Mock Interview Technical Questions

- What are the three places that tax comes up on the DCF?
o In calculating Unlevered FCF when you multiply EBIT by (1-Tax Rate)
o In the cost of debt in WACC because you multiply the interest rate by the (1-Tax
Rate)
o In calculating Unlevered and Levered Beta
- What happens when depreciation goes up by $10 on the DCF?
o EBIT falls by $10
o You multiply EBIT*(1-Tax Rate) so NOPAT falls by $6
o You add back depreciation so Unlevered FCF goes up by $4
- Where is the circular reference in a DCF?
o # of diluted shares depends on what’s in the money
o What’s in the money depends on the share price
o Share price depends on equity value which depends on the # of diluted shares
- What are some ways you can boost IRR?
o Lower Purchase Price
o Higher Exit Multiple
o Increased Leverage
o Operating assumptions like higher revenue growth, higher EBITDA margin
o Shorter time horizon
- A company has $100m of EBITDA, a 10x Purchase Multiple, financed through 60% debt,
sells at a 9x exit multiple, grows EBITDA to $150 million, and pays off $250 million of debt.
What is the IRR if the time horizon is 5 years?
▪ $1,000 million purchase price
▪ $600 million debt
▪ $400 million equity
▪ $1,350 million exit price
o (400 million)
o 1,350 million
o (600-250=350 million)
o 400 million → 1000 billion
o A bit over 2x in 5 years – so it is approximately 18-19% IRR
- Company A has a Net Income of $300,000, $40 share price, and 100,000 shares. Company
B has Net Income of $200,000, $80, and 25,000 shares. If Company A acquires Company B
for $2,000,000 using 50% debt and 50% equity, is this deal dilutive or accretive? The
interest rate is 5% and the tax rate is 30%
o Company A has a pre-deal EPS of $300,000/100,000 = $3.00
o $1,000,000 of equity → Company A has to issue 25,000 new shares.
o New share count after acquisition is 125,000 shares
o $1,000,000 of debt → $1,000,000*(.05) *(1-.30)= $35,000 cost of debt
o Pro-forma net income = $300,000+$200,000-$35,000 = $465,000
o Pro-forma EPS = $465,000/125,000=$3.72
o $3.72>$3.00 so the deal is accretive
- Company has $50 million of EBITDA and a 5x EV/EBITDA multiple. The company has $100
million of junior debt and $200 million of senior debt. What is the debt trading at?
o Enterprise Value = $250 million
o You use that money to pay off senior debt first and you have enough, so the senior
debt is trading at par value
o You have $50 million remaining to pay off junior debt so the junior debt is trading at
50 cents on the dollar.
- You buy $100 of capital assets with $50 of cash and $50 of debt. How does this affect the
three statements immediately after the purchase?
o Income Statement: no changes
o Cash Flow Statement: cash flow from investing decreases by $100 and cash flow
from financing increases by $50 → net change in cash is -$50
o Balance Sheet: cash account falls by $50, PP&E increases by $100, and debt
increases by $50
- Let’s say that the residual value of the capital assets are $40 and their valuable lifetime is
4 years. The interest rate on the debt Is 10% (5% cash interest and 5% PIK). The tax rate is
40%. How does this affect the three statements at the end of the first year?
o Income Statement: depreciation expense is $15 and interest expense is $5. So pre-
tax income falls by $20 and net income falls by $12.
o Cash Flow Statement: net income flows through at -$12. We have to add back the
$15 of depreciation and the $2.50 of PIK interest. So, the cash flow from operations
is +$5.50 and the net change in cash is $5.50.
o Balance Sheet: cash account increases by $5.50 and PP&E falls by $15 from the
depreciation. The PIK interest of $2.5 accumulates to the interest principal and the
decrease in net income flows into the retained earnings account. So both sides of
the balance sheet balance out with a reduction of $9.50.
- If WACC goes up, can Enterprise Value ever go up?
o Yes, if there are negative cash flows because the higher WACC would discount the
negative cash flows to a smaller loss.
- How do you get from Levered FCF to Unlevered FCF?
o You add back after-tax interest expense and you add back mandatory debt
repayments
- Two companies have the same Enterprise Value. Company A has 50% debt and 50%
equity, while Company B has 100% equity. The Enterprise Value of both companies goes
up by the same amount. Which company should you invest in?
o You should invest in Company A because if both companies’ enterprise values went
up to the same amount, it means that Company A’s equity value increased by more
considering the addition of net debt.
