Interview Questions

Behavioural Questions
BASICS
1. Tell me a bit about yourself

2. Why investment banking?

3. Why x firm? (Global)

4. Why y city?

5. What is your greatest strength? / Why should we hire you.

5.5 Tell me about another strength.

6. What is your greatest weakness?

7. What motivates you?

8. Where do you see yourself in 5 years?

9. What is your greatest accomplishment? / What are you most proud of?

10. Tell me about a time you accomplished a goal.

11. Tell me about a time when you failed.

12. Tell me about a time you made a mistake

13. Tell me about a time when you faced a stressful situation / made a pressing decision.

14. Tell me about a time when you had to work with unmotivated people.

15. Tell me about a time when you played a leadership role on a team.

16. Tell me about a time you received criticism.

17. Tell me about a time you went above and beyond the task at hand.

18. Tell me about a highly detail-oriented piece of work

19. Tell me about a time when you went out of your comfort zone to challenge yourself.

20. Tell me about a research intensive assignment

21. Tell me about a piece of work you are most proud of.

22. Tell me about a time you served to mediate a conflict.

23. Tell me about a time you took a big risk.

24. Tell me about a difficult decision.

25. Tell me about a role model.

26. Tell me about a situation that tested your ethics.

27. What do you think are the responsibilities of an investment banking analyst?

28. Investment banking involves working long hours. How will you be able to handle this?

Special
1. Why shouldn’t we hire you?

2. Tell me about an unconventional belief?

3. How would your friends / previous employer describe you?

4. What is a piece of criticism that your last employer gave you?

5. Why not consulting?

6. Why not software engineering?

SITUATIONALS
7. Tell me about a situation where you took a risk.

8. Tell me about a situation where you failed.

9. Tell me about a situation you went above and beyond.

Special

Technical Questions
https://quizlet.com/ca/414350138/technicals-flash-cards/
1. Walk me through a recent transaction
Caesars-Eldorado Merger
- $17 billion deal announced in June 2019
- Macquarie was financial advisor to Eldorado
- Elderado will be acquiring Caesars for $8 billion deal through a mix of cash and stock
 - Interesting for two reasons
o Carl Icahn’s involvement in initiating the deal
o Buyer is smaller than the seller
- Last year, Caesars struggled along with rest of gaming industry → Stock was down
- Icahn started to grow his holdings in Caesars and lobbying for a sale
o Grew his position to over 20% by April
- In June, Elderado agreed to buy Caesars for around $8 billion dollars, financed by cash and stock
- 30% premium
- Made sense for Elderado
o Acquiring a lot of regional casinos over last few years → Caesars gave them foothold in Las
Vegas market → Better compete with larger players
o Both companies had a lot of debt → Sold some of Caesars’ properties to VICI Properties,
generating $3.2 billion in cash to pay off debt
o Estimated $500 million in synergies
▪ Cost savings from Elderado
▪ Caesars rewards program allowed regional casinos to become very attractive
o Took on name of Caesars Entertainment after the transaction
▪ Creates the largest casino operator in North America
▪ A new regional casino operator to compete with Penn Gaming and Boyd Gaming
with strength of the Caesars name
- Elderado recently sold off two of its casinos → Isle of Capri and Lady Luck
o Open up balance sheet to finance transaction
o Avoid anti-trust problems
- Deal completed in June 2020
o A few follow-on transactions remain relating to anti-trust concerns
o Caesars is required to sell off at least 1 of its properties in Indiana because it holds over 50%
market share

WestJet-Onex
- $5 billion take-private transaction completed in December 2019
- Purchase price: $31 / share → 67% premium
- All cash purchase
- BAML was financial advisor to WestJet
- Onex’s history in the Aerospace industry
o Onex attempted a hostile takeover of Air Canada back in 1999 which was abandoned after an
unfavorable court ruling
o Onex tried to acquire Qantas Airways in 2007
- Background
o Since it was founded as a clone to SouthWest Airlines, focused on simplicity, low costs and a
cheery corporate culture that we learned about a lot in cases at Ivey
o However, as WestJet expanded it lost its corporate culture and started to expand into operations
that did not fit its low cost model
o Still cheaper than Air Canada, but the emergence of budget airlines means it was losing its
competitive advantage
o High fuel prices and unionization of staff led to WestJet suffering a loss in Q2 2018 after 13
years of consistent profit generation
o WestJet stock has lagged in recent years
- Onex’s Contribution
o Expanded into ultra low cost airline through Swoop and ordered new 787s to expand offerings
to Europe
 o Onex could be looking at the airline as a platform to develop low-cost long haul
- Dynamics of the Grounding of Boeing 737 max reduced price from $35.75 / share to $31
o 13 in fleet, 21 orders
- Air Canada acquired Transat AT for $529.4 million in response. Upped offer by $200 million ($18 / share
instead of $13 / share) to win over shareholders
- It will be interesting to see how WestJet plans to position itself following the pandemic

Aphria – Broken Coast Cannabis

- Aphria will buy Broken Coast Cannabis for $230 million in cash and stock
- Canaccord was sell side advisor to Broken Coast
- Broken Coast Cannabis is a premium cannabis producer on Vancouver Island that operates an indoor
cannabis production facility
- Uses a highly automated and standardized growing system to create affordable high quality cannibis
- Expansion project (60,000 sq.ft.) will increase annual capacity to 10,500 kg
- Aphria’s forecast annual production will be 230,000 kg at $2 / gram
- Transaction will add geographic diversification, cross Canada distribution and over 40,000 medical
patients
- Broken Coast can leverage Aphria’s scale and supply chain management experience; Aphria will benefit
from Broken Coast’s premium cannabis cultivation expertise
- Broken Coast had been EBITDA positive since 2015, which fits with Aphria’s low coast high margin
strategy
- Founders of Broken Coast will stay with the company

2. Pitch me a long position.

3. Pitch me a short position.

4. Tell me about a trend in the market.

5. Tell me about an industry you are following.

Renewable Energy Generation
- In 2019, renewable energy production beat out coal, representing 11.4% of total energy consumption
- Drivers:
o Economies of scale production
o Technological innovation
o Government policy
- The introduction of tax credits (PTC and ITC) has significantly reduced the cost of investing in wind and
solar projects
- Investment rushed into solar and wind. Improvements in performance efficiency and reduced production
cost, combined with increased competitive forces, have made solar and wind projects competitive with
conventional energy technologies on a levelized cost of energy basis
- States are not investing in conventional plants because they will become unproductive assets in the future
- Cost reduction has now slowed, and without storage solutions, wind and solar are not a substitute to
conventional energy sources for on-demand production
- While we have seen lithium ion technology improve and costs decline, they are still limited in their
storage capacity
- Trump administration has been hard on renewables
- Declined to extend the ITC for solar and offer tax credits to storage solutions
- It will be interesting to see where the clean technology sector goes in the future

4. What goes into a pitch deck?

5. What goes into a CIM?

6. Explain a finance topic in simple terms.

1. Beta is like the emotional stability of a person. High Beta = Emotional
2. M&A transaction structures is like purchasing a house. Share purchase = buy the rights to the keys;
Asset purchase = Buy every brick of the house

ACCOUNTING
3. Deferred revenue decreases by $100, how are the 3 statements affected? Assume 40% tax rate.
Assume 100% GM.
IS: CF: BS:
Rev +100 NI +60 Cash -40
GP +100 Unearned Revenue -100 Unearned Revenue -100
EBT +100 NCF -40 R/E +60
Tax -40
NI +60

3.5 What if it increases by $100?

IS: CF: BS:
No effect Unearned Revenue +100 Cash +100
NCF +100 Unearned Revenue +100

4. You buy $100 in capital assets for $50 of debt and $50 of cash. What happens to the 3 statements?
No change on IS. On CFS, CFFF is up by $50 and CFFI is down by $100, cash overall is down by $50. On
the BS, Cash is down by $50, PP&E is up by $100, and Debt is up by $50 (net $50 increase each side).

5. (Continued from last question) The capital asset has a $40 residual value and a useful life of 4
years. The interest rate is 10% (5% cash, 5% PIK). Tax rate is 40%. What happens to the 3 statements
after 1 year?
IS: CF: BS:
Depreciation: -15 ($100-$40/4) Net Income: -12 Cash +5.5
Interest: -5 ($50 * 0.10) + PIK Interest: +2.5 PP&E -15 (Assets Net: -9.5)
Pre-Tax Income: -20 + Depreciation: +15 Debt +2.5
Net Income: -12 (-20 * 0.6) CFFO (& Cash in General): +5.5 Retained Earnings -12

6. If $250mm of inventory is purchased using debt (5% bank debt, 5% PIK, 20% amortized), with a
40% tax rate, then sold at $500mm next year, walk me through the statements for next year.
IS: CF: BS:
Revenue up 500 NI up 135 Cash up 347.5
COGS up 250 Add PIK interest 12.5 Inventory down 250
PIK interest up 12.5 Add inventory change 250 Debt down 37.5
Bank interest up 12.5 Debt amortization down 50 Retained Earnings up 135
 Operating Income up 225 Net Cash Flow 347.5
Tax up 90
Net income up 135

7. What are the effects on the 3 statements of a $1000 debt write-down, assuming a 40% tax rate?
IS: CF: BS:
Debt Write-Down +1000 NI +600 Cash -400
Tax -400 Debt Write-Down -1000 Debt -1000
NI +600 NCF -400 R/E +600

15. You retire a $100 face value bond at 90%. How does this affect the 3 financial statements,
assuming a 20% tax rate?
IS: CF: BS:
Gain on Retirement of Bond +10 NI +8 Cash -92
Tax -2 Gain -10 Debt -100
NI +8 CFFF -90 R/E +8
NCF -92

9. If a company purchases a chair as a capital asset for $100, what happens to the 3 statements?
Nothing occurs on the IS. On the CF, there is a $100 use of cash in investing activities as CapEx. On the BS,
cash is down by $100 and PP&E rises by $100.

9.5. If a company decides to depreciate it by $15 in its government filings but $10 on its own books,
what happens to the 3 statements? (Assume 20% tax rate)
IS: CF: BS:
Depreciation -10 NI -8 Cash +3
Tax -2 Depreciation +10 PP&E -10
NI -8 DTL +1 DTL +1
NCF +3 R/E -8

M&A
1. Assuming you purchase a company with $1000 in fixed assets and $800 in liabilities for $1000 in
cash (stock acquisition method). Assuming no asset write-ups, walk through the changes on your
balance sheet.
Cash decreases by $1000, fixed assets increases by $1000, goodwill increases by $800. Liabilities increase by
$800. (Good to know: Company should only be worth $200, hence $800 of goodwill created).

Special
1. You sell a subscription that is $12 per year, delivered monthly. Walk me through the 3 statements
right after you sell the subscription (the $12 is delivered at the beginning of the year all at once).
IS: No change
CFS: Deferred Revenue +12 → CFO +12 → Cash +12
BS: Cash +12 → Asset +12; Deferred Revenue +12 → L&E + 12

1.5. Walk me through the 3 statements after one month.

IS: Revenue +1, (assuming no VC and 40% tax rate) NI + 0.6
CFS: NI + 0.6, Deferred Revenue -1 → CFO -0.4 → Cash -0.4
BS: Cash -0.4 → Assets -0.4; Deferred Revenue -1, Retained Earnings +0.6 → L&E -0.4

2. Assume you purchase $500 in inventory with 10% PIK debt, and you sell half of it for $500 within
the same year. Assuming a 40% tax rate, what is the effect on the 3 statements?
Revenue increases by $500, COGS increases by $250, EBIT increases by $250, interest expense increases by
$50, and pre-tax income increases by $200, so Net Income increases by $120. On the CF statement, Net
Income increases by $120, add back $50 in PIK debt, subtract the $250 increase in Inventory, (CFO down by
$80). Cash from financing increases by $500, net change in cash is +$420. On the BS, Cash increased by
$420, inventory is up by $250, debt is up by $550, retained earnings is up by $120.

3. You acquire a company with $1000 in fixed assets and $800 in liabilities for $100 in cash. Walk
through the changes to your 3 statements immediately after this transaction takes place, assuming a
40% tax rate.
Acquisitions price > book value, creating “negative goodwill” which is accounted for using a $100 gain in
extraordinary income on the IS (after EBITDA), so pre-tax income increases by $100 and net income by $60.
On the CF statement, net income increases by $60, subtract $100 in non-cash income, and cash decreases by
$40. CFFF goes down by $100 due to the acquisition. Net cash change is $140. On the BS, cash is down by
$140, assets are up by $1000, liabilities are up by $800, and retained earnings are up by $60.

