1) business profile and (2) financial profile.
I. Business profile:
i. Industry/sector
ii. Products/services
iii. Customers and end markets
iv. Distribution channels
v. Geography
II. ii. Financial profile
i. Size
ii. Profitability
iii. Growth profile
iv. Return on investment
v. Credit profile
III. *PFF Tip* The best precedent transactions analyses typically involve companies similar to the target on a fundamental level. As a general
rule, the most recent transactions (i.e., those that have occurred within the previous two to three years) are the most relevant as they likely
took place under similar market conditions to the contemplated transaction. Potential buyers and sellers look closely at the multiples that
have been paid for comparable acquisitions. As a result, bankers and investment professionals are expected to know the transaction
multiples for their sector focus areas.

19) How do you calculate free cash flow?

I. To get from revenue to free cash flow, subtract COGS and Operating Expenses to get to Operating Income (EBIT). Then, multiply by (1 – Tax
Rate), add back Depreciation and other non-cash charges, and subtract Capital Expenditures and the change in Working Capital.
II. *PFF Tip* This gets you to unlevered free cash flow, since you went off of EBIT rather than EBT.

Jefferies LLC / January 2020 17

Valuation Questions & Answers (Cont’d)
20) What is the difference between levered FCF and unlevered FCF?
I. Levered FCF: Includes the impact of interest expense, meaning the remaining cashflow has no more debt-holder obligations to satisfy and is
therefore only available to equity investors. Debt investors have already been “paid” with the interest payments they’ve received and have
no claim on the remaining cashflow.
II. Unlevered FCF: Excludes interest, thus represents money available to all investors.

21) What value is being determined when using levered and unlevered FCF, respectively?
I. Levered FCF: Equity value
II. Unlevered FCF: Enterprise value

22) What is a terminal value?

I. In finance parlance: In a DCF, the terminal value captures the value of a business beyond the projection period in a DCF analysis (typically 5
years) and is the present value of all subsequent cash flows.
II. In reality: why you assume you’ll sell the business for five years down the road.

23) What are the two ways to calculate a terminal value? Which is more commonly used, and why?
I. You can either apply an exit multiple to the company’s Year 5 EBITDA, EBIT or Free Cash Flow (Multiples Method) or you can use the
Gordon Growth method to estimate its value based on its growth rate into perpetuity.
II. The formula for Terminal Value using Gordon Growth is: Terminal Value = Year 5 Free Cash Flow * (1 + Growth Rate) / (Discount Rate –
Growth Rate).
i. Growth rate is normally the country’s long-term GDP growth rate, the rate of inflation, or something similarly conservative.
ii. For companies in mature economies, a long-term growth rate over 5% would be quite aggressive since most developed economies
are growing at less than 5% per year.
III. In banking, you almost always use the Multiples Method to calculate Terminal Value in a DCF. It’s much easier to get appropriate data for
exit multiples since they are based on Comparable Companies – picking a long-term growth rate, by contrast, is always a shot in the dark.
IV. However, you might use Gordon Growth if you have no good Comparable Companies or if you have reason to believe that multiples will
change significantly in the industry several years down the road. For example, if an industry is very cyclical you might be better off using
long-term growth rates rather than exit multiples.

24) How do you select an appropriate exit multiple when calculating Terminal Value?
I. Normally you look at the Comparable Companies and pick the median of the set, or something close to it.
II. As with almost anything else in finance, you always show a range of exit multiples and what the Terminal Value looks like over that range
rather than picking one specific number.
III. So if the median EBITDA multiple of the set were 8x, you might show a range of values using multiples from 6x to 10x.

