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Structural mechanics > BofA Interview Questions Technical > Flashcards

BofA Interview Questions Technical Flashcards

1
Q

Tell me about financial statements and why they are important.

A

The three common financial statements are balance sheets, income statements, and cash flow statements.

  • Balance sheets show a company’s assets and liabilities, including shareholder equity, debt, and accounts payable.
  • The income statement displays the company’s net income over a period of time and shows revenue and expenses.
  • Cash flow statements show a company’s cash flow from operating, financing, and investing activities.
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2
Q

What is enterprise value versus equity value?

A

Enterprise value - overall current value of the company considering debt and equity

Equity Value - measure of company’s value based solely on its outstanding equity

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3
Q

what is the formula for enterprise value

A

EV = MC + Total debt - C

Market capitalization is the current stock price multiplied by the number of outstanding shares

Total debt is the cumulative amount of short and long term debt

Cash is the liquid assets

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4
Q

What are the main components of WACC and how do you calculate it?

A

Weighted average cost of capital (WACC) is the average cost of a company’s financing, which includes both debt and equity. It’s used to determine the minimum return a company needs to earn on its investments to pay back its capital sources.

WACC = (E/V x Re) + (D/V x Rd x (1-T))

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5
Q

what is each symbol in WACC formula

A
  • Equity (E) is the market value of the company’s outstanding shares, so E/V is the percentage of the company’s value that is equity.
  • Debt (D) is the market value of the company’s debt, so D/V is the percentage of the company’s value that is debt.
  • Value (V) is the value of the company’s capital, or E+D.
  • Re is the cost of equity
  • Rd is the cost of debt
  • Tax (T) is the corporate tax rate.
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6
Q

Do an example question calculating enterprise value

A
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7
Q

do an example question calculating WACC

A
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8
Q

What is EBITDA

A

EBITDA is an acronym that stands for earnings before interest, taxes, depreciation and amortization. It is a measure of financial performance and helps determine a company’s earning potential.

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9
Q

what is amortization

A

the gradual payment of debt over a certain period of time

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10
Q

3 way to value a company

A
  • Comparable company analysis
  • Discounted cash flow analysis
  • Precedent Transaction analysis
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11
Q

short description of comparable company analysis

A

Comparable company analysis involves finding companies that are similar to the one you are trying to value and comparing their EBITDA, stock price, and price to earnings, among other variables.

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12
Q

short description of DCF

A

Discounted cash flow (DCF) analysis is a valuation method that measures the intrinsic value of a company based on its present value of future cash flows.

The first step is to project out future cash flow for 5-10 years by making assumptions on the company’s revenue growth and EBIT margins. Next you calculate the terminal value by either using the exit method or perpetuity growth method. You then discount back your projected future cash flow and terminal value using your WACC to the present value and sum them together t get your enterprise value

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13
Q

Short description of precedent transaction analysis as a valuation method

A

Precedent transaction analysis is similar to a comparable company analysis, except you find how much similar companies have sold to determine the worth of the company you’re valuing.

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14
Q

What is Terminal Value

A

Terminal value (TV) is the estimated value of a company after a specific period of time, and it is a core element of DCF analysis. There are two ways to calculate terminal value: the growth in perpetuity approach or the exit multiple approach.

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15
Q

Two ways to calculate TV

A
  • The growth in perpetuity approach involves assuming that cash flows grow at a stable rate indefinitely.
  • The exit multiple approach does not assume perpetual growth and instead looks at the net value of a company’s assets at a given moment in time. It is used for a company that is going to be acquired or liquidated in the future.
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16
Q

Walk through a DCF calculation

A

Specifically, to do a DCF analysis, you need to project unlevered future cash flows, determine a discount rate and calculate a terminal value. Then, discount the unlevered free cash flow and terminal value to present value to determine enterprise value. By subtracting net debt from the company’s enterprise value, you calculate the equity value.

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17
Q

Perform a DCF worked calculation

A
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18
Q

What is the discount rate you should use in an unlevered DCF analysis?

A

The discount rate is the required rate of return of both debt and equity, so the rate should be the weighted average cost of capital (WACC).

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19
Q

What is Beta

A

an estimate of how volatile an asset is compared to the overall market. anything above 1 holds more risk than the market

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20
Q

Why would you unlever beta

A

unlevered beta is to be used when comparing a company that is not on the market yet.

Allows you to see the volatility of the companys equity alone wothout considering debt

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21
Q

Which is more expensive: the cost of debt, or the cost of equity?

A
  • cost of equity is how much shareholders expect to make
  • cost of debt is the rate of return that bond holders expect from investing

cost of equity usually higher as shareholders not garunteed fixed payments so higher risk. Also, interest is tax deductible making debt cheaper

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22
Q

6 main factors that can cause the need for mergers and acquisitions

A
  • saving money
  • Improving financial health and overall metrics
  • Eliminating competition from the market
  • gaining more power over pricing by buying out supplier or distributor
  • diversifying or specializing
  • expansion of technological abilities
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23
Q

When should a company issue debt instead of equity

A
  • company can get tax shields from issuing debt
  • company has stable cash flows and can make interest payments
  • results in a lower WACC
  • company can get better return on investment with more financial leverage
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24
Q

What is Net working capital and what is the formula

A

NWC - how much company has if all short term debts are paid off

NWC = Current assets - current liabilities

liabilities - short term debts

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25
Q

what is an IPO

A

Initial Public Offering - when an investment bank helps a private company transition to being publicly traded by helping the company to sell shares for the first time

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26
Q

benefits of going public for a company

A
  • Raise capital
  • allow investors, original owners and employees cash out some of their investments
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27
Q

Explain the process of helping a company complete an M&A from the buy-side.