4. What kind of items would you see on all 3 financial statements?

Net income, depreciation / amortization, taxes, inventory.

5. You have 2 balance sheets from the start and end of the year. How do you calculate EBITDA?
You would take the difference in Retained Earnings to calculate Net Income, and adjust if necessary for
Dividends using Dividends Payable. Then, add back the ending value of Income Tax Payable to get EBT, and
calculate the interest paid using given interest rates and terms in the footnotes or in the line items to get
EBIT. Finally, look at the difference in Accumulated Depreciation / Amortization for each of the capital
assets and intangibles and add the difference back to get EBITDA.

6. You have an asset with a gross value of $1000 and a net book value of $400. You sell the asset for
$600 cash. What happens to the 3 financial statements, assuming a 40% tax rate?
IS: CF: BS:
Gain on Sale +200 NI +120 Cash +520
EBT +200 Gain on Sale -200 PP&E -400
Tax –80 CFFO -80 R/E +120
NI +120 CFFI +600
NCF +520

7. If you have $100mm of revenue and it takes 30 days for your customers to pay for your
merchandise, what is your average A/R account value?
DSO = [AR / Credit Sales] * 365
Assume all sales are credit and rearrange for AR: AR = Sales * DSO / 365 = $100mm * 30/365 = $8.2mm
~= $10mm

EQUITY VALUE VS. ENTERPRISE VALUE

1. You have an EPS of $2, 100 shares outstanding, a P/E of 4x, $200 in debt, $75 in NCI, $50 in cash
and $100 in inventory. What is the EV?
EPS * Shares Outstanding = NI --> $2 * 100 = $200.
P/E * NI = Equity Value --> 4 * $200 = $800
EV = Equity Value + Debt + NCI – Cash = $800 + $200 + $75 - $50 = $1025

2. A company trades at 7x EV/EBITDA with $100mm in EBITDA, $100mm in cash, $300mm in

debt, and 100mm shares outstanding. What is the implied share price?
The Enterprise Value is 7 * $100mm = $700mm.
Equity Value = EV + Cash – Debt = $700mm + $100mm - $300mm = $500mm
Implied Share Price = $500mm / 100mm = $5.

2.5. Now you raise $100mm of debt – how does this change your equity value?
This has no impact on your equity value.

3. You have a P/E of 20x, EV/EBITDA of 10x, interest expense of $20mm, 5% interest rate,
depreciation of $20mm, and a market cap of $200mm. What is the effective tax rate?
Market Cap / (P/E) = NI --> $200mm / 20 = $10mm.
Total Debt = $20mm / 0.05 = $400mm.
Enterprise Value = $200mm + $400mm = $600mm (assuming no NCI, preferred or cash).
EBITDA = EV / (EV/EBITDA) = $600mm / 10 = $60mm.
EBITDA – D&A – Int = Pre-Tax Income = $60mm - $20mm - $20mm = $20mm.
$10mm / $20mm = 50%. The effective tax rate is 50%.

Treasury Stock Method (TSM)

1. A company has 200 shares outstanding at $10 each, and 20 options at $5 each. What is the fully
diluted equity value and share count?
The company’s existing equity value is 200 * $10 = $2000. The options are in the money, so 20 shares are
exercised, and the company gets $100 for the creation of these shares. With this $100, it buys back 10 shares.
Therefore, there are 210 shares outstanding, with a diluted equity value of $2100.

6. A company’s share price is $50 and it has 200 shares outstanding. There are 50 options
outstanding with a strike price of $20, 30 RSUs, and $6000 in convertibles with a $1000 par value and
conversion price of $40. What is the fully diluted equity value?
1) The options are in the money ($20 < $50), so they will be exercised. 50 options are exercised at the price of
$20, generating $1000 for the company, which repurchases $1000 / $50 = 20 shares. Net 30 new shares are
created.
2) 30 new shares are created from the RSUs.
3) $1000 par value / $40 conversion price = 25 new shares per convertible. $6000 / $1000 * 25 = 150 new
shares created.
4) 200 + 30 + 30 + 150 = 410 total shares outstanding. 410 * $50 = $20500 is the diluted equity value.

2. A company has debt/equity of 1.25x. Common equity of $4 million, with 160,000 shares and a
current share price of $25 per share. The company has $1 million in convertible bonds, with par
values of $1000 – they can convert into 50 common shares at a time. Are they in the money? How
does your debt/equity multiple change once it is exercised?
Yes, these convertibles are in the money as the implied exercise price per share is $1000/50 = $20. If they are
exercised, then there are now 50,000 more shares outstanding, and the common equity has risen by 50,000 *
$25 = $1,250,000 while the debt has fallen by $1,000,000. The debt balance is now down to $4 million, while
the equity value is $5.25 million. The new multiple is 4/5.25 = ~0.76x.
Special
1. Assume a company issues a surprise dividend with excess cash that it has on its balance sheet.
What should be the change to the company’s intrinsic P/E ratio as a result?
P/E decreases. Equity value represents the value of all asset to equity investors, so a decrease in cash should
result in a decrease in equity value. Alternatively, earnings yield increases with an increase in dividend, so P/E,
the inverse, decreases.

2. If a company were to find $100 on the ground, what would be the impact on Equity Value and
Enterprise Value?
Cash would increase by 100, as would Equity Value (same transaction as for an equity infusion). Enterprise
Value would not change the company’s expected free cash flow generation (operational value) does not
change. This is seen through the EV equation (Equity Value increase and cash increase offset each other)

3. How does a dividend issuance impact your P/E, EV/EBITDA, and P/BV ratios?
Equity value decreases, Enterprise value does not change, Book Value decreases by the pre-existing P/BV.
Therefore, P/E falls, EV/EBITDA stays the same, and P/BV would stay the same if it was 1, increases if it
was greater than 1, and decreases if less than 1.

4. $100 in debt is issued, how does it impact your P/E and EV/EBITDA ratios?
The impact on P/E is dependent on what the debt will be used for.
ASSUMING DEBT RAISED IS JUST CASH:
P/E does not change (Equity Value does not change because net assets does not change)
EV/EBITDA does not change (Core business is not affected. New cash cancels out the increase in debt)
ASSUMING DEBT IS SPENT ON A VALUE-GENERATING CAPITAL PROJECT:
P/E does not change (Equity Value does not change because net assets does not change)
EV/EBITDA increases (Expected cash flow generation increases. Net debt is increases)

5. You have a target with an EV of $100 million and a debt / total capitalization of 60%. A 50%
premium on the share price is given. What is the equity value of the firm?
The market value of the Equity Value is 40% of $100 million, or $40 million. If there is a 50% premium on
the share price, the Equity Value is $60 million.

6. A company experiences $100 million in fines it will have to pay. Before it pays it off, what is the
impact to the equity and enterprise values of the company? What about after?
The fine creates a $100 million liability attributable to equity holders (net assets decrease by $100 million).
Before paying it off, Equity Value decreases by $100 M. Operational value remains the same, so EV does not
change. After paying the fines, the equity value remains lower (cash decreases) and EV has also not changed
(decrease in liability and decrease in cash offset each other).

7. A company raises $100 debt to buyback $100 in shares, how does that affect its EV?
Enterprise Value stays the same. No change in core business. Increase in net debt is offset by decrease in
equity value from the share repurchase.

8. What would be the impact of a share buyback on P/E? Why does the yield change?
The P/E ratio would fall because the repurchase of shares lowers the Equity Value of the company while
earnings remain the same. The yield increases because earnings are spread across fewer shares, so each share
has a proportionally larger share of earnings.
9. A company has 100 shares outstanding. it just issued $100 in convertible bonds that have 15% PIK
interest rate. After 5 years, the bonds are converted at strike price of $1. What’s the % dilution?
15% PIK interest over 5 years means the debt is compounded by 15% annually. Using the rule of 72: 72/15
= 4.8 ~ 5, so the debt balance doubles after 5 years to $200. This means 200 shares get converted after 5
years – a 200% dilution on the original equity.

FINANCIAL METRICS, MUTLIPLES, VALUATION, INVESTING CONCEPTS

1. If a company has Debt/EBITDA of 5x and interest coverage of 5x, and a tax rate of 50%, what is
the after-tax interest rate on the debt?
Debt/EBITDA of 5x implies that there is 5x as much debt as EBITDA. Interest coverage of 5x implies that
there is 5x as much EBITDA as interest expense. Interest expense is 1/5 * 1/5 = 1/25 of the debt. 1/25 =
4%. Accounting for the tax shield, (1-0.5)(4%) = 2%. The after-tax interest rate is 2%.

2. What kind of industries / companies would have EBITDA close to Net Income?
Companies with low leverage and minor D&A expense, which implies low capital expenditures and an asset-
light business model (Ex. software companies).

3. What are the pros and cons of EBITDA as the proxy to value EV?
Pros: Easily comparable across various capital structures (capital structure neutral), neutralizes impact of
varying tax schemes, neutralizes impact of different accounting standards (impacting depreciation)
Cons: Does not account for D&A and therefore inappropriate for asset-heavy business models like
manufacturing, not applicable for early-stage companies (without earnings), not applicable for balance-sheet
centric business models

4. A company is trading at 10x EV/LTM EBITDA. Do you expect the EV/NTM EBITDA multiple
to rise or fall?

In general, the multiple will fall because EV is constant and most companies anticipate growth in EBITDA.
However, this would depend on the state of the company and its industry.

5. A company’s EV/EBITDA goes from 10x to 20x and EV/Sales goes from 2x to 4x. What is
happening to the company and its EBITDA margins?
Relative to the company’s Enterprise Value, the company’s sales and EBITDA have halved. Therefore, the
company’s EBITDA margins have not changed, remaining at 20%.

6. In Y0, EV/Revenue = 8x and EV/EBITDA = 12x. In Y1, EV/Revenue = 6x and EV/EBITDA =

12x. Is this company growing, and why or why not?
Assuming EV remains identical, while EBITDA (and therefore profitability) is not growing year-to-year, the
top-line of the company is still growing by 33.3%, and therefore the company is still growing.

6.5. What is the EBITDA margin for both years?

The EBITDA margin for Y0 is 66.7%, and the EBITDA margin for Y1 is 50%.

7. A company has EBITDA of $40 and a market cap of $150. The P/E multiple is 10x, and the
company has $5 in D&A and $5 in interest expense. What is the company’s tax rate?
Net Income of the company is $15 ($150 / 10). With EBITDA of $40, the EBT must be $30 ($40 - $5 - $5).
Tax is $15, so the company’s tax rate is 50% ($15 / $30).
8. Name 3 valuation methods. Name 3 more. Name 3 more.
1. DCF Model / DDM / NAV Model
2. Comparable Companies Analysis
3. Precedent Transactions Analysis
4. LBO Analysis
5. Future Share Price Analysis (projecting a company’s share price based on P/E multiples of public
comps, then discounting back to present value)
6. M&A Premiums Analysis (analyzing M&A deals and figuring out the premium paid by each buyer)
7. Sum-of-the-Parts Valuation
8. Liquidation Valuation
9. Replacement Value (valuing a company based on the cost of replacing its assets)

9. If two companies have an EV / LTM EBITDA of 10x, one has an NTM ratio of 15x and the other
an NTM ratio of 5x, which company would you invest in?
Invest in the company with an NTM ratio of 5x because it means the EBITDA is rising into the next 12
months. As a result, investing in the company with an NTM ratio of 5x is investing in a growing company,
which is more desirable than the investment with the 15x ratios.

Operating Leverage

1. If a company’s revenue is expected to increase by $100, would you rather buy a company with
higher operating leverage or lower?
Higher operating leverage, as this implies a greater proportion of costs will be fixed, and therefore the
increase in COGS accompanying the revenue increase will be lower.

2. When would you rather invest in a company with lower Operating Leverage?
If you are investing in a company with demand uncertainty or considerable cyclicality, it is important that the
company has lower Operating Leverage so it can weather periods of lower revenue and reduce costs.