Jefferies LLC / January 2020 18

Valuation Questions & Answers (Cont’d)
25) Why would two companies with similar growth and profitability be valued differently?
I. There are a variety of possibilities:
i. Since you only said profitability, one could have much higher OpEx than the other.
ii. One has a more respected management team.
iii. One recently developed a patent / proprietary tech that will allow it to significantly reduce its costs in the future.
iv. One of them manages their networking capital very efficiently and the other has a very long cash conversion cycle.
v. One of them has much better terms on its debt than the other.
1. Maybe the competitor just clawed its way back from Chapter 11 bankruptcy and still has onerous covenants it has to
adhere to.
2. Maybe one just has way lower interest on their debt than the other or a much higher debt balance that its current levels of
profitability can’t sustain.
vi. One has a key supplier, which the other does not use, that is about to go bankrupt.

26) Rank the valuation methodologies from highest to lowest expected valuation.
I. Trick question – there is no ranking that always holds. In general, Precedent Transactions will be higher than Comparable Companies due to
the Control Premium built into acquisitions. Beyond that, a DCF could go either way and it’s best to say that it’s more variable than other
methodologies. Often it produces the highest value, but it can produce the lowest value as well depending on your assumptions. Assuming
your DCF has reasonable assumptions then the LBO model will, in general, have the lowest TEV since the banker and / or the PE firm are
back solving TEV for the highest possible IRR.
II. *PFF Tip*: It’s important that you note that the TEV in an LBO is assumed, not explicitly solved for. An LBO model doesn’t work unless you
plug in an assumed capital structure, and you can’t determine a capital structure without a TEV. What you can do, however, is solve for the
IRR and use a sensitivity table to see how returns to the buyer change as the TEV the business is purchased at goes up or down.

27) What are the most common multiples used in Valuation?

I. The most common multiples are EV/Revenue, EV/EBITDA, EV/EBIT, P/E (Share Price / Earnings per Share), and P/BV (Share Price / Book
Value per Share).
II. All of these, of course, depend on the company. A business generating negative EBITDA won’t use any metrics other than TEV/Revenue,
TEV / Gross Profit, or some industry-accepted KPI (e.g. in tech, TEV / monthly users).

28) Why isn’t Equity Value to EBITDA a correct multiple to use?

I. EBITDA is available to all investors in the company – rather than just equity holders. Similarly, Enterprise Value is also available to all
shareholders so it makes sense to pair them together.
II. Equity Value / EBITDA, however, is comparing apples to oranges because Equity Value does not reflect the company’s entire capital
structure – only the part available to equity investors.

Jefferies LLC / January 2020 19

Valuation Questions & Answers (Cont’d)
29) What are some other valuation methodologies besides DCF / comps / precedent transaction / LBO, how do you do them, and when are they
appropriate?
I. Sum-of-the-Parts – valuing each division of a company separately and adding them together at the end.
i. Most often used when a company has completely different, unrelated divisions (used for conglomerates, e.g. General Electric).
ii. If you have a plastics division, a TV and entertainment division, an energy division, a consumer financing division and a technology
division, you should not use the same set of Comparable Companies and Precedent Transactions for the entire company. Instead,
you should use different sets for each division, value each one separately, and then add them together to get the Combined Value.
II. Liquidation valuation – valuing a company’s assets, assuming they are sold off and then subtracting liabilities to determine how much
capital, if any, equity investors receive.
i. This is most common in bankruptcy scenarios and is used to see whether equity shareholders will receive any capital after the
company’s debts have been paid off. It is often used to advise struggling businesses on whether it’s better to sell off assets
separately or to try and sell the entire company.
III. Replacement value – valuing a company based on the cost of replacing its assets.
i. Another common valuation method in bankruptcy scenarios.
IV. M&A Premiums analysis – analyzing M&A deals and determining the premium that each buyer paid, and using this to establish what your
company is worth.
V. Future share price analysis – projecting a company’s share price based on the P/E multiples of its public company comparables, and then
discounting back to present value.

30) How would you value an apple tree?

I. The same way you would value a company: by looking at what comparable apple trees are worth (relative valuation) and the value of the
apple tree’s cash flows (intrinsic valuation). You could probably keep it simple and say: “Determine the average revenue the sale of the
apples would produce every year, less the cost of maintaining the tree and distributing the apples to grocers, discounted over time to NPV.
You would want to determine the probability that the tree dies or is somehow rendered permanently unable to produce fruit in a given
year. You could use that as your discount rate.”