- Rank this in order of biggest impact to smallest impact on valuation: CapEx, Revenue, and
Operating Expenses
o 1) CapEx
o 2) Operating Expenses
o 3) Revenue
 ▪ Think of these in if they changes by $5 considering all the stuff you would
have to deduct before ending up at Unlevered FCF.
- How do companies spend excess cash?
o 1) Issue Dividends
o 2) Invest in Capital Expenditures
o 3) M&A
o 4) Buyback shares
o 5) Pay off debt
- Two companies have a Net debt/Ebitda multiple of 5x. Then, company A issues debt and
company B issues equity. What happens to their Net debt/Ebitda multiples?
o Company A’s multiple doesn’t change because the increase in total debt and the
increase in cash from the debt cancel each other out
o Company B’s multiple will decrease because the total debt doesn’t change but the
cash increases, lowering net debt, and multiple.
- A company has a leverage multiple of 5x and an Interest coverage ratio of 5x. What is the
interest rate of the debt?
o Net Debt/Ebitda = 5x
o Ebitda/Interest = 5x
o You want to find interest/debt multiple, so you multiply the two ratios given to get
net debt/interest = 25x
o Then, you find the reciprocal which is 4%
- Going from LIFO to FIFO, how does net income and cash flow change. What if you include
the effects of tax in it? Terminal value?
o LIFO to FIFO means lower COGS -> higher gross profit -> higher net income
o However, you add back changes in net working capital for UFCF so it balances out
o You have more assets $ on your balance sheet so + working capital and you - change
in NWC
o Including impacts of tax -> because NWC isn't impacted by tax, it has a greater
magnitude and cashflows decrease
o Multiples method -> increases valuation because EBITDA is higher
o Gordon growth -> decreases valuation because UFCF is lower
- Company A has 10 shares, $25 shares, and $10 Net Income. Company B has an equity
value of $150, Net Income of $10. In an all-stock transaction is this deal accretive or
dilutive?
o The pre-deal EPS of Company A is $10/10= $1.00
o Company A will have to issue 6 new shares to purchase Company B. The pro-forma
number of stocks is 16 shares.
o The pro-forma Net Income is $20 so the EPS after the deal will be $20/16 = $1.25.
o So, the deal is accretive.
- What if this deal was all debt now? What interest rate would you have to be on the debt
for the pre-deal EPS to equal the pro-forma EPS?
o The pre-deal EPS of Company A is $10/10=$1.00
o The post-deal number of shares in Company A would be 10 shares.
 o The post-deal net income would be $20. Therefore the cost of debt has to be $10 so
$10/10 =$1.00.
o $10 = $150*x*(1-40%)
o $10 = $150*(60%)*x
o $10 = $90x
o X = $10/$90
o Interest Rate = 11%
- D/E x-axis and WACC y-axis -> u shaped
- D/E x-axis and unlevered beta y-axis -> horizontal line
- D/E x-axis and levered beta y-axis -> positive linear line

- In a DCF, you start with 100 in AR, in year 4 AR goes up by 50 but in year 5 AR goes down
by 50. What happens to cash flows and valuations
o Year 4 has 50 cash inflow and year 5 has 50 cash outflow
o Because year 5’s cashflow has a bigger discount. Year 4’s increase is greater and you
get cash sooner which decreases cash flow. Your terminal value stays the same but
the present value of your projection period decreases and valuation decreases
- PE firm buys scuba diving company that mines gold out of Lake Ontario. There are 10
hotspots and it makes $1 million per hotspot found. What is its beta?
o Beta=0 because there is no correlation between market’s performance and this
company’s returns
- Lottery ticket beta?
o Beta=0
- Beta of company looking for sunken shares in Lake Ontario.
o Beta of just over 0 around 0.1 because there is an extremely low probability of
finding them but a bit higher because if it you find them it will be impacted by
market performance.
- Hotdog stand outside Bay Street. What is its beta?
o Just under 1 because it is dependent on market and economic conditions
- These three companies above have those betas. What is the impact on their valuation?
o Lower beta = lower discount rate = higher free cash flows = higher valuation
- Which company would you buy theoretically based on these betas?
o The company with a beta of 0 because it has the highest value.
- Would CPP also agree with this?
o No, because there are no realized revenues, the market risks are different, etc.
- What would you do to fix this mechanically?
o You would put a premium on the cost of equity to account for this.