3. An airline company has $3000 in revenue, $300 in variable costs, and $1000 in fixed costs. A
trucking company has $3000 in revenue, $900 in variable costs and $400 in fixed costs. Which is
riskier?
The airline company is riskier because it has higher operating leverage – a higher proportion of fixed costs. As
a result, in economic downturns when revenue falls, the company continues to pay significant fixed costs and
operating leverage compresses more significantly.

3.5. What is the relationship between revenue and operating profit for each company?
For the airline company, operating profit fluctuates more significantly with the top-line as the reduced
variable costs create greater profit in times of high revenue while the high fixed costs reduce operating profit
in downturns. The trucking company’s operating profit varies less significantly as the more significant variable
costs change in-line with the top-line.

Special
1. If one company uses cashiers and another uses vending machines, which has the lower
EV/EBITDA multiple?
The vending machine company will have greater depreciation (not factored into EBITDA) but lower wages,
therefore increasing its EBITDA. Therefore, assuming EV stays the same, the multiple is lower.
2. If the EV/Sales multiple is 2x and the EV/EBITDA multiple is 8x, what is the EBITDA margin?
25%.

2.5. If the EV/EBIT multiple for the same company is 16x, what industry could this be a part of?
D&A is large, so the company is part of a capital-intensive industry CapEx, such as manufacturing.

3. If two companies are trading at 8X EBITDA, one 100% Equity, one 50% Debt and 50% Equity,
which has a higher P/E?
The company financed by 100% equity will have a higher P/E because the Equity Value is double that of the
company funded partially by debt, and the impact of interest will not likely impact the valuation as heavily.

4. One precedent transaction had a selling multiple of 10x while another was 5x – why could this be
the case?
Some possible reasons:
- One company may be acquired by a financial sponsor rather than a strategic sponsor
- One process may have been a more competitive bidding process
- One transaction may have been acquired during a market upswing
- The transactions may vary by geography
- The size profile of the companies may differ
- The companies had different growth profiles
- One company may have a competitive advantage
- One company may be going through litigation

5. Would you invest in a company with 30% growth and 5% ROIC or 10% growth and 15% ROIC?
It depends on the companies’ cost of capital (WACC). If WACC > 15%, invest in neither. If 5% < WACC <
15%, then invest in the company with the 15% ROIC. If WACC < 5%, then if you are a short-term investor
– invest in high growth; if you’re a long-term investor, invest in the company with higher consistent returns.

6. There are 2 companies with the same profiles and 0% gross margin, one with 15% and one with
20% growth – what metric would you use to differentiate between them?
Use a revenue growth multiple like [EV/Revenue] / Revenue Growth.

7. Company A has an EV/EBITDA of 8x and EV/EBIT of 10x. Company B has an EV/EBITDA of

10x and an EV/EBIT of 8x. Which of these scenarios is impossible?
The Company B scenario is impossible. EBITDA is always greater than EBIT (because D&A cannot be
negative), so EV/EBITDA must be smaller than EV/EBIT.

8. What type of companies could have a negative Enterprise Value?

1. Financial institutions with large cash balances
2. Companies in distressed situations
3. Tech companies with large accumulated losses

9. What type of companies would have a low ROA but high ROE?
The numerator (return) is identical for ROA and ROE, but assets must be large while equity must be small.
Therefore, the company is highly levered. An example of a company profile that fits this is a financial
institution, which has a large cash balance, or an asset-heavy business model company like manufacturing.
10. There are two companies – one has a higher P/E but lower EV / EBITDA than the other. How
could this be?
Once company is more capital intensive, has a different capital structure, or different tax rate.

11. A company has a Net Debt / EBITDA of 10x and sells off a positive-EBITDA generating
business for 5x EV / EBITDA. What happens to the Net Debt / EBITDA ratio?
The whole company prior to the divestiture has an EV / EBITDA of >10x (Since equity value must be
positive). While the divesture generates cash that will reduce net debt, the sale’s lower valuation means more
EBITDA was given up relative to the sale value than the average of the entire firm. As a result, EBITDA
declines by more than net debt, and the ratio increases.

12. Imagine I flip a coin. If it lands on heads, I pay you $2. If it lands on tails, I continue flipping
until it lands on heads. I pay you $2n, with n the number of flips. How much would you pay for this
“instrument”?
Looking at this mathematically, any financial instrument is priced given the probability of each return. In the
event of this: $2(1/2) + $22(1/4) + $23(1/8) + … = 1 + 1 + 1 + … = infinity
However, this does not make sense as infinite returns are impossible in the real world. Essentially, you would
cap the potential return at a certain number x, and then pay n in the event where x = 2n

13. You have an instrument that pays $100 in year 1, $200 in year 2, $300 in year 3, and so on. How
much would you pay for this instrument, assuming a discount rate of 5%? (Perpetuity of a
perpetuity)
The initial perpetuity ($100 per year, starting in year 1) is worth $100/0.05 = $2000. Each year, the perpetuity
that begins in that year is worth $2000 at that time. These annuities form one perpetuity due of $2000 in PV
per year, which when discounted using 5%, becomes $2000*(1+0.05)/0.05 = $42,000.

DISCOUNTED CASH FLOW (DCF)

1. Walk me through a DCF.
Discounted cash flow is intrinsic valuation methodology that values a company based on the present value of
its projected future free cash flows. After projected free cash flows for a given period, usually 5 years, and
calculating a terminal value, a discount rate, is applied to each of the cash flows to provide an implied
valuation of the company.

Free Cash Flow

1. What is Free Cash Flow?
Recurring cash flows that are accessible to a company after operating (and financial obligations) are satisfied.

2. Walk me through how you get from Revenue to Unlevered Free Cash Flow.
Revenue – COGS – Operating Expenses = EBIT
EBIT * (1-t) + D&A – NWC – CapEx = UFCF

2.5. How do you calculate Levered Free Cash Flow?

LFCF = Net Income + D&A – NWC – CapEx – Mandatory Debt Repayments

3. How far into the future are free cash flows usually projected?
Usually around 5 years
3.5. Why might we project more than 5 years?
1. Cyclicality
2. Company will achieve profitability by a certain year

4. Is it always correct to leave out most of the Cash Flow from Investing section and all of the Cash
Flow from Financing section?
Most of the time, yes. Only add back items that are recurring.

5. What does “Changes in Operating Assets and Liabilities” mean?

Working capital items are constantly changing, representing sources and uses of cash.

6. What happens in the DCF if Free Cash Flow is negative?

The analysis is still valid as long as cash flows turn positive at some point. Longer periods of negative FCF
result in lower valuations. Terminal Value will be higher % of valuation and a higher WACC may result in a
higher valuation.

8. What changes in a DCF if Levered Free Cash Flow is used instead of Unlevered Free Cash Flow?
Output value will be equity value instead of enterprise value.

9. If you use Levered Free Cash Flow, what should you use as the Discount Rate?
Use Cost of Equity to discount LFCF.

10. How do you factor in one-time events such as raising Debt, completing acquisitions, etc.?
Ignore one-time expenses because FCF only considers recurring and predictable items.

11. How does Net Income Attributable to Noncontrolling Interests or Equity interests factor into the
FCF calculation?
No adjustments need to be made, they are already factored in.

12. Should you use the statutory or effective tax rate when calculating FCF?
Use the effective tax rate to capture what the company is actually paying out in taxes.

13. As an investor, would you rather have a $10 increase in revenue, a $10 increase in gross profit, or a
$10 decrease in CapEx?
Decrease in CapEx (doesn’t affect tax) > Increase in gross profit > Increase in revenue (increases COGS).

14. Which of the following has a greater impact in a DCF valuation? A $1 increase in revenue, a $1
increase in cash OpEx, or a $1 increase in changes in NWC? Rank them.
NWC > OpEx > Revenue. NWC is the highest as it has no bearing on tax. OpEx will have a greater impact
than revenue because an increase in revenue increases COGS as well.

15. Does increased depreciation increase or decrease your valuation?

Increased depreciation increases your valuation as it reduces EBT, thereby reducing the cash tax expense
paid. This increases annual FCF, ultimately leading to a higher valuation.

16. Go from UFCF to LFCF.

LFCF = UFCF – tax adjusted interest expense - mandatory debt repayments (- other tax adjusted non-
operational items)
WACC
1. How do you calculate WACC?
𝑊𝐴𝐶𝐶 = 𝐾𝐷 × (1 − 𝑡) × (% 𝐷𝑒𝑏𝑡) + 𝐾𝐸 × (% 𝐸𝑞𝑢𝑖𝑡𝑦 ) + 𝐾𝑃 × (% 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 )

2. How do you calculate Cost of Equity?

Cost of Equity is calculated using the Capital Asset Pricing Model (CAPM). 𝐾𝐸 = 𝑟𝑓 + 𝛽(𝑀𝑅𝑃)

2.5. How can we calculate Cost of Equity WITHOUT using CAPM?

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝐾𝐸 = + 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐺𝑟𝑜𝑤𝑡ℎ %
𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒

3. What does Cost of Equity represent?

The returns expected by equity investors. Equity is a cost to companies because of:
1. Dividends
2. Stock price appreciation represents losing upside

4. A company has a ROA of 10%. It is financed with 50% debt and 50% equity. The cost of debt is
5%. What is the cost of equity?
ROA = WeKe + WdKd --> 0.10 = 0.5(Ke) + 0.5(0.05) --> ROA = 15%

5. What is a firm’s optimal capital structure?

The optimal capital structure is a combination of Debt, Equity and Preferred Shares that minimizes WACC

6. Does WACC increase or decrease during an economic crisis?

Overall, WACC would likely increase. There is greater risk of unstable returns during an economic crisis,
which increases credit risk. Therefore, Cost of debt would increase. Cost of Equity would increase because
systematic risk and the MRP increases.

7. What’s the relationship between Debt and Cost of Equity?

As debt increases, Cost of Equity increases as well because of the additional financial risk.

8. Two companies are exactly the same, but one has Debt and one does not – which one will have
the higher WACC?
The company without debt will generally have the higher WACC because debt is cheaper than equity.

9. Should Cost of Equity be higher for a $5 billion or $500 million Market Cap company? Why?
Generally, the smaller company should have a higher CoE because smaller companies are riskier and
expected to outperform larger companies

9.5 What about WACC – will it be higher for a $5 billion or $500 million company?
Depends on the capital structure of the two companies. If equal, the smaller company will generally have a
higher WACC. If not, we do not know.

10. What are the 3 ways you would personalize WACC for a specific company?
- Modifying beta to optimal capital structure (using industry peers)
- Changing the market risk premium to something more industry-specific
 - Adding size premium to the company

Beta
1. How do you un-lever Beta?
𝛽𝐿
𝛽𝑈 = 𝐷 where D/E is the company’s current capital structure
(1+(1−𝑡)× )
𝐸

2. How do you re-lever Beta?

𝐷
𝛽𝐿 = 𝛽𝑈 × (1 + (1 − 𝑡) × 𝐸 ) where D/E is the company’s target capital structure. Target capital structure
is usually determined by assessing the capital structure of comparable companies.

3. Why do you have to un-lever and re-lever Beta?

Un-levering Beta isolates the business risk, re-levering Beta reflects the financial risk associated with the
company’s target capital structure.

4. Can Beta ever be negative? What would that mean?

Yes, the security moves in the opposite direction from the market.

4.5 What kind of company or asset would have a negative beta?

Gold! Gold has intrinsic value, so investors pursue gold when the equity markets are down. When equity
markets rise and the intrinsic value of companies looks stronger, gold moves down. Other potential
candidates include bankruptcy firms and discount consumer staples businesses. A negative Ke is created,
meaning investments in these assets or companies can be used as insurance.

5. Would you expect a manufacturing company or a technology company to have a higher Beta?
A technology company would have a higher Beta because of great business risk associated with the
technology industry.

Terminal Value
1. How do you calculate the Terminal Value?
Two methods: Perpetuity Growth Method and Exit Multiple Method.
𝐹𝑖𝑛𝑎𝑙 𝑌𝑒𝑎𝑟 𝐹𝐶𝐹×(1+𝑔)
Perpetuity Growth Method: 𝑇𝑉 = 𝑊𝐴𝐶𝐶−𝑔
Exit Multiple Method: TV = 𝐹𝑖𝑛𝑎𝑙 𝑌𝑒𝑎𝑟 𝑀𝑒𝑡𝑟𝑖𝑐 × 𝐸𝑥𝑖𝑡 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑒

2. Why would you use the Gordon Growth Method rather than the Multiples Method?
1. No good comparable companies
2. Cyclical business (industry multiples will change in several years)
3. Size profile is too large to be bought on a multiple (ex. Apple)

3. What’s an appropriate growth rate to use assume?

The growth rate must be equal to or below the long-term economic growth rate.