Jefferies LLC / January 2020 20

Valuation Questions & Answers (Cont’d)
29) How would you value an apple tree? (Cont’d)
I. If they ask for more detail, and you want to have a bit of fun, say you think a DCF is probably most appropriate and walk them through it.
Start with the forecast. Say you’d need to determine how many store-viable apples this breed of tree, in this climate, typically produces
during a growing season. You’d also need to know how much each apple, on average, can be sold for and whether the apples that are not
store-viable (bruised, partially eaten, worms, etc.) have any residual value. You assume conducting some market research and a robust
comparable tree analysis should be sufficient to determine this information, at which point you’d be able to project the tree’s revenue with
some degree of confidence. From there, you’d need to know costs associated with maintaining and harvesting a tree and distributing its
produce, but you assume that should be fairly straightforward info to find. Now that you have a rough idea of how much EBITDA the apple
tree will generate, you can make the assumptions you need to get to unlevered FCF and determine the NPV of the tree. You may also
suggest an LBO to examine potential capital structures and ascertain the optimal debt package the maximize returns. Do note your concern
that, though you’re no pomologist, you don’t think apple trees produce year-round and this leaves you wondering whether first lien paper
burdening the tree with cash interest and mandatory amortization in quarters when your tree cannot generate produce is wise. Upon
further reflection, you conclude that if you want to lever this tree you’ll need to resort to mezzanine paper, likely with onerous PIK interest
given the risks associated with single-tree investments. So, at this point, you’ve convinced yourself taking on debt isn’t prudent, maybe not
even possible, in this scenario and would need to make a 100% equity commitment. Once you know the probability that the might tree die
or is somehow be rendered permanently unable to produce fruit in a given year, you have your discount rate and can value the tree at its
NPV.

Jefferies LLC / January 2020 21

Transaction Questions & Answers

Jefferies LLC / January 2020 22

Transaction Questions & Answers
1) If I were looking at evaluating a paper towel company what might I do to put a value on the business?
I. First you could look at what the public paper towel manufacturers are trading at and their relevant financial metrics, next you could look at
precedent transactions in the industry for other paper towel transaction, third you could project out the values of their cash flows in a DCF.

2) What is EBITDA?
I. EBITDA stands for earnings before interest, taxes, depreciation and amortization.
II. It effectively represents how much cash the core business generates (business makes a gross profit on its sales, you have to deduct the cash
expenses associated w/ running the business such as rent, payroll, shipping, etc., and what you’re left with is EBITDA).

3) When [insert asset] goes up is that a source or use of cash? When [insert liability] goes down is that a source or use of cash?
I. Assets are inversely related: Assets go up, cash goes down.
II. Liabilities are directly related: Liability goes up, cash goes up.

4) What is the mid-year convention, what is it used for and why?

I. To account for the fact that annual FCF is usually received throughout the year rather than at year-end, it is typically discounted in
accordance with a mid-year convention.
II. Mid-year convention assumes that a company's FCF is received evenly throughout the year, thereby approximating a steady (and more
realistic) FCF generation.
III. The use of a mid-year convention results in a slightly higher valuation than year-end discounting due to the fact that FCF is received sooner.
IV. Discount factor using mid-year convention: 1/(1+WACC)^(n-0.5) where n = year in projection period.
i. 0.5 is subtracted from n in accordance with a mid-year convention.

5) What is more expensive, Debt or Equity?

I. Debt is less expensive for two main reasons. First, interest on debt is tax deductible (i.e. the tax shield). Second, debt is senior to equity in a
firm’s capital structure. That is, in a liquidation or bankruptcy, the debt holders get paid first before the equity holders receive anything.
Therefore, equity is riskier and commands a higher return.