- Two companies have revenue of $200 each and their combined revenue is $450. If there
are no revenue synergies, how is this possible?
o If both companies have a non-controlling interest in a third company. If they merge
and the percentage of the third company becomes more than 50%, then we would
have to include the revenues of that third company on their income statement.
o If a company shifts between accrual basis of accounting and cash basis of
accounting, it can sometimes change the company’s revenues.
- 4. News has just broken about the BP oil spill. In response, BP’s market cap has fallen by
$40 million. Is this justified?
o 1) What are the litigation fees and financial penalties expected?
o A: $100 million, paid upfront.
o 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?
o A: Yes.
o 3) The cash will therefore have to be generated through an asset sale of $100 million
in assets. What is the ROA?
o A: 5%.
o 4) Can we use return as a proxy for cash?
o A: Yes.
o 5) $100 million * 0.05 = $5 million cash lost through the sale of assets. What is the
Cost of Equity?
o A: 10%.
o 6) This is a perpetuity of -$5 million, so -$5 million / 0.10 = -$50 million. Therefore,
the market underreacted.
- A company has revenue of $100 and an EBITDA margin of 20%. 40% of its costs are fixed
and 60% are variable. If revenue goes up by 10%, what will happen to EBITDA?
o Revenue goes up to $110
o Costs are $80 initially
o Fixed costs are 40% of $80 = $32
o Variable costs are 60%*80%*=48%
o 48%*110=52.8
o 110-52.8-32=$25.2 of EBITDA
- A company has $2 billions of Assets, a 3x Debt/Equity ratio, and a 2x Price/Book ratio.
What is the market cap of the company?
o A company has 3x debt/equity ratio, so it is a quarter equity and three quarters
debt. Therefore, the equity of the company is $500 million.
o If the company is trading at 2x Price/Book, then the market cap of the company is $1
billion.
- A PE firm buys a company for $1 billion. It makes 10% of the purchase price as cash each
year. What is the IRR if the PE firm sells the company 7 years later?
o What is the exit price? They sell it for $1 billion.
o Therefore, the IRR of the company is 10% because that the purchase price equals
the exit price and 10% is what the company has returned each year.
o It is analogous to a bond.
- One bond has a coupon of 8% and yield of 10%. Another has a coupon rate of 10% and a
yield of 8%
o Second is trading higher at a premium to par value, higher yield is discount to par
value.
- What are the four differences between Cash Flow from Operations and Unlevered FCF?
o Unlevered FCF includes CapEx
 o Cash Flow from Operations includes Interest Expense
o They have different tax amounts – CFFO has tax After Interest Tax Expense and
Unlevered FCF has Pre-Interest Tax Expense
o CFFO has one-time expenses while Unlevered FCF adds back non-recurring charges
- Two companies have a P/E multiple of 10x. They merge in an all-stock deal and the deal is
accretive.
o Revenue synergies
o Expense synergies
o Leverage Synergies (bigger companies are seen as less risky and might be able to get
better credit terms)
o Tax Synergies (if the buyer has a lower tax rate than the seller)
- A company has a EV/Revenue multiple of 8x in 2017 and a EV/revenue multiple of 6x in
2018. The company has an EV/Ebitda multiple of 12x in both years. How is this possible?
o If revenue increased from 2017 to 2018 but the EBITDA margin got worse for some
reason over the year.
- One precedent transaction had a selling multiple of 10x while another was 5x - why could
this be the case?
o Some possible reasons:
▪ One company may be acquired by a financial sponsor rather than a strategic
buyer
▪ One transaction may have been acquired during a market upswing
▪ The transactions may vary by geography
▪ The size profile of the companies may differ
▪ One company may be going through litigation
▪ One company may have a competitive advantage
▪ One process may have been a more competitive bidding process
- A company has an EV of $1000 and a debt/total capital of 60%. If the shares are trading at
a 50% premium and there are 10 shares, what is the share price?
o Company has debt of $600 so you have to subtract this from EV to get the Equity
Value of $400.
o The shares are trading at a premium of 50% so the equity value of the company is
$600.
o Therefore, the shares are trading at $60 per share.
- Name 3 ways lowering tax rate affects your DCF valuation. What is the overall impact of
lowering the tax rate on your valuation?
o 1) Lowers cash tax, increasing cash flow
o 2) Increases cost of debt as it lessens the tax shield, decreasing cash flow due to
increased WACC
o 3) Increases cost of equity because leveraged beta is higher, increasing WACC and
decreasing cash flow
o Overall effect: uncertain.