4. How do you know if a DCF is too dependent on future assumptions?

Generally, if 50% of a company’s implied value comes from the TV, it is too dependent.

5. How can you check if your assumptions for TV make sense?

Calculate TV using one method and solve for the assumptions using the other method.
Comprehensive
1. Two companies produce identical total FCF over a 5-year period. Company A generates 90% of its
FCF in the first year and 10% over the remaining 4 years. Company B generates the same amount of
FCF in each year. Which one has the higher net present value?
Company A will have the higher present value.

2. Which change will have a bigger impact on valuation: a 1% increase in revenue growth or a 1%
decrease in WACC?
Decreasing the discount rate by 1% will have a greater impact because it directly impacts the present value of
FCFs. A 1% increase in revenue growth is shielded by other items such as COGS and taxes.

3. The Free Cash Flows in the projection period of a DCF analysis increases by 10% each year. Will
EV increase by more or less than 10%?
Less than 10%.

4. A company has a high Debt balance and is paying off a significant portion of its Debt principal
each year. How does that impact a DCF?
Do not account for debt repayments in an unlevered DCF. In a levered DCF, account for mandatory debt
repayments and decreasing interest payments. Levered FCF decreases each year, lowering equity value.

5. In a Levered DCF, is the company better off paying off Debt quickly or repaying the bare
minimum required?
Repaying the minimum required. Debt repayments are larger than the incrementally higher interest expenses
resulting from unpaid debt principle. TVM values short term future FCF more than long term future FCF.

6. How are Convertible Bonds treated in a DCF?

If in-the-money, convertible bonds are treated as additional shares and contribute to share dilution. If out-of-
the-money, convertible bonds are treated as debt throughout the DCF.

7. What about Mezzanine and Other Debt variations?

If interest is tax-deductible, they are treated as debt throughout the DCF. Otherwise, they are treated as
equity. Cost of Debt will be the weighted average effect interest rate on each type of debt.

8. How do Pension Obligations and the Pension Expense factor into a DCF?
In an unlevered DCF, if pension related expenses are treated as debt, they are excluded when calculating
UFCF. Same idea as ignoring interest expense in UFCF. In a levered DCF, pension related expenses are
included in LFCF as a form on interest.

9. A company is planning to buy a factory for $100 in Cash in Year 4. Currently the net present value
of this company is $200. How would we change a DCF valuation of the company to account for the
factory purchase, and what would the new Enterprise Value be?
- CapEx in year 4 increases by $100, causing FCF in year 4 to decrease by $100.
- EV decreases by the PV of $100 in year 4.

10. What happens to your EV when CapEx increases by $100 on your DCF?
EV falls because FCF decreases.
10.5. If this is the case, then why does your EV increase when you use $100 of cash to buy a capital
asset according to the EV equation? How do you explain this difference?
The DCF’s EV valuation decreases because it does not consider the FCF generation of the newly bought
asset, whereas in the EV equation, by converting cash into capital investment, EV increases because the
firm’s future cash flow generation (operating value) increases. If the FCF generated by the new capital asset is
included in the DCF valuation, EV may increase.

11. Name 3 ways lowering tax rate affects your DCF valuation.
1. Lowers cash tax, increasing cash flow
2. Increases cost of debt as it lessens the tax shield, decreasing cash flow due to increased WACC
3. Increases cost of equity because leveraged beta is higher, increasing WACC and decreasing cash flow

11.5. What is the overall impact of lowering the tax rate on your cash flows?
Overall effect is uncertain.

Special
1. Explain why we use the mid-year convention in a DCF.
Cash flows are not received in full at beginning of year or end of year, so we assume cash flows are
distributed evenly through the year and use the mid-year convention because it represents the average time of
arrival. This adjustment to the discount period is important for necessary to avoid overvaluation and
undervaluation due to TVM.

2. Why would you not use a DCF for a bank or other financial institution?
Debt, interest income/expenses, NWC, and CapEx are significantly different for financial institutions. It is
more common to use a DDM or Residual Income Model.

3. Walk me through a Dividend Discount Model (DDM).

A dividend discount model is intrinsic valuation methodology that values a financial institution company
based on the present value of its projected future dividends. DDM can either follow a 1-stage or 2-stage
model. A 1-stage model simply involves dividing projected EPS by the appropriate discount rate. In a 2-stage
model, EPS is projected for a given period, usually 5-10 years, by assuming a Dividend Payout Ratio from
projected net income, and terminal value is calculated applying the final year dividend to the 1-stage model.
Both the projected dividends and terminal value are discounted using the cost of equity to present value,
which are then summed to calculate the implied share price of the company.

4. Why wouldn’t a DCF work well for an oil & gas company?
1. FCF may be low or negative in the projection period because of large CapEx needs
2. Commodity prices are often cyclical or unpredictable, making revenue and FCF difficult to project
3. The natural resource assets have finite cash flow generation potential, so a terminal value may not be
applicable
It is more common to value each natural resource asset separately using a NAV model.

5. How does a DCF change if you’re valuing a company in an emerging market?

1. Higher discount rate (premium for political risk)
2. Government debt may not be viewed as risk free
3. Lack of comparable companies

6. When would increasing WACC increase your EV?

If your cash flows for your projection period are mostly negative, then increasing WACC reduces the effect
of these negative cash flows on the PV of your UFCFs (even though your PV of your Terminal Value will be
reduced somewhat).

7. What is the impact on COGS of switching from FIFO to LIFO in an inflationary environment?
This would increase COGS as with LIFO you expense the most recently purchased items in COGS, which
were more expensive.

7.5. What is the impact on your DCF of switching from FIFO to LIFO in an inflationary
environment?
While COGS will increase, lowering the taxes paid in cash, regardless of using FIFO or LIFO, in an
inflationary environment the effect on change in NWC (inventory purchases) will be the same whether using
FIFO or LIFO. Therefore, using LIFO will actually increase UFCF and thus increase the valuation.

8. A treasure hunting company has a 50% chance of finding a treasure chest of cash next year and
50% chance of finding nothing. What is its beta?
0. The company does not have systematic risk because its performance is completely uncorrelated with the
market. The company only has unsystematic risk.

9. What are the differences between Cash Flow from Operations and Unlevered Free Cash Flow?
1. One-time expenses / income that CFFO includes but UFCF does not
2. Capital Expenditures that UFCF includes by CFFO does not
3. Interest Expense & Corresponding Tax Savings that CFFO accounts for but UFCF does not
4. Tax Treatment: in UFCF, it is assumed all tax expense is immediately paid in cash, whereas CFFO
only reflects the amount of tax that the company actually pays

9.5. What are the differences between EBITDA and Cash Flow from Operations?
1. One-time expenses (normalized for in EBITDA)
2. Interest expense (uncounted in EBITDA)
3. Working capital changes (uncounted in EBITDA)
4. Tax payments (uncounted in EBITDA)

10. What discount rate would you use for NOLs?

NOLs should be discounted using cost of equity, since they do not benefit debtholders at all. NOLs are only
applied to taxes paid, which only affects returns for equity holders.

11. What are 3 things wrong with a DCF?

1. The DCF model is built entirely on assumptions based on prior performance (from discount rate to
growth rate), creating a large degree of uncertainty
2. A considerable portion of the valuation is placed on the terminal value (which is heavily reliant on
assumptions, difficult to estimate and extremely sensitive to projections)
3. Capital expenditure projections are typically presumed to be entirely maintenance-based and
therefore do not represent accretion of company value through associated topline growth. It is
therefore difficult to model specific growth opportunities in the future
4. Not applicable to business models that are balance-sheet centric (financial institutions, real estate /
energy / mining)
5. Not very effective for cyclical businesses or businesses that have negative free cash flow
12. You’re running a DCF on a biotech company and a consumer staples company both with the
same WACC – which has a higher terminal value as a % of EV and why?
The biotech company will likely have a higher TV as a % of EV because it is less mature and stable than a
consumer staples company. Its high R&D expense also reduces the amount of FCF it has throughout the
projection period.

13. If a company is contracted for 10 years of projects but none beyond that, how would you value it?
Project out the company’s revenue for the first 10 years with terms of the contracts, and then use historical
data on contract value and growth to determine a growth rate for the terminal value. It can also be argued
that you can use only the T-bill yield for discount rate for the first 10 years as there is greater certainty for this
revenue.

14. If a company’s post-growth FCF is half of EBITDA and the growth rate is 2% and WACC is 10%,
what is EV/EBITDA?
EV/EBITDA = ([EBITDA/2]/[0.10-0.02])/EBITDA = 6.25x

15. Into perpetuity, what would be the relationship between D&A and CapEx?
D&A is the loss of capital, and CapEx is the growth of capital. D&A makes a company shrink while CapEx
makes a company grow. Into perpetuity, D&A = CapEx

15.5. Let’s say at the end of the projection period, they’re both 10%, and assumed into perpetuity.
Does that imply that the company can’t grow?
Theoretically, this implies the company will remain the same size into perpetuity.

16. Imagine a sensitivity table set up like so below. The EBITDA multiple in the table corresponds
to the market valuation. The company’s WACC is 8%. Moving down each column and across each
row, what happens to the multiple?
ROIC
4% 8% 16% 24%
Earnings

4% 7.1x ? ? ?
Growth

6% ? ? ? ?
8% ? ? ? ?
10% ? ? ? ?
Moving across each row, as ROIC increases, the return for all investors (including equity) increases, which
will increase the ratio as investors are willing to pay more for higher-return investments. However, when
ROIC is below WACC (the return is below the expected return for investors), moving down the column (4%)
the multiple declines with increasing earnings growth because the company is becoming more value
destructive. Moving down the 8% column, the multiple remains the same as more value is neither being
created nor destroyed. Moving down the 16% and 24% columns, more value is being created with increased
growth, so the multiple increases.

17. Which would have a higher WACC – Dominos or a small pizza store?
Generally, the small pizza store would have a higher WACC as it represents an investment that is illiquid and
likely riskier, given its smaller potential target audience and limited human capital.

17.5. In what circumstances would the small pizza store be less risky?
A small pizza store may be less risky if it has a captive audience (e.g. a University student population) or
limited competition within its local area.
18. What are 3 reasons why a DCF would have a higher valuation than an LBO?
- In an LBO, most of the cash flows from the projection period are used to repay debt, and therefore
aren’t available to accrue to the valuation
- Cost of Equity for an LBO is higher because the sponsor expects greater returns due to high leverage
and illiquidity
- The higher amount of leverage and higher interest expense therefore limits both organic value
creation through growth CapEx, producing a lower valuation

19. News has just broken about the BP oil spill. In response, BP’s market cap has fallen by $40
million. Is this justified?
1) What are the litigation fees and financial penalties expected? $100 million, paid upfront.
2) Operating cash flow and the existing balance cannot pay for the $100 million fees. Equity raises are off the
table as the stock price has fallen dramatically. Debt raises are also unlikely in the current environment. Is this
correct? Yes.
3) The cash will therefore have to be generated through an asset sale of $100 million in assets. What is the
ROA? 5%.
4) Can we use return as a proxy for cash? Yes.
5) $100 million * 0.05 = $5 million cash lost annually through the asset sale. What is the Cost of Equity? 10%.
6) This is a perpetuity of -$5 million, so -$5 million / 0.10 = -$50 million. Therefore, the market
underreacted.

20. Where might you find a circular reference on a DCF?

When calculating the final share price, you divide the company’s equity value by the FDSO. However, the
final share price is needed to determine which options are in-the-money, which determines the FDSO.

21. How does an increase in the tax rate affect the value of a company?
Generally, higher tax rates cause a decrease in valuations. However, it really depends on the increase in FCF
from tax savings relative to the decrease in WACC (from the tax-shield effect of debt).

22. What's the relationship between the D/E ratio and WACC?
If we graph x = D/E and y = WACC, the curve would be U-shaped. As debt is cheaper than equity, so a
100% equity financed company will have a high WACC. As more debt is used in the capital structure, WACC
decreases. However, at a certain point, too much debt becomes unserviceable and causes financial distress,
resulting in a higher cost of debt and cost of equity, raising WACC.