Jefferies LLC / January 2020 23

Transaction Questions & Answers (Cont’d)
6) What are the different types of debt and what are their characteristics?
I. Broadly speaking, there are 2 “types” of debt: “bank debt” and “high-yield debt.” There are many differences, but here are a few of the
most important ones:
i. High-yield debt tends to have higher interest rates than bank debt (hence the name “high-yield”).
ii. High-yield debt interest rates are usually fixed, whereas bank debt interest rates are “floating” – they change based on LIBOR or
the Fed interest rate.
iii. High-yield debt has incurrence covenants while bank debt has maintenance covenants. The main difference is that incurrence
covenants prevent you from doing something (such as selling an asset, buying a factory, etc.) while maintenance covenants require
you to maintain a minimum financial performance (for example, the Debt/EBITDA ratio must be below 5x at all times).
iv. Bank debt is usually amortized – the principal must be paid off over time – whereas with high-yield debt, the entire principal is due
at the end (bullet maturity).
II. Usually in a sizable Leveraged Buyout, the PE firm uses both types of debt.
III. Again, there are many different types of debt – this is a simplification, but it’s enough for entry-level interviews.

7) Why does preferred equity exist?

I. Most shareholders are attracted to preferred stocks because they offer more consistent dividends than common shares and higher
payments than bonds.
II. However, these dividend payments can be deferred by the company if it falls into a period of tight cash flow or other financial hardship.
i. This feature of preferred stock offers maximum flexibility to the company without the fear of missing a debt payment.
III. Some preferred shareholders also have the right to convert their preferred stock into common stock at a predetermined exchange price. In
the event of bankruptcy, preferred shareholders receive company assets before common shareholders.
IV. Companies that offer preferred shares instead of issuing bonds can accomplish a lower debt-to-equity ratio.
i. That allows them to take on significantly more future financing from new investors.

Jefferies LLC / January 2020 24

Transaction Questions & Answers (Cont’d)
8) What is PIK interest and how do you account for it?
I. Payment-in-kind notes give the issuer a chance to delay making dividend payments in cash and in return for the delay, the issuing company
typically agrees to offer a higher rate of return on the note.
II. Unlike “normal” debt, a PIK loan does not require the borrower to make cash interest payments – instead, the interest just accrues to the
loan principal, which keeps going up over time.
III. Typically, debt that accrues PIK is junior in the capital structure to other tranches of debt and therefore more risky than other forms of debt
and carries with it a higher interest rate than traditional bank debt or high yield debt.
IV. Adding it to the debt schedules is similar to adding high-yield debt with a bullet maturity – except instead of assuming cash interest
payments, you assume that the interest accrues to the principal instead.
V. You should then include this interest on the Income Statement, but you need to add back any PIK interest on the Cash Flow Statement
(cashflow from operations) because it’s a non-cash expense.
VI. All else being equal, a PIK note will cause a borrower to pay slightly more interest over the life of a loan due to its compounding nature.
However, the critical point is that it lessens the cash portion of debt payments for a borrower allowing that cash to be utilized for other
corporate needs such as growth investments, capital expenditures, or acquisitions.

9) What are positive and negative covenants?

I. Positive covenant:
i. A positive covenant is a type of promise or contract that requires a party adhere to certain terms.
ii. For example, a positive bond covenant could provide that an issuer maintain adequate levels of insurance or deliver audited
financial statements.
iii. Additional examples of affirmative covenants include obligating the issuer to return the principal of a loan at maturity or maintain
its underlying assets or specific collateral, such as real estate or equipment.
II. Negative covenant:
i. A negative covenant is a bond covenant preventing certain activities unless agreed to by the bondholders.
ii. Negative covenants are also referred to as restrictive covenants (think of it as a promise not to do something such as no
acquisitions over a certain size, not exceeding a certain leverage ratio, or limitations on which assets the company can sell).

10) Two identical companies are identical in earnings, growth prospects, leverage, returns on capital, and risk. Company A is trading at a 15x P/E
multiple, while Company B trades at 10x P/E. What would you prefer as an investment?
I. Company B. Investors would rather pay less per unit of ownership.

