16 IB group specific questions Flashcards
(M&A)
What are some reasons that would incentivize two companies to merge?
The main reason two companies would want to merge would be the synergies the companies could create by combining their operations. However, some other reasons include gaining a new market presence, an effort to consolidate their operations, gaining brand recognition, growing in size, or gaining the rights to some property (physical or intellectual) that they couldn’t gain as quickly by creating or building it on their own.
(M&A)
What is the difference between a strategic buyer and a financial buyer?
A strategic buyer is generally a corporation that wants to acquire another company for strategic business reasons such as synergies, growth potential, etc. An example of this would be an automobile maker purchasing an auto parts supplier in order to gain more control of their COGS and keep costs down.
A financial buyer is generally a firm looking to acquire another company purely as a financial investment. An example is a private equity fund doing a leveraged buyout of the company.
(LevFin)
If I have a credit card loan, a car loan, and a mortgage, explain and rank their relative interest rates.
The rank of each with respect to the interest rates they carry, from higher to lower are:
- Credit card
- Car loan
- Mortgage
A car loan and a mortgage are less riskier than credit cards as they are both secured by some Web picture of carcollateral. With the credit card, VISA can’t chase you down to get the takeout meal you purchased with it, so there are no assets to collateralize against.
A car loan is riskier than a home loan because a car loses its value much quicker. To compensate for the higher risk profile and lack of collateral, credit card companies charge much higher interest rates when compared to a typical car loan and mortgage while the risk associated with a lower value of collateral in car loans is why they carry higher interest rates compared to mortgages.
(LevFin)
If I have a hardware and a software company, both with the same revenue and EBITDA, which can I lever up more and why?
The software company because of recurring revenues from annual contracts that are even more guaranteed than a hardware store, assuming that both companies are mature.
(DCM)
What are some of the major macro factors that can affect the spreads on corporate bonds? Explain their effects.
Think about how bonds are priced – based on their discounted future cash flows. If any of those cash flows is in doubt, then the bond’s value falls accordingly. (Think of a UST bond as being priced with risk-weighted cash flows of 100%. A BBB bond might be priced with risk-weighted cash-flows of 95%, just as an example - although in reality the bonds are priced with a spread/all-in yield that implicitly contains the risk, rather than calculating the risk % driving the spread). So any macro event that would impact companies’ profitability/cash flow would affect the price of corporate bonds. That said, corporate bond spreads are more driven by micro factors than by broader economic trends unless those economic/systemic factors are very pronounced.
(DCM)
If the price of a bond increases, what happens to the yield?
The price and yield of a bond move inversely to one another. Therefore, when the price of a bond goes up the yield goes down.
The reason for this is that the return on a bond (when annualized, this is called yield) is the difference between its current price and future repayment (generally bonds are redeemed at par). The lower the price, the higher is the return as the repayment is constant regardless of its price. As the price increases, the return reduces thereby reducing the yield.
Let’s understand this better with the help of an example. Let’s assume a bond can be redeemed at a par value of $100 on maturity (one year from now). Let’s now assume that the bond is trading at $80. The yield on the bond can be calculated as 25% ((100/80) - 1). What if the price instead was $90? The yield reduces to 11.11% ((100/90) - 1). Hence, higher prices mean lower yields and vice versa.
(ECM)
What is an IPO?
An Initial Public Offering or IPO is the very first sale of stock to the public by a private company. This is also known as “going public”. Two kinds of companies will undertake an IPO:
- Startup companies looking to raise capital and investors
- Large private companies looking to become publicly traded
(ECM)
How would you calculate the WACC of a private company?
Since a private company has no market capitalization and no beta, you would most likely use the WACC for a comparable public company adjusted upwards for the lack of liquidity.
(Restructuring)
If a firm has a leverage ratio of 5x and it has an interest coverage ratio of 5x, what is the firm’s interest rate?
This depends on the formal definition of the leverage ratio, but assuming debt/EBIT is implied we can set up two simple equations:
- Debt/EBIT = 5
- EBIT / (Debt * Interest rate) = 5
Solving these equations we find that the interest rate is 4%.
(Restructuring)
Given an operating income of 40, depreciation of 10, a tax rate of 40%, interest expense of 15, and CAPEX of 15, what’s the levered FCF?
Assuming operating income is EBIT, add back depreciation (a non-cash expense) and deduct CAPEX to get Unlevered Free Cash Flow (UFCF) = 35. Then deduct the interest expense but add back interest tax shield, for the net expense of $9 (15 * (1 - 40%)) assuming 40% tax rate. This gives us a Levered Free Cash Flow (LFCF) of $26.
(ER)
In a high inflation environment, do you favor value or growth stocks?
Value, because the payoff will be quicker. In high inflation periods, short-duration equities are favored as cash flows are eroded less by the higher cost of capital imposed by higher inflation. Growth equities need a longer holding period before capital yielding projects are realized, at which point the discount factor will be higher making them subject to more erosion from inflationary pressure.
(ER)
Is it right to use WACC as the discount rate in a DCF model?
It depends, if the product portfolio of the company is vastly different with varying risk profiles, then it would not be right to use WACC as the discount rate. The discount rate is the cost of capital. If the risks in each product line are vastly different, so should the cost of capital. Using a broad stroke denominator such as the company’s WACC would not be right in this case.
(S&T)
How would you approach a client to sign them?
Two steps. I’d look at what they’re interested in, and then I’d look at how they wanted to change.
(S&T)
How can you create an equity portfolio with 0 beta?
Quite impossible for equities, 0 beta would be risk-free like treasuries. You would have to find two industries that were negatively correlated to remove idiosyncratic risks.
(Risk)
How do credit card companies make money? What are the costs?
They earn revenue through APR, interchange, late fees, and subscription fees and their primary costs are operations and marketing-related expenses.