22.5. What's the relationship between the D/E ratio and the value of a company?
Valuation is inverse of WACC, so it will be inverse U-shaped.

LEVERAGED BUYOUTS (LBO)

1. Walk me through an LBO.
A leverage buy out (LBO) model is an acquisition strategy that uses debt to finance a significant portion of
the purchase price. During the holding period, the buyer will make operational improvements and use the
asset’s cash flows to pay down the debt principle, thus increasing the buyer’s equity stake and allowing for a
higher return upon selling the asset. LBOs are commonly used by private equity buyers.

2. What variables impact a leveraged buyout the most?

- Purchase multiple
- Exit multiple
 - Leverage
- FCF generation (EBITDA margins, interest rates, maintenance CapEx)

3. What are 3 ways to increase IRR?

- Decrease the purchase price
- Increase leverage
- Increase exit multiple
- Improve operating metrics (revenue growth, EBITDA margin, LFCF margin, etc.)
- Increase growth rate (organic or acquisition)

4. What is an “ideal” candidate for an LBO?

- Stable cash flow generation
- Low maintenance CapEx
- Strong asset base
- Strong management team
- Low risk business
- Competitive advantage / Economic moat
- Undervalued
- Opportunities for margin expansion

5. Which of the following makes a stronger LBO candidate: a company that provides services or a
company that manufactures products?
Service company because reduced CapEx needs frees cash to pay off debt

5.5. Is there anything bad about investing in a service business?

Service businesses are asset light, so there is less collateral for taking on debt

6. As a private equity buyer, would you rather purchase a company with $5mm in CapEx or $10mm
in CapEx, if the first has $4mm in maintenance CapEx and the second has $1mm in maintenance
CapEx?
Buy the company with $10mm in CapEx ($1mm of which is maintenance), as you can optimize the business’
growth and reduce the amount of growth expenditure needed.

7. How can a company increase its exit multiple without reducing its EBITDA?
- Gaining a competitive advantage
- Becoming more efficient in its operations
- Economic improvements
- Switching industries

8. What are 3 ways that P/E firm can return equity from an LBO?
- Dividends
- Dividend recaps
- Exits

9. Why might a PE firm use Bank Debt rather than High-Yield Debt in an LBO?
A PE firm will use bank debt if they are concerned about the company meeting interest payments or want to
avoid incurrence covenants. Bank debt provides lower interest payments, but may require principle
repayments.
9.5 Why might a PE firm use High-Yield Debt rather than Bank Debt in an LBO?
A PE firm will use high yield debt if they believe they can grow the company by using FCF for CapEx rather
than debt principle repayments, or if they intend to hold the business for a longer period.

10. How does refinancing vs. assuming existing debt work in an LBO model?
ASSUMING DEBT: The debt remains on the Balance Sheet and must be paid off over time, but it has no
net effect on the funds required (existing debt in both the Sources and Uses columns)
REFINANCE DEBT: The debt is paid off and replaced with new debt that was raised to acquire the
company. Refinancing debt requires additional funds, so the effective purchase price goes up (existing debt in
the Uses column, New debt in Sources column).

11. How do transaction and financing fees factor into the LBO model?
All fees are paid upfront in cash, but legal & advisory fees are expensed while financing fees are amortized.

Paper LBO
1. A company has $10m in EBITDA. You purchase at 10x EV/EBITDA with 5x leverage for a 4-year
holding period and sell at 10x with no EBITDA growth. You pay down all the debt during the period
and LFCF is break-even. What is the IRR?
The initial equity stake is $50m. After paying off all debt after 4 years, the equity stake is the full $100m selling
price. $100m / $50m = 2x MOIC. Using the rule of 72, 72/4 = 18% IRR.

2. PAPER LBO: You buy a company (LTM EBITDA of $100) for 5x LTM EBITDA, levered up 3x.
EBITDA grows by $10 per year. You sell after a 5-year holding period for 5x. There is a 20% LFCF
margin from EBITDA. Assume bullet maturity. What is the IRR?
Purchase Price: $500 Sources: Debt - $300, Equity - $200
Holding Period 1 2 3 4 5
Year
EBITDA 110 120 130 140 150
LFCF 22 24 26 28 30
Ending Equity Value: $150 EBITDA * 5x EV/EBITDA - $300 (Debt Principal) + $30 + $28 + $26 + $24 +
$22 = $580
MOIC = $580/$200 = ~2.9
Use rule of 114: IRR = 114/5 = 22.8% ~22% (as 2.9 < 3)

3. PAPER LBO: You buy a company with $50 EBITDA for 6x EBITDA with 4x leverage, hold it for
6 years, and sell at 6x with no EBITDA growth. 5% interest rate (paid as a percent of the starting
principal at the time of the transaction), 20% tax rate, $20 in D&A, $3 in CapEx per year, and $15 in
increased Working Cap efficiencies per year. All FCF is used to pay off principal. What is the IRR?
Purchase Price: $300 Sources: Debt - $200, Equity - $100
Holding Year 1 2 3 4 5 6
EBITDA 50 50 50 50 50 50
D&A -20 -20 -20 -20 -20 -20
Interest -10 -10 -10 -10 -10 -10
Pre-Tax Inc. 20 20 20 20 20 20
Net Income 16 16 16 16 16 16
+D&A 20 20 20 20 20 20
CapEx -3 -3 -3 -3 -3 -3
 -ΔNWC -15 -15 -15 -15 -15 -15
FCF 48 48 48 48 48 48
Cash accruing 0 0 0 0 40 48
to equity
Ending Equity Value: $50 * 6 + 40 + 48 = $388
$388/$100 = 3.88 MOIC
Use rule of 144: IRR = 144/6 = ~24%

4. A company has $300mm of EBITDA. You purchase the company at 10x EBITDA with 40% equity
stake. It generates LFCF of $400mm. EBITDA does not grow, and after a period of time you sell for
10x EBITDA. Your MOIC is 3.0x. How many years did you hold the company for?
MOIC = (Excess Cash Flows + Final Equity Stake) / (Initial Equity Stake). Let t be the time in years.
3 = (400t + 1200)/1200
t=6

9. A financial sponsor (private equity fund) acquires Leverage Corp for $400mm, representing an
8.0x entry multiple based on $50mm of EBITDA for the trailing twelve-month period. They finance
their acquisition with $300mm of debt and the remaining $100mm is financed with equity from the
financial sponsor. Debt carries an interest of 5%. EBITDA in year 1 is $60mm, depreciation is
$10mm capital expenditure is $20mm, and there are no other cash inflows or outflows. Tax rate is
20%. What is the excess free cash flow available to pay down debt?
EBITDA $60mm
-D&A -$10mm
-Interest -($300mm)(0.05)
EBT $35mm
-Tax -$7mm
Net Income $28mm
+D&A +$10mm
-CapEx -$20mm
LFCF $18mm
Therefore, $18mm is available in excess FCF to pay down debt.

9.5 In year 5, assume $150mm of debt is paid down. What exit multiple (on the basis of trailing 12-
month EBITDA of $60mm), will be necessary for the sponsor to realize a 4.0x return on their equity
investment (money multiple)?
400mm Purchase Price → 300mm Debt, 100mm Equity
Let y be the exit multiple.
4 = (60mm * y – (300mm – 150mm)) / 100mm
400mm = 60mm * y – 150mm
y = 9.17x

10. A private equity firm buys a business with $100 in EBITDA at 4x EV/EBITDA. The company
will continue to generate $100 in EBITDA for all future years and will be sold in 5 years for $400 plus
all the FCF that has been generated by the business during the 5-year hold period. No debt is paid
off during the hold period. D&A is $40, interest rate is 10%, there is no tax, no change in NWC, and
CapEx is $40. If the private equity firm generated MOIC of 2.5x, what was the original equity
cheque at entry?
Entry = Equity + Debt = 400.
MOIC = (Exit EV – Debt + FCF) / Equity → 2.5 = (400 – Debt + FCF) / Equity
Exit = 2.5*Equity + Debt = 400 + 5*FCF
FCF = EBITDA – Interest Expense – Change in NWC – CapEx
FCF = 100 – 0.1*Debt – 40
FCF = 60 – 0.1*Debt
2.5*Equity + Debt = 400 + 5*(60 – 0.1*Debt)
2.5*Equity + Debt = 400 + 300 – 0.5*Debt
2.5*Equity + 1.5*Debt = 700 (Equation 1)
Debt = 400 – Equity (Equation 2)
2.5*Equity + 1.5*(400 – Equity) = 700
Equity + 600 = 700
Equity = 100, Debt = 300.
Therefore, the original equity cheque was $100mm.

15. Bought a company at $500 with $400 in debt and $100 in equity. FCF each year is $100, debt is
amortized at $75 a year. Sold for $500 after 5 years. What is the MoM?
Purchase Price: $500 Sources: Debt - $400, Equity - $100
MoM: ($500 + $100 * 5 - $400) / $100 = 6 --> Therefore, the MoM is 6.

17. You have entry EBITDA of $200mm, and you purchase the company at 10x with leverage of 6x.
Your exit EBITDA is $300mm, and you sell at 10x with 4x leverage. Assume no LFCF generation.
What is the MoM and IRR, assuming a 4-year hold?
Purchase Price: $2bn Sources: $1.2bn debt, $0.8bn equity
Exit Price: $3bn Remaining Debt: $1.2bn
MoM= ($3bn - $1.2bn) / $0.8bn = $1.8bn / $0.8bn = 2.25x
Slightly over MoM of 2x, so use Rule of 72: 72/4 = 18%. Therefore, the IRR was slightly higher than 18%.

18. You purchase a company with 100 M EBITDA at a 10x multiple, funded by 4x debt / EBITDA.
You hold the company for 5 years before selling it. No debt is paid off and EBITDA stays the same.
What is the return of this deal? You can ask me for more information. [Moelis & Co. 2021 First Round]
Purchase EV = 10 * 100 EBITDA = 1000 M. Transaction funded by 400 M debt, 600 M equity.
(Ask for D&A, interest rate, tax rate, CapEx, Change in NWC, Exit multiple)
D&A = 10 M, Interest = 10%, Tax = 20%, CapEx = 10 M, Change in NWC = 0, 15x exit multiple
EBITDA 100
D&A 10
Interest 40 * 10% = 40
EBT 50
Tax 10
NI 40
D&A 10
CapEx 10
FCF 40
Exit EV = 15 * 100 M = 1500 M
MOIC = (1500 – 400) + (40 * 5) / 600 = 1300 / 600 = ~2.17x (just over doubling money in 5 years)
Rule of 72: 72 / 5 = ~15% → Around 16%

Special
1. Should IRR be higher, or WACC?
IRR represents the Cost of Equity of the target (the expected return of the financial sponsor), and as the
company will be highly levered with debt that is less expensive than equity, the WACC should be lower.

2. What is more important – MOIC or IRR?

Both metrics are important – MOIC is useful for quickly determining the equity value at the exit, and IRR
demonstrates the annualized return and can be benchmarked against the market return. However, IRR is the
more important metric because it considers the length of the holding period (something that MoM does not)
and is therefore a more comparable return for reference.

3. How do you decide how much leverage to use?

Look at current debt levels and leverage used in precedent transactions, and ensure that projected cash flows
will be able to sufficiently cover interest expense and principle repayments while not sacrificing operations.
Look at historical performance and understand the business profile. If it’s cyclical with high operating
leverage, you may not be able to put many turns of EBITDA (<4x of debt), while if it has proven to be stable
and still growing effectively, you can put on additional leverage – then optimize mechanically.

4. How do you use an LBO model to value a company, and why is it the “floor valuation” for the
company?
You use it to value a company by setting a targeted IRR and Exit Multiple, and then back-solving in Excel to
determine what purchase price the PE firm could pay to achieve that IRR. This is sometimes called a “floor
valuation” because PE firms almost always pay less for a company than strategic acquirers would.