Jefferies LLC / January 2020 25

Transaction Questions & Answers (Cont’d)
11) What are synergies?
I. Synergies refer to cases where 2 + 2 = 5 (or 6, or 7…) in an acquisition. Effectively, the buyer gets more value than out of an acquisition than
what the acquired company’s standalone financials would generate.
II. There are 2 types: revenue synergies and cost (or expense) synergies.
i. Revenue Synergies: The combined company can cross-sell products to new customers or up-sell new products to existing
customers. It might also be able to expand into new geographies as a result of the deal.
ii. Cost Synergies: The combined company can consolidate buildings and administrative staff and can lay off redundant employees. It
might also be able to shut down redundant stores or locations or get cheaper raw materials / services given the now greater
economies of scale they can produce.

12) Are revenue or cost synergies more important?

I. Serious investors tend not to take revenue synergies seriously because they’re so hard to predict / guarantee. Cost synergies are
considered more valid because it’s more straightforward to see how buildings and locations might be consolidated and how many
redundant employees might be terminated (e.g., the accounting department of the acquired firm is typically eliminated wholesale since, to
make a gross oversimplification, combining two businesses does not double the amount of work an accounting department needs to do, it
just doubles the values of the numbers they add – having two teams becomes redundant). Cost synergies are the result of identifying clear
instances of redundancy post-close, attributing a dollar value to them, and assuming they are eliminated.

13) List some reasons that two companies would merge.

I. Synergies
II. Increase supply chain pricing power (economies of scale; buyers get a discount for buying things in bulk; per unit cost of a 1,000-unit
purchase is lower than that of a 500-unit purchase)
III. Chance to increase market share
IV. Diversification in the business
V. Eliminate competition (e.g. if Google were to acquire Bing from Microsoft)
VI. Take on a larger competitor (Sprint and T-Mobile)
VII. Multiple arbitrage / accretive M&A

14) Why might a strategic acquirer in the target’s industry pay more for a business than a private equity firm?
I. Because the strategic acquirer can underwrite revenue and cost synergies that the private equity firm cannot unless it combines the
company with a complementary portfolio company. Those synergies allow the strategic to justify paying a higher price for the target
company.

Jefferies LLC / January 2020 26

Transaction Questions & Answers (Cont’d)
15) How do you determine how much leverage a company can take on in a merger or acquisition?
I. Generally you would look at Comparable Companies/ Precedent Transactions to determine this. You would use the combined company’s
LTM (Last Twelve Months) EBITDA figure, find the median Debt/EBITDA ratio of the companies you’re looking at, and apply that to your
own EBITDA figure to get a rough idea of how much debt you could raise.
II. You would also look at “Debt Comps” for companies in the same industry and see what types of debt and how many tranches they have
used.

16) What are the levers to increase returns in an LBO?

I. EBITDA / Earnings growth
i. Organic and inorganic
II. Greater leverage / lower equity check
III. Multiple arbitrage (selling the business for a higher multiple than you paid for it)
IV. Dividend recaps
V. Accretive M&A
i. Typically, the larger a business’ EBITDA the higher it trades at.
ii. You can have a business generating $100m of EBITDA that trades at 10x, and a smaller business doing $20m of EBITDA but only
trades at 6x. The larger business could pay 8.0x, way above what the market would for this, and still realize $40m of value creation
for itself (that $20m EBITDA was only worth $120m (6.0x * $20m) when it was being generated by the smaller company, but when
added to the larger business, it becomes worth $200m (10.0x * $20m).
VI. Those are the primary levers, but you can also lower CapEx, tighten the cash conversion cycle, and refinance the debt at a lower interest
rate.

17) In an LBO, if you buy a company for a dollar and sell a company for a dollar can you make a return?
I. Yes, by paying down debt or taking out dividends.

18) What if you sold the company with the same debt/equity split? Could you still make a return?
I. Yes, you could take out a dividend during your hold.

Jefferies LLC / January 2020 27