- 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?
o Pre-deal EPS of $200/10 = $20
o The equity value of company D is 5*6=$30 and is bought at a 20% premium so the
company is bought for $36.
o Company C has to issue 6 new shares to acquire this company so it has 16 shares
outstanding after acquisition.
o The combined company’s Earnings is $200+$200 = $400.
o Therefore, the pro-forma EPS is $400/16 = $25 so the deal is accretive.
- Company A has a P/E multiple of 10x and Company B has a P/E multiple of 20x. Is the deal
dilutive or accretive? What assumptions do you have to about the deal?
o It is dilutive.
▪ That it is all-stock
▪ They have the same tax rates
▪ There is no premium on the deal or multiples have the premium factored in.
- Now Company A acquires Company B in an all-debt deal with a cost of debt of 10%. What
does the tax rate on the debt have to be for the deal to break-even?
o Company B’s yield is 1/20 = 0.05
o Cost of debt = cost of yield
o (1-Buyer’s tax rate)*.1 = .05
o 1-Buyer’s tax rate = 0.5/.1
o 1-.5 = Buyer’s Tax rate
o .5 = 50% buyer’s tax rate
- Company A has a share price of $50, 200 shares outstanding, 50 options at an exercise
price of $20, 30 RSUs, $6000 worth of convertible bonds convertible at $40 with a par
value of $1000. What is the dilutive Equity Value of the company?
o 200 shares outstanding
o 50*$20 = $1000 → $1000/50 = 20 options we can buy back → 50 - 20 = 30 new
shares created
o 30 RSUs → 30 new shares created
o $6000/$1000 = 6 convertible bonds → $1000/$40 = 25 shares created per bond →
25*6 = 150 new shares created
o 200+30+30+150 = 410 shares outstanding
o 410*50 = $20500
- A PE firm acquires a company with $50 million of debt and $50 of equity. It sells the
company in 2 years at a 20% IRR. What is the exit Enterprise Value of the company?
o $50 million purchase
o Company grows to 1.2*50 = $60 million in first year
o Company grows to 1.2*60 = $72 million in the second year
o $72 + $50 of debt = $122 million Enterprise Value
- 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?
o Market Cap / (P/E) = NI --> $200mm / 20 = $10mm.
o Total Debt = $20mm / 0.05 = $400mm.
 o Enterprise Value = $200mm + $400mm = $600mm (assuming no NCI, preferred or
cash). EBITDA = EV / (EV/EBITDA) = $600mm / 10 = $60mm.
o EBITDA – D&A – Interest = Pre-Tax Income = $60mm - $20mm - $20mm = $20mm.
o $10mm / $20mm = 50%. The effective tax rate is therefore 1 – 0.5 = 50%.
- A company has $10 of EBITDA, 3x leverage ratio, it grows to $15 of EBITDA in year 5, and
the company has a 2x MOIC multiple when sold. The purchase multiple equals the exit
multiple and no debt is paid off. What is the purchase multiple/exit multiple?
o 2 = Exit Equity Value/Purchase Equity Value
o Debt = 3*10=$30
o 2 = (15x-30)/(10x-30)
o 2(10x-30) = 15x-30
o 20x-60 = 15x-30
o 20x -15x = -30+60
o 5x=30
o X=6
o The exit multiple and purchase multiple are 6x Ebitda
- A company has 2x EV/Sales and 8x EV/EBITDA. What is its EBITDA margin?
o EBITDA margin = EBITDA/Sales
o Find reciprocal of one of the two multiples – ½
o 1/2*8 = 4x = Sales/Ebitda
o Reciprocal = 1/4 = .25 = 25%
o Company has an EBITDA margin of 25%
- One company has forward P/Es of 3x, 4x, and 5x over the next three years. Another
company has forward P/Es of 5x, 4x, 3x over the next three years. Which one should you
invest in?
o P/E = Equity Value/Net Income
o Generally, in forward multiples, the numerator stays the same and denominator is
falling.
o Therefore the company with falling forward P/E multiples is increasing in Net
Income
o So you would want to invest in the one with falling forward P/E multiples
o Same logic for EV/Ebitda mutliples
- Build out a SaaS Cash Flow Model of this company for the next five years. It has 100 initial
customers, 3 year contracts, $90 contract value. You add 10 new customers each year and
it has a 10% churn rate.