5. Why would a private equity firm buy a company in a “risky” industry, such as technology?
- Industry consolidation (buying competitors to gain market share)
- Turnaround (Struggling companies with upside, low valuations)
- Divestitures (Improving and selling off specific, strong division)

6. After running at LBO model, the target company is valued at twice its market cap. What
assumptions would you check to confirm it is returning the right implied equity value?
When an LBO model outputs a high valuation, this means that the projected returns of the company are large
enough that the target IRR can be achieved despite a high entry price. This likely means that the determinants
of return are too aggressive. I would check:
- Target IRR
- Cash flow projections (optimistic assumptions, capex requirements)
- Leverage used

MERGERS AND ACQUISITIONS (M&A)

1. Walk me through a merger model

2. How can you fund an M&A transaction and what are the qualities of the 3 options?
An M&A transaction can be funded through (1) cash, (2) debt, and (3) equity.
Cash is generally the cheapest source of capital to fund a transaction, as cash has the lowest foregone interest
received. However, it can be ill-advised to use cash if there are R&D needs, restrictive debt covenants,
litigation expenses, mandatory dividend payments or a required amount of cash to meet working capital
requirements.
Debt is generally cheaper than equity and more expensive than cash and should be used if the company is
underleveraged and/or the target has significant stable cash flows projected into the future. However, debt
may not be accessible to companies with high leverage.
Equity is the most expensive way to fund an M&A transaction and is generally flexible – it may be used if the
stock is trading at an all time high or if the company is already highly levered and has a low cash balance.

50. How would you value an acquired company’s pool of NOLs?

According to the Section 382 Limitation, acquired NOLs can only be used with the following maximum
annual use constraint: the FMV of the acquired company * “Federal Long-Term Tax-Exempt Rate”.
Calculate the annual NOL used with this formula, project the income shielded per year and multiply by the
appropriate tax rate, then apply a discount rate, sum up the discounted projections and record it as a DTL on
the balance sheet.

Accretion / Dilution
1. We’re advising Company A on the potential acquisition of Company B. Our client wants to use
50% debt, 25% cash and 25% stock to fund this acquisition, and wants to determine if it is accretive
or not. Company A has a Share Price of $10, 100 shares outstanding, debt of $300, cash of $100, Net
Income of $200. Company B has a Share Price of $10, 25 shares outstanding, debt of $75, cash of $25,
and Net Income of $25. The tax rate is 40%, pre-tax Kd is 5%, and pre-tax foregone interest on cash
is 1.0%.
1) Earnings Yield of the Company = 1/(P/E) = 1/10 = 10%.
2) Cost of debt = 5% * (1-40%) = 3%. Cost of cash = 1%*(1-40%) = 0.6%. P/E = $10 / ($200/100) = 5.
Cost of Equity = 1/5 = 20%.
3) Cost of capital = 50% * 3% + 0.6% * 25% + 20% * 25% = 6.65%.
Return = 10%, cost of capital = 6.6%, therefore accretive.

2. Company A has Net Income of $500, 100 shares outstanding and a share price of $100. Company B
has Net Income of $300, 100 shares outstanding and a share price of $45. Company A acquires
Company B in an all-stock deal with no synergies. How accretive or dilutive is this deal?
EPS of Company A prior to Number of new shares issued: New EPS:
acquisition: $45 * 100 = $4500 ($500 + $300)/(100 + 45) =
$500/100 = $5 $4500 / $100 = 45 $5.51
$5.51/$5 – 1 = ~10% Accretive

2.5. (Continued from last question) Now imagine Company A buys B with 50% stock and 50% debt.
Tax rate is 20%. What interest rate would lead to the same level of accretion?
$2250 in debt issued, 22.5 new Net Income / 122.5 = 5.5 2250(1-0.2)Kd = 800 – 673.75
shares issued. Net Income = 673.75 Kd = 0.07014 = 7.014%
To maintain accretion level, EPS Therefore, interest expense must
is the same. be the difference between pro-
forma net income and 673.75.

3. Company A has a 20x P/E multiple. Company B has a 10x P/E multiple. Company A acquires
Company B with 50% stock and 50% debt. What is the after-tax interest rate required to make this
deal neither accretive nor dilutive (breakeven)?
Equate earnings yield of B to 0.10 = 0.5Ke + 0.5(1-t)Kd (1-t)Kd = 0.15
weighted cost of equity and debt 0.10 = 0.5(0.05) + (0.5)(1-t)Kd
issued. 0.075 = 0.5(1-t)Kd
3. Company A has a market cap of $100, Net Income of $20, and 10 shares outstanding. Company B
has a market cap of $80, Net Income of $20, and 5 shares outstanding. Company A buys Company B
at a 50% premium (all stock). Is this accretive or dilutive, and by how much?
EPS of Company A: $20 / 10 = $120 / $10 = 12 new shares $1.82/$2 – 1 = -9% (9% Dilutive)
$2 issued
New Market Cap of Company B New EPS: ($20 + $20) / (10 +
with 50% Premium: $120 12) = $1.82

4. Company A has a P/E of 10x and Company B has a P/E of 20x. Company A buys Company B for
50% in debt and 50% in equity, and the interest rate is 10%. What must the tax rate be to breakeven?
0.05 = 0.5(1-t)Kd + 0.5Ke 0.05 = 0.5(1-t)(0.1) + (0.5)(0.1) t=1
Kd = 0.10, Ke = 0.1 0 = 0.5(1-t)(0.1) Therefore, tax rate must be 100%.

5. Company C has Net Income of $200, a share price of $6 and 10 shares outstanding. Company D
has Net Income of $200, a share price of $5, and 6 shares outstanding. Company C buys D in an all-
stock deal at a 20% premium. No synergies. How accretive or dilutive is this acquisition?
Current EPS for C: $200/10 = New shares issued: $36/$6 = 6 $25/$20 – 1 = 25% accretive
$20 New EPS for C: ($200 +
New Market Cap for D: $5 * 6 * $200)/(10+6) = $25
1.2 = $36

6. Company A has 1 million shares outstanding at a price of $25, with $4 million in Net Income.
Company B has 500K shares outstanding at a price of $15 with $1 million in Net Income. Company A
acquires Company B with 40% equity and 60% debt and $250K of hard (post-tax) synergies are
created. Interest rate is 6%, tax rate is 40%. How accretive or dilutive is this deal?
Current EPS for A: $4mm/1mm Number of new shares issued: New EPS: $5,088,000/1,120,000 =
= $4 $3mm / $25 = 120,000 new 4.54
Mkt Cap for B: $15 * 500K = shares $4.54/$4 – 1 = 13.6% Accretive
$7.5mm Pro-Forma NI w/ Synergies:
Equity Purchase Val: $7.5mm * $4mm + $1mm + $250K -
0.4 = $3mm $7.5mm * 0.6 * 0.06 * (1-0.4) =
$5,088,000

7. Company A has a Market Capitalization of 100M and a P/E of 20x. Company B has a Market
Capitalization of 200M and a P/E of 10x. Company B purchases Company A at a 50% premium. Is
this accretive or dilutive? How much in synergies would be required to make this deal breakeven?
You’re buying a company that trades at a higher PE, so this deal will be dilutive. With a 50% premium,
Company A’s valuation increases to 150M, and its PE multiple will increase to 30x. There must be an increase
in earnings to lower Company A’s PE to 10x. Based on the Market Cap and PE ratio, you know that
Company A has earnings of 5M, therefore there must be 10M of net income synergies to lower its PE ratio to
10x and make this deal breakeven.

9. What premium would a company trading at 15x P/E pay for a company trading at 12x P/E?
(Assuming break-even)
Take ratio of earnings yields --> [1/12] / [1/15] = 1.25 --> 25%
13. Company A has a P/E of 10x, stock price of $5, EPS of $0.50, and 50 shares outstanding.
Company B has a P/E of 20x, EPS of $0.20, 10 shares outstanding. Company A buys B for $100 with
50% stock and 50% cash, and the after-tax interest foregone on cash is 10%. How accretive or
dilutive is this deal?
Net Income for Company A = $0.50 * 50 = $25. Net Income for Company B = $0.20 * 10 = $2.
New Shares Issued: ($100 * 0.50) / $5 = 10 new shares issued
New EPS for MergeCo: ($25 + $2 - $50(0.10)) / (50 + 10) = 22/60 ~0.367
0.367 / 0.50 = 0.7333. Therefore, the deal was ~27% dilutive.

13. If you buy a company trading at 20x P/E and the deal is financed 100% with debt at 5% interest,
is the deal accretive or dilutive?
Accretive. Buyer yield is 5%. While Cost of Debt is 5%, the tax rate cannot be 0%, so the after-tax Cost of
Debt is < 5%.

Special
1. Company A and B both have $200 in revenue, A acquires B and A now has $450 in revenue. There
is no synergy and no growth. Where did the extra $50 in revenue come from?
1. Different revenue recognition policies
2. Companies A and B both own minority interest in the same company C. After the acquisition, the
two minority stakes combine to form a majority interest, therefore consolidating company C’s
financial profile under company A.

2. What are the 4 types of M&A synergies?

- Revenue Synergies
- Cost Synergies
- Tax Synergies
- Leverage Synergies

3. Company A has a tax rate of 40% and B has a tax rate of 30%. A acquires B. Is the deal accretive or
dilutive?
The acquisition is dilutive because the after-tax earnings of the company acquired will decrease with the
higher tax rate of the new company, lowering the overall earnings per share post-acquisition.

4. If Company A has an EV of $500mm and Company B has an EV of $100mm and Company A

purchases Company B for $200mm by raising $200mm in equity, what is the final enterprise value of
Company A?
$700mm ($500mm originally + $200mm additional Equity Value).

5. If an acquisition is announced for $10, and the stock currently trades at $5, why would it only rise
to $8?
Execution Risk: It would not rise to the full value of the announced price because of investor skepticism that
the deal will not go through.

5.5. Why might the share price rise above $10?

The price might rise further if investors believe there may be other bidders that may attempt to outbid the
existing price. It could also vary with differences in transaction structure.
6. Company A has equity value of $1000, net debt of $600, and minority interest of $400. Company B
has EV of $400. Company A acquires company B using 100% debt. What is the EV of the company
after the acquisition?
Company A has EV = 1000 + 600 + 400 = 2000. Company B has EV = 400.
Company A raises 400 in debt to buy Company B.
Total EV = 2000 +400 (debt) – 400 (Company A equity value) + 400 = 2400.
Enterprise value is the operating value of a company. Therefore, taking on debt does not change the EV of
Company A, and the total EV is the sum of the two companies’ EVs.

6.1. In what situation would the combined EV be higher than $2400?

Company A and Company B hold minority interest in the same company.

6.2. In what situation would the combined EV be lower than $2400?

Company B is a holding company that owns a minority interest in Company A. This minority interest is
equivalent to Company A’s non-controlling interest. Therefore, when Company A acquires company B, it
purchases back the non-controlling interest in itself, so its EV does not change.

7. In general, is accretion important? Would a company ever do a dilutive deal?

- Meet strategic goals
- Acquirer believes deal will become accretive over time

RESTRUCTURING (RX)
1. What is Restructuring?
“Restructuring” refers to changing to the debt obligations of a distressed company so that it can better repay
them in the future. Restructuring teams advise distressed companies – businesses going bankrupt, in the
midst of bankruptcy, or getting out of bankruptcy – to help them change their capital structure to get out of
bankruptcy, avoid it in the first place, or navigate with a sale process.
2. What can trigger a restructuring?
- Economic downturns, higher operating costs
- Liquidity issues:
o Covenants
o Interest payments
o Principal repayments
- Large one-time expenses
- Large asset write-down (Reduced net asset values)
- Drop in stock price

2.5. What triggers a bankruptcy?

Bankruptcy stems from insolvency or illiquidity.
- Failure to meet debt obligations/interest payments
- Liquidity crunch
- Large one-time expense (ex. litigation)
- Breach of covenants
- Accelerated debt payments forcing debtor into bankruptcy
- Inability to restructure out-of-court

3 What are some signs that a company may be distressed?

 1. Stock is trading under a dollar
2. Market capitalization is less than 15% of enterprise value
3. Very high yield-to-worst (YTW) or market value of debt well below par when risk free interest rates
have not moved that much

4. What is the difference between insolvency, illiquidity and bankruptcy?

Illiquidity describes an inability to meet obligations due to a temporary shortage of liquid assets.
Insolvency is a state of financial distress where a firm’s debts exceed assets, resulting in the inability to meet
financial obligations to creditors as they become due because debts exceed assets. Insolvency is a more
serious problem because it cannot be fixed through a capital injection.
Bankruptcy is a legal process dictating how the distressed company will restructure its debts and deliver
returns to its creditors.

