16 common IB industry specific questions Flashcards
(Consumer&retail)
If the CFO of the company needs to increase their margins for the quarter but revenue is lower than in the past, what would you recommend doing?
The answer to increasing your margins while having lower revenue is to cut back on expenses.
Revenue - expenses = gross profit and gross profit/revenue = gross margins.
(Consumer retail)
If assets increase by X amount what would happen to shareholders equity? Are assets recorded at cost, market value, or book value?
The increase in shareholders equity would be equivalent to the increase in assets (x), due to the effect of the equation below:
Assets = Liabilities + Shareholders equity.
Assets are recorded at cost (what you paid for them).
(Energy and Utilities)
What are some possible regulatory issues facing the power sector?
The main regulatory hurdle that the power sector faces is distributed electricity generation. Distributed generation poses a threat to existing power utilities because it takes away power demand from them.
However, there are a number of ways in which to handle this emerging trend. One way is to structure tariffs in a way that increases affordability. The other is to offer time-of-use tariff structures that can flatten the duck curve, which occurs when renewables ramp down in the evenings, exactly when electricity demand is highest.
(Energy and Utilities)
How would you forecast the forward-year production of an E&P company with a well-established production history?
If we assume it’s a single asset company, we can estimate the capital efficiency based on historical data and apply it against the company’s CAPEX forecast to reach a “new additions” production estimate. From there, applying the historical asset production decline rate against “base” production and summing the numbers together leads us to a forward estimate.
(FIG)
Graph the WACC as a function of the debt-to-equity ratio.
WACC decreases at low levels of leverage due to the tax shield created by interest payments and then increases exponentially due to the increasing riskiness of investing in a highly levered company.
(FIG)
Walk me through a DCF and a DDM for FIG and explain how they are different.
A DCF involves predicting the unlevered free cash flows that a business will generate, discounting it into the present and then adding it up to get the enterprise value.
A DDM on the other hand only looks at dividends the company pays, and then divides it using the required rate of return to find the value of equity.
A DCF typically spits out an enterprise value whereas DDM is an equity value based on the present value of projected free cash flow to equity (% of dividends for a bank since they have regulatory capital requirements, which is a limiter on growth assumptions on a bank DDM).
(Healthcare)
When would you use DCF vs. trading comps to value a company?
Comps are more market-based and sensitive to environmental trends, such that in times of high valuations (such as now), comps > DCF, and in times of lower than FMV valuations, DCF > comps.
(Healthcare)
Why is there no terminal value for biotechnology companies?
This is because biotech companies don’t operate in perpetuity, we assume that once the patent ends, generics will flood the market driving profits close to zero.
(Industrials)
What is the difference between a levered and unlevered beta?
Levered beta measures the risk of a firm with debt and equity in its capital structure to the volatility of the market. Unlevered beta removes the debt component.
(Industrials)
When you’re doing a DCF, how do you calculate the terminal value using the multiples method?
Take terminal year EBITDA, calculate TEV using current EV/EBITDA multiples of comp set, and take the present value of that total.
(Natural Resources)
Rank the betas of four segments of the oil industry: 1. Upstream 2. Downstream 3. OFS 4. Midstream
- Upstream
- OFS
- Downstream
- Midstream
Upstream is likely to be the most volatile, due to its association with risk of exploration and sensitivity to prices. OFS is second because it’s adjacent to upstream. Downstream is third because demand is relatively inflexible and is subject mostly to price sensitivity. Midstream is the lowest beta because it’s a volume business.
(Natural Resources)
What’s a Section 338(h)(10) election and why might a company want to use it in an M&A deal?
A Section 338(h)(10) election blends the benefits of a stock purchase and an asset purchase.
- Legally it is a stock purchase
- However, accounting-wise it’s treated as an asset purchase.
- The seller is still subject to double-taxation – on its assets that have been appreciated and on the proceeds from the sale.
- The buyer receives a step-up tax basis on the new assets it acquires, and it can depreciate/amortize them so it saves on taxes.
Even though the seller still gets taxed twice, buyers will often pay more in a 338(h)(10) deal because of the tax-savings potential.
It’s particularly helpful for:
- Sellers with high NOL balances (more tax-savings for the buyer because this NOL balance will be written down completely – and so more of the excess purchase price can be allocated to asset write-ups).
- If the company has been an S-corporation for over 10 years – in this case, it doesn’t have to pay a tax on the appreciation of its assets.
The requirements to use 338(h)(10) are complex and bankers don’t deal with this – that is the role of lawyers and tax accountants.
(Real Estate)
How would you underwrite a real estate loan?
- Find key ratios LTV, DSCR, Debt Yield
- Assess property value
- Assess similar properties in the area
- Go over potential covenants
(Real Estate)
What do you look at when deciding whether or not to invest?
Some statistics to consider in such a situation would be,
- Market Stats (Cap Rate, Rent, Vacancy)
- Asset Class
- Value add or Core
(TMT)
What is the difference between MOIC and IRR?
MOIC’s simplistic calculation tells investors how much money they’re ultimately receiving from an investment while IRR includes the impact of time over which the returns were generated.