o Year 1: 100 customers*(90/3) = $3000 of ARR (annual recurring revenue)
o Year 2: 100+10 *(90/3) = $3300 of ARR
o Year 3: 110+10 *(90/3) = $3600 of ARR
o Year 4: 120+10-(100*.1) *30 = $3600 of ARR
o Year 5: 120+10 – (10*.1) *30 = $3870 of ARR
- The Rule of 40 states that, at scale, a company's revenue growth rate plus operating
margin should be equal to or greater than 40%
- GM manufactures 100% of its cars in the U.S only in $USD. It’s competitor has a factory in
Japan where they manufacture 30% of their cars, but they also only do business in $USD.
The Yen falls 20% and GM loses $50 million in market cap. Why did the market cap fall?
o The relative costs of the Japanese company falls and their operating margin
increases. Therefore, they are able to sell at a lower price and take sales away from
GM.
- The U.S car market is stagnant and 3 million cars are sold in the market. It is an oligopoly
with 3 main players (GM, Japanese manufacturer, and other) each selling 1 million cars
each. 1% decrease in price increases the volume of sales by 10,000 and each car represents
$100 cash flow. What this fall in market cap justified?
o .30*.20 = .06 = 6% → They can decrease the price of their cars by 6%
o Therefore they sell 60,000 more cars → they take 30,000 sales away from GM
o 30,000*100= 3,000,000 → GM loses $3 million in sales
o What is the discount rate? 10%
o -3,000,000/.10 = -$30,000,000
o Therefore the market underreacted by $20,000,000
- What can you do to reduce its effects?
o You can outsource production to Japan
o You could differentiate your product from competitors so your sales aren’t so elastic
o You could invest in the Japanese firm
- Where is the circular reference in an LBO?
o The interest expense on the Income Statement in an LBO model depends on how
much Debt is paid off over the course of a year – because the company pays interest
each quarter or each month.
o So normally in models you average the beginning and ending Debt balances to
determine the annual interest expense – but that also creates a circular reference
because the ending Debt balance depends on how much cash flow you had, after
paying for interest... but the interest itself depends on the ending Debt balance!
o To simplify models you can base the interest expense on only the beginning Debt
balance each year to get around this problem.
- Covid-19 impact on WACC?
o Break it down and think of the individual components of WACC: Cost of Equity, Cost
of Debt, Cost of Preferred, and the percentages for each one.
o Then, think about the individual components of Cost of Equity: the Risk-Free Rate,
the Equity Risk Premium, and Beta.
▪ The Risk-Free Rate would decrease because governments worldwide would
drop interest rates to encourage spending.
▪ But then the Equity Risk Premium would also increase by a good amount as
investors demand higher returns before investing in stocks.
▪ Beta would also increase due to all the volatility.
▪ So overall, we can guess that the Cost of Equity would increase because
▪ the latter two increases would likely more than make up for the decrease in
the Risk-Free Rate.
o Now, for WACC:
 ▪ The Cost of Debt and Cost of Preferred Stock would both increase as it would
become more difficult for companies to borrow money.
▪ The Debt to Equity ratio would likely increase because companies' share
prices would fall, meaning that Equity Value decreased for most companies
while Debt stayed the same...
▪ So proportionally, yes, Debt and Preferred would likely make up a higher
percentage of a company's capital structure.
▪ But remember: the Cost of Debt and Cost of Preferred both increase, so that
shift doesn't matter too much.
▪ As a result, WACC almost certainly increases because almost all these
variables push it up - the only one that pushes it down is the reduced Risk-
Free Rate.
o There's a simpler way to think about it as well: all else being equal, did companies
become more valuable or less valuable during the financial crisis?
o Less valuable - because the market discounted their future cash flows at higher
rates. So WACC must have increased.
- Company A with a P/E of 10x buys Company B with a P/E of 8x. Is this dilutive or
accretive?
o Is it an all stock deal? Yes.
o Cost of issuing stock = 1/10 = 10%
o Seller’s Yield =1/8 = 12.5%
o The deal is accretive
- The deal is dilutive. How is this possible?
o Disenergies like cultural differences, difficulty integrating, etc.
o The tax rate of the buyer is higher than the seller
o Company ended up paying too high premium for company B
- How NOLs impact EV?
o Net operating losses can be treated as deferred tax assets in the future so they are
sometimes subtracted from Enterprise Value like cash as they may result in savings
in the future.