5. What options are available to a distressed company?

1. Refinancing: obtain fresh debt or equity capital
2. Sell the company
3. Out-of-Court Restructuring: reduce / delay obligations, issue new debt
4. Chapter 11 Bankruptcy: obtain DIP financing, restructure obligations, be freed of obligations

5.5 What are the advantages and disadvantages of each option?

Option Advantages Disadvantages
Refinancing - Least disruptive - May not be accessible
- Revive confidence
Sell the company - Avoid further value destruction - Lose option value of equity
- Best option for secured creditors - Poor valuation
Out of Court - Minimize time and cost - Requires cooperation between many
Restructuring - Less public exposure parties with conflicting incentives
-
Chapter 11 Bankruptcy - Efficient at facilitating negotiation, - Lengthy and costly
reducing obligations, opening - Significant public exposure
financing and triggering sale - Significant disruptions
- Damages confidence

6. What options are available to a creditors?

1. Refinancing: invest additional capital
2. Conditional financing: provide financing with cost reduction requirements and incurrence covenants
3. Demand immediate sale: force company to hire investment bank to sell itself
4. Foreclosure: seize collateral and force bankruptcy filing

7. What is the difference between Chapter 7 and Chapter 11 bankruptcy?

Chapter 7 refers to “liquidation bankruptcy”, where the company must liquidate its assets and pay-off
creditors. Chapter 11 refers to an “reorganization”. Where the company renegotiates the terms of its debt and
potentially receive new financing.

7.5. Who prefers Chapter 7?

Secured creditors. Chapter 7 allows secured creditors to exit their position, potentially re-claim their entire
initial investment and avoid value erosion due to in-court restructuring.

8. What are the main differences between an out-of-court restructuring over in-court restructuring?
Out-of-court restructuring is generally preferred because it avoids the time-consuming and costly nature of
in-court restructuring. It also avoids negative press for the debtor, avoids business disruptions and preserves
supplier relationships. In-court restructuring is referred to as Chapter 11 Bankruptcy, whereby a 3 rd party legal
body facilitates negotiations between the debtor and creditors under Bankruptcy law. It is a time-consuming,
costly, and publicized process that may create significant business disruptions. However, certain negotiation
points are enforceable in-court, which can create a most productive negotiation process.

9. How do you get a settlement in an out-of-court restructuring?

Ultimately, there has to be a solution that works for all stakeholders; otherwise the discussions may fail and
force an in-court restructuring.

9.5. What are some out of court restructuring solutions?

New financing, extended repayment period, reduced interest, partial repayment, exchange of debt for equity,
complete equitization

10. What is debtor-in-possession (DIP) financing and how is it used with distressed companies?
DIP financing is money borrowed by a distressed company in bankruptcy with repayment priority that is
senior to all existing debt. It is considered “safe” by lenders because it is subject to stricter terms than other
forms of financing.

11. If the market value of a distressed company’s debt is greater than the company’s assets, what
happens to its equity?
Book value of equity turns negative. However, market value of equity remains positive, through it may move
towards 0.

11. Why might a creditor have to take a loss on the debt it loaned to a distressed company?
Secured creditors have firm claim on the proceeds from a sale; if proceeds run out, they have to take a loss.

12. What are the differences in work and strategy in approaching a debtor engagement and a creditor
engagement?
The strategy of a debtor engagement is more reactive in its analysis compared to a creditor, and provides a
more holistic look at the company’s capital structure in all aspects, and also takes into consideration the ability
of the firm to become a going concern moving forward. In working for a creditor, the analysis is more
proactive and there is additional strategy in terms of capital recovery. Both involve examining and working
within the legal framework.

18. What industry is likely to need restructuring advice? Can you think of a specific company?
Retail (Toys R Us), Oil & Gas (+ Services)

Valuation and M&A Process

1. What adjustment to the 3 financial statements are made when valuing or modelling a distressed
company?
- Inflated COGS
- Non-recurring advisory and rx fees
- Non-recurring costs
- Above-market lease expenses
- Above-market salaries
- Non-normal working capital
 - Deferred working capital

1.5. What happens to Account Payable days with a distressed company?

Accounts payable goes beyond the industry normal.

2. How would valuation change for a distressed company?

- Valuation methodologies stay the same, with the addition of liquidation valuation
- Make accounting adjustments when projecting financials
- Use multiples on the lower end of the range for comparable companies and precedent transactions
- Use revenue multiples over EPS, EBIT and EBITDA multiples
- Assume turnaround period, lower projections and higher WACC in DCF valuation
- Value companies on both an asset-only and current liabilities-assumed basis

3. How would the M&A process be different than it would for a healthy company?
- Timing is critical
- Company has no negotiating power
- Competitive bidding process is the only way to increase price
- Competitive bidding process involves sales provisions
- Out-of-court sale process requires approval from creditors
- Creditors often initiate the process rather than the company itself
- Distressed sales cannot fail, they always result in a sale, bankruptcy, restructuring or liquidation

4. Normally in a sell-side M&A process, you always want to have multiple bidders to increase
competition. Is there any reason they’d be especially important in a distressed sale?
In a distressed sale, the seller has no negotiating leverage, so the only way to improve sale price is through a
competitive bidding process.

5. What’s the difference between an asset sale and stock sale, and what would a buyer in a distressed
sale prefer? What about the seller?
Stock sale involves the buyer acquiring 100% of the seller’s shares, and therefore all of its assets and liabilities.
Asset sale involves the buyer purchasing all or some of the seller’s assets, effectively choosing which assets
and liabilities to acquire. Buyers prefer asset sale because of tax benefits (from asset write-ups) and liability
transparency. Sellers prefer stock sale because of tax benefits and the opportunity to be rid of liabilities

6. Sometimes a distressed sale does not end in a conventional stock/asset purchase – what are some
other possible outcomes?
- Foreclosure (either official or unofficial)
- General assignment (faster alternative to bankruptcy)
- Section 363 asset sale (a faster, less risky version of a normal asset sale)
- Chapter 11 bankruptcy
- Chapter 7 bankruptcy

7. Are shareholders likely to receive any compensation in a distressed sale or bankruptcy?

They may receive something in such a scenario, but it’s usually very little and is simply a nominal amount to
make them go forward with the company’s plan.

8. A company wants to sell itself or simply restructure its obligations – why might it be forced into a
Chapter 11 bankruptcy?
The company’s creditors may not agree with the sale or restructuring terms, and will accelerate debt payments
to force a bankruptcy.

9. Why would you perform a liquidation analysis?

Multiply the book value of each asset by an estimated recovery %, and sum of the estimated recovery values.

9.5 Why would you perform a liquidation analysis?

Liquidation analysis provides a baseline valuation to assess the purchase prices.

10. How is cost of debt measured for a company if it is too distressed to issue additional debt?
Use the yields on bonds or the spreads of credit default swaps of comparable companies.

11. Will the adjusted EBITDA of a distressed company be higher or lower than non-adjusted
EBITDA?
In most cases it will be higher because you’re adjusting for higher-than-normal salaries, one-time legal and
restructuring charges, and more.

12. Would you use Levered Cash Flow for a distressed company in a DCF since it might be
encumbered with debt?
No. With distressed companies, it’s really important to analyze cash flows on a debt-free basis because they
might have higher-than-normal debt expenses.

13. What are some common transactions seen in a corporate restructuring?

- Could involve either paying out existing debt holders for their principal or renegotiating better terms
on debt repayments and interest
- Could involve an asset sale to raise funds
- The exchange of debt obligations for equity for some creditors in the fulcrum security tranche

Debt
1. Walk me through the different types of debt.
- Revolvers
- Term Loan A
- Term Loan B
- Senior Notes
- Subordinated Notes
- Mezzanine Debt

2. What is the difference between Bank Debt and High-Yield Debt?

Bank Debt High Yield Debt
Senior Junior
Lower interest rates Higher interest rates
Fixed interest rates Floating or PIK interest rates
Secured Unsecured
4-8 year maturity 8-12 year maturity
Amortized Bullet repayment
Prepayments No prepayments
Maintenance covenants Incurrence Covenents
2.5. Wait a minute. If High-Yield Debt is “riskier,” why are early principal repayments not allowed?
Shouldn’t investors want to reduce their risk?
Investors want to be compensated for their risk. Prepayments reduce the amount of income that investors
expected to make by reducing interest payments.

3. In a bankruptcy, what is the order of claims on a company’s assets?

1. New debtor-in-possession (DIP) lenders
2. Secured creditors (revolvers and “bank debt”)
3. Unsecured creditors (high-yield bonds)
4. Subordinated debt investors (subordinated notes)
5. Mezzanine investors (convertibles, convertible preferred stock, preferred stock, PIK)
6. Shareholders (equity investors)

4. What is a borrowing base facility?

A secured lending facility which may extend credit relative to available collateral (ex. borrower may borrow
against the value of 75% of receivables). Thus, the lender will always be overcollateralized.

5. What is a discounted offering (AKA discount bond, original issue discount)?

Bonds are usually issued at par with the coupon priced at the market clearing yield for the company’s risk
profile. A discounted offering happens when a company issues debt at a discount to its par value (ex. 90 cents
on the dollar) to offer a market clearing yield at the lower coupon rate. It can also be used to incentivize
investors with higher yield when there are doubts about the company’s solvency.

6. You buy a bond for $0.70 on the dollar, with a 14% coupon and a 5-year maturity. Assume there are
5 years left to maturity. What is the YTM on the bond?
There are 2 components to the yield to maturity: the coupon yield and the principal yield.
Coupon Yield: $0.14 / $0.70 = 0.20 = 20%
Principal Yield: $1.00 / $0.70 – 1 = 0.4286 / 5 = 0.0857 = 8.57% annually (dividing by 5 to approximate)
Total Yield = 20% + 8.57% = 28.57%

7. A company’s debt has a face value of $100 and is trading at $80. It pays an 8% coupon and matures
in 5 years. What is YTM?
Coupon Yield: $8 / $80 = 0.10 = 10% annually
Principal Yield: $100 / $80 – 1 = 0.25 / 5 = 5% annually (divide by 5 to approximate)
Total Yield = 10% + 5% = 15% annually

7.5 Will the actual yield be higher or lower?

Lower, the approximation does not account for compounding.

17. If two bonds have the same price, face value and coupon but the only difference is their maturity,
which has a higher yield to maturity?
The two bonds have the same YTM. The only way for bonds with different maturities to have the same price
and coupon is if they are both trading at par. At par, bond 1’s YTM equals its coupon, and bond 2’s YTM
equals its coupon. Since the coupons are the same, then the YTM is the same.

Waterfall Calculations
1. If a company has $50mm in EBITDA, is trading at 6x, with $200mm in bank debt, $200mm in
high yield debt. What will the debt be trading at?
Company’s EV = $300mm ($50 M x 6). Bank debt is worth $200mm as it is secured. The remaining debt
must be worth $100mm in value. Therefore, it is trading at $100mm/$200mm = $0.50 on the dollar.

1.1 Is Equity Value negative?

If a company’s EV is exceeded by its total debt obligations, then the company is insolvent, and the equity
(market) value of the company should be 0 to reflect this.

1.2 If the enterprise value of the company is less than the face value of the debt, why is the equity
market capitalization still positive (the shares still trade above zero)?
In the real world, a company’s market value cannot be 0 because of the option value of equity. Equity
securities in theory are priced based on the probability weighted outcomes. If there was a liquidation today,
the equity is ascribed a value of zero, but if there is a small chance the company can make a comeback, the
equity should be the probability weighted value of that outcome. Moreover, a company’s will still be liquid in
the short term because the debts do not mature immediately, providing cash flow that is potentially (although
highly unlikely) accessible to equity investors.

2. What is value break (fulcrum security)?

This is the tranche of the capital stack where the security will not get full recovery as valued.

3. A company has $50 in EBITDA and trades at a 5x EV/EBITDA multiple. It has $180 in bank debt
and $120 in high-yield debt. How much is each tranche trading at? What is the equity value?
The $180 in bank debt is secured and can be supported by the enterprise value of the company (there is
collateral to meet principal payments). Therefore, it is trading at par. There is $120 in face value of high yield
debt, but only $70 in EV left to cover the debt. Therefore, it trades at 7/12 of a dollar, or ~$0.58 on the
dollar. The equity value is either 0, or barely positive as investors may believe the company has turnaround
potential and may want the call option of being able to partake in potential future profits.

