Q&A on Investment Banking topics

In this article we have listed down important Q&A on Investment Banking topics. Hope it helps you learn about some important concepts which would also help you in cracking Investment banking interviews.

Q&A on Investment Banking topics – Merger & Acquisition (M&A)

1. Briefly explain the process of an buy-side M&A deal

• Analyst spend lot of time in researching potential acquisition targets and multiple cycles of selection and filters are applied.
• Narrow down the list and decide which ones are to be further approached.
• Meetings are conducted to gauge the receptivity of potential seller.
• Serious discussions with the seller take place which calls for in depth due diligence and figuring out the offer price.
• Negotiate the price and other key terms of the purchase agreement.
• Announce the M&A deal/transaction.

2. Briefly explain accretion and dilution analysis

• In order to gauge the impact of an acquisition to the acquirer’s Earnings per share (EPS) and also compare it with the company’s EPS if acquisition would have not been executed accretion and dilution analysis is undertaken.
• In simple words we could say that in the scenario of the new EPS being higher, the transaction will be called “accretive” while the opposite would be called “dilutive.”

3. Given a situation where a company with a low P/E acquires a company with a high P/E in an all-stock deal, will the deal likely be accretive or dilutive?

• Other things being equal, in a situation where a company with a low P/E acquires a company with a high P/E, the transaction would be dilutive to the acquirer’s Earnings per Share (EPS).
• The reason for this is that the acquirer will have to shell out more for each dollar of earnings than the, market values its own earnings. Therefore in such situation the acquirer would have to issue proportionally more shares in the transaction.

4. What are synergies and its types?

• Synergies are where the buyer gets more value than out of an acquisition than what the financials would predict. There are basically two types of synergies:
  • Revenue synergy: the combined company can cross sell products to new customers or up sell new products to existing customers. Because of the deal it could be possible to expand in new geographies.
  •  Cost synergies: the combined company could amalgamate buildings and administrative staff and can lay off redundant employees. It could also be in a position to close down redundant stores or locations.

Q&A on Investment Banking topics – Valuation

1. Describe the ways through which a company is valued

• Precedent transaction analysis: This is when you look at how much others have paid for similar companies to determine how much the company is worth. To use this method effectively you need to be extremely familiar with the industry of the company you are valuing as well as the normal premiums paid for such a company.
• Comparable Company Analysis: it is similar to Precedent Transactions Analysis except you are using the whole company as an assessment unit, not the purchase of a company. So to use this method you would also look for out similar companies to the one you are valuing and look at their price vs. earnings, EBITDA, stock price and any other variables you think would be an pointer of the health of a company.
• Discounted Cash Flow Analysis: This is when you use future cash flow, or what the company will make in the upcoming years, to determine what the company is worth now. To calculate DCF you need to work out what the probable or future cash flow is for a company for the next 10 years. Then work out how much that would be in today’s terms by “discounting” it at the rate that would give a return on investment. Then you add in the terminal value of the company and that will tell you how much the company is worth.

2. Which are the situations in which we do not use a DCF in the valuation?

• We would not use a DCF in the valuation if the company has an unstable or unpredictable cash flow or when debt and working capital serve a fundamentally different role.
• For example financial institutions like banks do not re-invest debt and working capital forms a major part of their balance sheets- so here we do not use a DCF for such companies.

3. List the most common multiples used in valuation

•  EV/Revenue
• EV/EBITDA
• EV/EBIT
• P/E
• P/BV

4. Explain PEG ratio?

This stands for Price/earnings to growth ratio and takes the P/E ratio and then accounts for how fast the EPS for the company will grow. A stock which is growing rapidly will have a higher PEG ratio. A stock that is fine priced will have the same P/E ratio and PEG ratio. So if a company’s P/E ratio is 20 and its PEG ratio is also 20 some might argue that the stock is too expensive if another company with the same EPS has a lower P/E ratio, but that also means that it’s growing faster because the PEG rate is 20.

5. Give the formula for Enterprise Value?

The formula for enterprise value is:  market value of equity (MVE) + debt + preferred stock + minority interest – cash.

6. Why do we consider both enterprise value and equity value?

Enterprise value signifies the value of the company that is attributable to all investors, whereas equity value represents the portion available to equity shareholders. We consider both because equity value is the number the public at large sees, while enterprise value represents its true value.

7. What does it signify, if a company has a negative enterprise value?

The company could have negative enterprise value when the company has extremely large cash balances or an extremely low market capitalization or both. This could occur in companies which are:

1. On the brink of bankruptcy
2. Financial institutions such as the banks, which have large cash balances.

Q&A on Investment Banking topics – Initial Public Offer (IPO)

1. Briefly describe what would you do if you are working on an IPO for a client

• First of all we would meet the client and gather all the necessary information such as their financial details, customers and learn about the sector they belong to.
• After this you would meet other bankers and lawyers the registration statement which would describe the company’s business and market to its investors.
• Next you would receive comments from the SEC and keep revising the document until it is acceptable. Now you would spend the coming weeks in organizing road shows where you would present the company to the institutional clients and also convince them to invest in them.
• After raising capital for the clients the company would start trading on the exchange.

Q&A on Investment Banking topics – Miscellaneous

1. What is in a pitch book?

Pitch book depends on the kind of deal the company is pitching for but the common structure would include:

• Bank credentials to prove their expertise in completing similar deals before.
• Summary of company’s options
• Appropriate financial models and valuation
• Potential acquisition targets or potential buyers
• Summary and key recommendations

2. Explain what makes up a cash flow statement

The place to start when looking at a cash flow statement is the beginning cash balance. Then you must look at cash from operations, and then the cash made from any investments, then cash from financing. All of that will make up the ending cash.

3. When buying a company why do private equity firms use leverage?

• The private equity firm reduces the amount of equity to the deal by using significant amounts of leverage (debt) to help finance the purchase price.
• By doing this it will increase the private equity firm’s rate of return substantially when exiting the investment.

4. What is convexity?

• Convexity is a more accurate measure of the relationship between yield and price changes in bonds in relation to the change in interest rates.
• Duration calculates this as a straight line, when in actuality it is a convex curve, hence the name. This is used as a risk calculation because it can tell how a bond yield will respond to interest rate changes.

5. Define risk adjusted rate of returns

• When looking at an investment you cannot simply look at the return that is projected. If the profit from investment A is greater than the profit from investment B you may immediately want to go with investment A.
• But investment A might have a greater chance of a total loss than investment B so even though the profit may be larger, it is a lot riskier and therefore not necessarily a better investment.
• Adjusted rate of return is when you not only look at the return that an investment may give you, but you also measure the risk of that investment.
• The adjusted rate of return is usually denoted as a number or rating. If you are technically minded you may also want to mention the ways that risk is measured: beta, alpha, the Sharpe ratio, r-squared and standard deviation.

6. Briefly explain leveraged buyout?

• A leveraged buyout (LBO) is when a company or investor buys another company using mostly borrowed money, loans or even bonds to be able to make the purchase.
• The assets of the company being acquired are usually used a collateral for those loans. Sometimes the ratio of debt to equity in an LBO can be 90-10. Any debt percentage higher than that can lead to bankruptcy.