14 hard tech questions Flashcards
Walk me through a Leveraged Buyout (LBO) model.
- Calculate the total acquisition price, including the acquisition of the target’s equity, repayment of any outstanding debt, and any transaction fees (such as the fees paid to investment banks and deal lawyers, accountants, consultants, etc.)
- Determine how that total price will be paid, including:
- Equity from the PE sponsor,
- Roll-over equity from existing owners or managers,
- Debt, seller financing, etc. - Project the target’s operating performance over ~5 years and determine how much of the debt principal used to acquire the target can be paid down using the target’s FCF over that time.
- Project how much the target could be sold for after ~5 years in light of its projected operating performance; Subtract any remaining net debt from this total to determine projected returns for equity holders.
- Calculate the projected IRR and MoM return on equity based on the amount of equity originally used to acquire the target and the projected equity returns upon exit.
What might cause a company’s Present Value (PV) to increase or decrease?
Factors that may cause a company’s PV to increase:
- An increase in cash flow causes an increase in future value (FV)
- An increase in the growth rate of future cash flows
Factors that may cause a company’s PV to decrease:
- Increased discount rate
- Delay in receiving future cash flows
- Reduction in the growth rate of future cash flows
How would a significant event impact financial markets?
The COVID-19 Delta Variant is predicted to cause an upsurge in total worldwide cases, therefore volatility would increase within the stock market as speculating investors debate the impact of the variant. This may cause a runover effect with the Federal Reserve System keeping interest rates low moving forward.
How do interest rates affect the market?
An increase in the interest rates will affect the cost of borrowing for companies. This means a lesser amount of funding from banks, which leads to companies having slower growth on average as compared to before the interest rate hike.
The higher cost of borrowing will also affect DCM. I would expect companies to issue fewer bonds or maintain the same capital structure but cut back on other expenses e.g. layoffs. Given the slower growth of companies, I would expect lesser interest from investors on IPOs. The slower growth and low valuations will then lead to an increase in M&A by strategics. On the other hand, the higher cost of borrowing might reduce the amount of leveraged M&A activity at the same time.
Overall, I feel that the increase in interest rates will affect M&A and capital markets negatively, and thus hiring will be down next year.
Are there any special multiples that only apply to some industries or sectors?
Retail or Airlines: EV / EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization & Rental Expense)
Energy: EV / EBITDAX (Earnings Before Interest, Taxes, Depreciation, Amortization & Exploration Expense), EV / Daily Production, EV / Proved Reserve Quantities
Technology (Internet): EV / Unique Visitors, EV / Page views
If there was an earthquake in a country, what would happen next year to the country’s GDP growth compared to the year of the earthquake?
An earthquake would cause the country’s GDP to immediately decline sharply due to the immediate effects of the earthquake as a lot of productive resources may be put out of use. But then the GDP growth will start to increase to an above-average level as there would be an increased amount of spending on rebuilding the infrastructure.
Can a company have a negative book equity value?
Yes, a company could have a negative book equity value if the owners are taking out large cash dividends or if the company has been operating for a long time at a net loss, leading to the company having to take on debt to fund loss of cash. Eventually, equity can be negative implying that the entire operation is funded by debt.
What is risk?
There are many different types of risks that businesses, and individuals alike, experience.
Credit Risk - This is the risk of a possible loss being incurred by a business or an individual, should their borrower fail to repay a loan or meet contractual obligations. It is impossible to quantify credit risk and precisely predict which borrowers will default on loans, but there are risk management teams built to minimize a business’ risk and manage their credit exposure. An example of credit risk would simply be a bank lending a citizen a loan of $100,000 to start their business as an entrepreneur, on which the bank incurs the risk of not having the loan repaid should the citizen’s business go bankrupt.
Interest Rate Risk - This is the risk incurred where there may be a reduction in the value of investment assets should the interest rate environment change drastically in a short period. An example of this would be that if interest rates increased, the value of fixed-income investments would decrease.
How do you calculate Terminal Value?
Terminal Value or TV is the value of any investment at the end of the investment period. This will usually assume a constant growth rate into the future. it can be calculated by applying an exit multiple to the company’s last projected year’s EBITDA, EBIT, or Free Cash Flow (multiples method). Alternatively, the Gordon Growth method can be used to estimate TV based on its growth rate into perpetuity.
The formula for calculating TV without accounting for growth is:
Expected cash flow / (1 + Required rate of return)^Time
The formula for calculating TV using Gordon Growth is:
Terminal Value = Expected dividend / (Required rate of return – Growth rate).
What does an investment banking division do?
The investment banking division is sometimes referred to as corporate finance and is broadly split into 2 sectors, products and industries. The purpose of both is to provide advisory on transactions, mergers, and acquisitions and to arrange (and sometimes even provide) financing for these transactions.
Investment banking product groups are broken down into:
- Mergers and Acquisitions (M&A): Advisory on sale, merger, and purchase of companies.Web picture of Bank
- Leveraged Finance (LevFin) - Issuance of high-yield debt to firms to finance acquisitions and other corporate activities.
- Equity Capital Markets (ECM) - Advice on equity and equity-derived products (IPOs, shares, capital raises, secondary offerings, etc.)
- Debt Capital Markets (DCM) - Advice on raising and structuring debt to finance acquisitions and other corporate activities.
- Restructuring – Improving the structures of a company to make it more profitable or efficient.
If a REIT is trading below NAV, what strategic options would you provide them as a banker?
M&A seems to be off the table because REITs have low cash balances and can’t do stock issuances because they would be dilutive. Therefore, my advice would be to basically sell assets in non-core markets to raise cash.
Walk me through the full math for the deal now. Assume that Company A has 10 shares outstanding at a share price of $25.00, and its Net Income is $10. It acquired Company B for a Purchase Equity Value of $150. Company B has a Net Income of $10 as well
Company A’s EPS is $10 / 10 = $1.00.
To complete the deal, Company A must issue 6 ($150 / $25.00) new shares which means that the combined share count after the deal is 16 (10 + 6).
Since no cash or debt was used and the tax rates are the same and the combined net income = Company A net income + Company B net income = $10 + $10 = $20.
The Combined EPS, therefore, is $20 / 16 = $1.25, which is an increase of 25% in the EPS, and this is what is called accretion.
Company A is acquiring Company B; firm A has a stock price of $10/share, B’s share price is $20/share. A has a $4 Cash Flow (CF)/share and B $8 CF/share; is the deal accretive or dilutive if the transaction was all-stock?
Thinking of cash flow/share the same way as earnings per share, the PE for A is 2.5 and B is 2.5. As both their EPS are equal, the transaction is neither accretive nor dilutive.
Company A has an Enterprise Value (EV) of $1B, an EBITDA of $200M and is leveraged 2.5x wants to buy company B which has EBITDA of $100M; A will finance the acquisition with $250M debt; how does this transaction affect leverage? What if the deal was e
You need to remember that the leverage multiple stands for Debt/EBITDA; so calculating out the leverage multiples, you will see both A and B are leveraged at 2.5, hence, the combined leverage multiple of A and B is still 2.5; if the transaction is equity-financed, the leverage would decrease and the company would be de-leveraged; deals are usually more accretive with debt due to tax deduction on interest expense.