4. A company in a liquidation scenario has EV of 100 M. It has a term loan of 75 M and a 2 nd lien
loan of 50M. What are the two tranches of debt trading at, and what is its equity trading at? [Moelis &
Co. 2021 First Round]
Company EV = $100 M. Term loan of 75 M is secured, so it trades at par. The 2 nd lien loan is under-secured
and is worth 25 M, so it trades at 50 cents on the dollar. The equity would theoretically trade at $0, but this is
impossible and it’s value comes from the option value of equity.

Special
1. How could a decline in a company’s share price cause it to go bankrupt?
It does not directly cause bankruptcy. After the share price drops, customers, suppliers and creditors may
begin to view the company in a negative light and are more reluctant to do business with the company. As a
result, revenue may drop and trade credit terms may weaken, creating a greater need for capital.

2. Should a cyclical company have more or less debt in general?

Less debt. Cyclical cash flows are less reliable for servicing debt payments.

3. What is a cram down?

A cram down is a bankruptcy technique where the court will approve the plan of reorganization over the
objections of certain creditor classes

4. What may a corporate do right before they declare bankruptcy?

Fully draw down their revolver so that they have cash and liquidity to survive Chapter 11.

5. Does the management always only have a fiduciary duty to shareholders?

When a company is nearing liquidation, management’s fiduciary duty shifts to maximize value for all
shareholders.

6. What is a par-for-par exchange?

A pay-for-par exchange is where a bond can be exchanged for new consideration of notes. The new bonds
can offer a higher coupon, longer dated maturity, or equity warrants to offer a higher yield.

7. What is an uptier exchange?

An uptier exchange is when a bond issuer offers a lower principal amount for more seniority in the capital
structure. While it can be used as a bankruptcy avoidance tool, uptier exchanges can also be used to reduce
debt, interest payments, and covenants, or to change maturity dates.

8. What could incentivize creditors to take up an up-tier exchange instead of being a holdout?
- Reduced liquidity of remaining original issue
- Early tender incentives offering more principle
- Tenders may require a 90% or other threshold so they cannot free ride

9. What is a debt for equity exchange?

A feature that allows bondholders to exchange bonds for a certain % of equity in the company.

10. What are some other liquidity management solutions to stave off distress and bankruptcy?
- Amendments
- Covenant waivers (not sustainable)
- Distressed debt repurchases (offer to buy back debt at reduced price)

11. If the enterprise value of the company is less than the face value of the debt, why is the equity
market capitalization still positive (the shares still trade above zero)?
In the real world, a company’s market value cannot be 0 because of the option value of equity. Equity
securities in theory are priced based on the probability weighted outcomes. If there was a liquidation today,
the equity is ascribed a value of zero, but if there is a small chance the company can make a comeback, the
equity should be the probability weighted value of that outcome. Moreover, a company’s will still be liquid in
the short term because the debts do not mature immediately, providing cash flow that is potentially (although
highly unlikely) accessible to equity investors.

12. There are 3 tranches of debt, each $100m. One is senior secured that trades at 100 cents on the
dollar with 5% interest. The second is unsecured with 7% interest and trades at 70 cents on the
dollar. The last is 10% high yield debt that trades at 30 cents on the dollar. With an EBITDA of $50m
and a multiple of 3x, which tranche of debt would you rather invest in? (ask for cash balance, tax
rate, NWC and CapEx)
Find YTM to see which of the 3 has the highest yield assuming they survive until maturity. Conduct waterfall
analysis. Right answer is 10%??? Find FCF (which will be negative), and use cash balance to figure out how
long the company will stay solvent for. Calculate returns during solvency period to determine which tranche
to invest in.
13. If a company has two tranches of debt – senior debt at 60 cents on the dollar and unsecured
bonds at 12 cents on the dollar – why might the unsecured bonds still have any value if the senior
tranche doesn’t have full recoverable value?
- Interest payments for the time before the default could be of some value
- Since the senior debt isn’t fully collateralized, the unsecured bonds might be entitled to some of the
collateral since unsecured assets are paid equally to creditors on the same level and the partial
collateral may be the only reasons for seniority

14. There are two tranches of debt with the same interest rate: one is convertible, one is not. Which
would you rather invest in?
It depends on the situation. If the company (and economy) is healthy, then you would take the convertible
option as it provides the optionality of taking an equity ownership stake in the company. However, if the
company is in distress, you would rather take the non-convertible option as it is often more senior in the
capital stack and is seen as less risky.

15. If two bonds have the same maturity, same coupon, and both are secured, why could one have a
YTM of 10% and the other a YTM of 20%?
The yield-to-maturity is a two-part calculation including the annualized yield of the principal payment and the
coupon payment yield. As both coupons are the same, the difference must be in price. Some reasons:
- One bond may be convertible
- One bond may be callable
- Even though both are secured, they are unlikely to be secured against the same assets, and some
collateral may be easier to extract value from than others
- Differences in covenants may also play a factor

16. What are 2 reasons why a bond would trade below its face value?
- The market interest rate (set by central bank) is now higher than the bond’s coupon
- The company is in distress and repayment is unlikely
- The bond has a callable option
- There might be a liquidity discount due to low demand

17. You have $1bn in unsecured debt trading at 30 cents on the dollar. If the company issues a debt
swap for $600mm trading at 60 cents on the dollar, what is the gain or loss on this trade?
The current debt held is worth 0.30 * $1bn = $300mm. The new debt is worth 0.60 * $600mm = $360mm.
Therefore there is a gain of $360mm - $300mm = $60mm on the trade.

18. You have an asset-based lending revolver worth $90mm secured against $100mm in A/R with
85% recoverable value. If $35mm is already drawn on the revolver, $10mm due to vendors, and
$50mm in cash, what is the company’s liquidity?
Cash represents $50mm in liquidity as a base. $10mm is due to vendors, so total liquidity before the revolver
is used is $40mm. The revolver is secured up to $85mm, with $35mm already drawn: $85mm - $35mm =
$50mm left to be drawn. $50mm + $40mm = $90mm total liquidity

19. Why would a company with positive EBITDA go bankrupt? [Moelis & Co. 2021 First Round]
- Positive EBITDA =/= Positive Cash Flow
- Company does not need to run out of cash flow to go bankrupt
o Insolvency (assets < liabilities)
o Covenant breach
 o Liquidity crunch
- Accelerated payments
- Large one-time expense

BUSINESS KNOWLEDGE
1. What distinguishes a good business from a good investment?
You need to be able to buy into a good business at an attractive price for it to be a good investment.

2. Company A can produce oil at $50 / barrel. Company B can produce oil at $30 / barrel. Oil sells
for $70 today, and will sell for $100 in a year. Which company would you rather invest in?
Invest in Company A --> margins will expand from $20 to $50 (versus $40 to $70 for Company B), a far
greater relative margin expansion.

3. What makes a good business?

Look at this from a top-down analysis.
Belongs to a strong industry (tailwinds, growth, low regulatory risk, high barriers to entry) --> Competitive
Advantage (supply-side, demand-side, economies of scale) --> Good Management Team (flexibility) -->
Stable Cash Flows, Low Maintenance Capex, etc.

4. Why would a company stay private?

• Not at the whims of public shareholders that want strong quarterly results – makes you freer to
optimize operations and not worry about short-term gains
• Less strict reporting requirements – get to keep financials private
• Less intense accounting standards
• Save on the costs of reporting and releasing financials

5. A company sells two types of chairs. In two years, it sells the same total number of chairs and the
same volume of chairs, but its gross margin increases. How could this happen?
1. The company sells more of the chair that is cheaper to produce.
2. The input prices for the chairs decrease.
3. Accounting standards change.

6. If there are two companies in the same industry, what qualitative factors would cause one to trade
at a higher price point than another?
It all comes down to risk and growth prospects. Major news points, competitive advantages, management,
future growth prospects, etc., could all be valued into the company with a higher price point.

7. Scylla Corp trades for a P/E multiple of 4x. Charybdis Corp trades for a P/E multiple of 10x. Both
companies are in the same industry and have similar business models. List as many reasons as you
can think of that could explain such a difference.
• Charybdis may have a strong competitive advantage not reflected in its financial statements
• Major litigation or news may depress Scylla Corp’s valuation and/or improve the market sentiment
on Charybdis
• Future growth prospects may be stronger for Charybdis than Scylla
• A strong management team may also inspire more investor confidence in Charybdis
• Charybdis may have recently exceeded earnings expectations, or Scylla may have missed guidance
8. What are some common uses of cash on a company’s balance sheet?
1. Capital Expenditures (investments into the company)
2. Dividends
3. Debt Repayments
4. Stock Buybacks
5. M&A (artificial growth through acquisition)

9. You invest $50m in a company. It generates $0 in LFCF currently. You can either sell your stake
for $55m immediately, or invest another $50m in the company and it will begin to generate $3m in
LFCF into perpetuity. Which would you rather invest in?
It depends. Selling your stake initially generates a 10% return instantly, which can then be reinvested into the
market. The value of doubling your investment depends on the discount rate. For example, if these securities
are guaranteed by the government, then if the risk-free rate (the effective discount rate) is low, it makes sense
to choose this option. However, if they are not guaranteed by the government and the market return is higher
than 3%, it makes sense to sell the stake immediately.

10. When is a company over-levered?

A company is over-levered when the burden of interest payments and mandatory debt repayments damages
the company’s ability to grow effectively and pursue new growth opportunities (the original purpose of taking
on additional leverage) through excessive use of cash. A company is insolvent when it can no longer meet those
debt obligations.

11. Does a weaker $CAD help or hurt exports? Why and when would it hurt?
A weaker $CAD typically helps exports as it reduces the relative price of exported goods and makes them
more competitive in the international markets, improving commerce. It would hurt exports if the value of the
dollar deflates significantly due to high inflation, making it unstable as a currency, which would inhibit trade.

12. A holding company and operating company both have debt on their balance sheets. Which debt
is likely to be more senior?
The debt of the operating company is likely to be more senior as (1) it has more assets available for collateral,
and can therefore secure its debt, and (2) it generates its own internal operational cash flow, whereas a
holding company simply holds other assets that generate cash flow.

13. If a company has international offices, and has cash in the system, how would you transfer cash
to one of the international jurisdictions?
To transfer cash to one of the international jurisdictions (as there are limitations in place to transferring
wealth across sovereign borders), raise debt in the intended target jurisdiction collateralized against the
company’s subsidiary with the cash balance (regardless of its location).

14. Which sectors have the most spending fluctuations?

Typically, natural resources and technology have the most and greatest spending fluctuations. Natural
resources and mining firms typically forecast expenditure based on specific geographical and time-sensitive
projects, with significant growth capital fluctuations as a result of new well-drilling and initial operation. In
turn, these projects are driven by returns that are based on overall health of the economy and commodity
prices (the latter of which can swing wildly). Technology firms also require significant equity funding for
specific new ventures and do not take on significant additional debt (until reaching suitable scale and
profitability). As a result, with many companies not yet at this mature stage, capital is deployed in stages
coinciding with funding and specific projects.

15. If you are running a company with no cash balance, good cash flow, and you wish to delever,
how can you do this?
1. Use operational cash flow to pay down debt at a reasonable rate.
2. Raise equity in the public markets
3. Raise equity in the private markets

16. If you run a company that has prepaid contracts and A/P of 30 days, will you need a cash loan?
If the company has prepaid contracts, it is receiving payment upfront before completing the contract. As a
result, its DSO (or days of receivables outstanding) is negative, which significantly reduces the length of cash
conversion (Cash Conversion Time = DSO + DIO – DPO). Therefore, it is unlikely the company will need a
cash loan.

17. How do you determine an appropriate capital structure for a business?

In general, a stable company should take on debt to improve its ability to execute on growth projects
(whether organic (greenfield, brownfield) or inorganic), but should not impede the company’s stability and
ability to grow earnings past the short-term. Once debt begins to significantly diminish cash flow and hurts
growth prospects, the company is over-levered. However, the specific capital structure of a business depends
on its strategy.
Depends on the strategy of the business.
• Businesses that are early-stage (i.e. looking to grow rapidly, but very risky) are likely to be financed
almost entirely with equity – like tech and bio-tech start-ups
• Taking on significant additional debt can also be acceptable when purchased by a financial sponsor as
long as the business supports it

Special

BRAIN TEASERS

OTHER

1. Pitch me a stock.

2. Tell me about a recent deal.