A
  1. Research potential companies
  2. filter options based on feedback from the client (buyer)
  3. figure out if potential companies are interested in being bought
  4. discussing offer price with buyer and seller
  5. negotiating the purchase agreement
  6. announcing the transaction
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28
Q

what is a P/E value

A
  • ratio of price to earnings
  • used for valuing a company by measuring current share price against the earnings per share
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29
Q

Two companies are almost exactly the same in every way, except Company A is trading at 20 P/E and Company B is trading at 18 P/E. Which would you invest in?

A
  • P/E demonstrates the cost per unit of earnings
  • Choose company B as has lower price/earnings so is cheaper and better investment
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30
Q

Why are manhole covers round

A
  • cannot fall into hole
  • can be easily roller around
  • round covers are easy to fit and design
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31
Q

how do interest rates affect bond prices

A
  • Inverse relationship
  • when cost of borrowing money increases, bond prices decrease
  • most bonds pay fixed interest rates so they become more attractive if interest rates fall so demand increases and prices go up
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32
Q

what is a bond

A

A fixed income instrument that represents a loan made by an investor to a borrower

33
Q

Explain Internal rate of return

A
  • metric used to estimate the profitability of potential investments
  • used to measure the profitability of an investment or project. It’s a way of calculating the average rate at which an investment will earn money, taking into account the amount invested, the time period of the investment, and the cash flows generated by the investment.
34
Q

what does NPV stand for and what is it

A

Financial metric that attempts to capture the total value of an investment oppurtunity.

The idea is to project all the future cash inflows and outflows associated with the investment

35
Q

What is the formula for NPV

A

google it

36
Q

What is discount rate

A

the interest rate charged to commercial banks and other financial institutions for short term loans they take from the federal bank

37
Q

What is capital structure

A

the mix of debt and equity that is used to finance an operation or asset

38
Q

what is a healthy capital structure

A

low levels of debt and large amounts of equity

39
Q

what is an aggressive capital structure

A

higher debt to equity ratio

40
Q

what is a high leverage ratio

A

company uses mostly debt to finance an operation - leads to higher potential growth rates

41
Q

Pros of debt (5)

A
  • not giving up any control of a company as not selling a chunk
  • no liability once debt is paid
  • debt payments are tax deductible
  • less costly than equity financing
  • allows business to leverage capital to create growth
42
Q

cons of debt (6)

A
  • regular repayments may not always be affordable during certain periods.
  • can lead to collateral damage.
  • interest rates lead to greater repayments.
  • variable financing terms can affect repayments.
  • lots of debt impacts profitability and company valuation.
  • Risky if cash flow is inconsistent for business.
43
Q

Pros of equity

A
  • Less burden as no loan
  • No credit issues.
  • Can learn or gain from partners.
44
Q

Cons of equity

A
  • Share profit with investors.
  • Loss of control as diluted.
  • Conflict due to shared ownership
45
Q

why is money today worth more than money tomorrow

A
  • inflation - general increase in prices means that money will be worth less
  • interest rates - money can be invested to earn interest
  • money now can lead to return from investments
46
Q

What are financial statements

A

records that show business activities or a company and their financial performance

47
Q

3 types of financial statements

A
  • Balance sheet
  • Income statement
  • Cash flow statement
48
Q

what is an income statement

A

overview of revenues, expenses, net income, earnings per share

over a specific period of time

49
Q

what does a balance sheet show

A

overview of companies assets, liabilities and shareholders equity at a point in time

50
Q

what does cash flow statement show

A

shows the inflow and outflow of cash in a business over a specific period of time

51
Q

Name 3 valuation metods

A
  • DCF
  • Comparable Analysis
  • Precedent Transactions
52
Q

5 steps of performing a DCF

A
  1. Calculate stage 1 cash flow
  2. Calculate terminal value (stage 2) using either method
  3. discount stage 1 and stage 2 at weighted average cost of capital
  4. subtract debt and add cash to find equity value from enterprise value
  5. divide equity value by number of diluted shares to find price per share
53
Q

how do you perform step 1 of a DCF

A

EBIT (profit) - Taxes + deprication and amortization - capital expenditures +/- changes in net working capital

54
Q

what is capital expendature

A

investments made by the company into long term assets

55
Q

what is net working capital

A

difference between a companies assets and liabilities (debts)

56
Q

how do you perform step 2 of a DCF

A

Calculate terminal value using either perpetuity growth method or exit multiple - formulas can be googled

57
Q

how do you perform step 3 of a DCF

A
  • add up al stage 1 cash flows and TV
  • discount them at 1+ wacc to power of number or periods

This gives us enterprise value

58
Q

Formula for WACC

A

google

59
Q

how do you perform step 4 of a DCF

A

Equity value = enterprise value - debt + cash

60
Q

how do you preform step 5 of a DCF

A

price per share = equity value/number of shares

61
Q

what is comparable analysis valuation method

A

compare to similar companies of similar size in similar industries

62
Q

what is the precedent transactions valuation method

A

price paid for similar companies in the past is used to indicate a companies value

63
Q

pros and cons of DCF as a valuation technique

A

+ considers future performance so more accurate than methods that use just past performance
+ incorporates the time value of money
+ allows for consideration of a companys growth potential
+ can be applied to lots of different assets

  • relies on accurate forecasting which is difficult and error prone
  • assumes constant growth rate
  • doesn’t account for market trends or macroeconomic factors
  • complex and time consuming
64
Q

what is meant by macroeconomics

A

Macroeconomics is a branch of economics that studies the behaviour and performance of an economy as a whole, rather than the individual parts that make it up. It deals with issues such as:

growth, inflation, and unemployment and how they are affected by changes in government policy, international trade, and other factors.

65
Q

pros and cons of comparable analysis valuation method

A

+ simple and straightforward
+ required data is publicly available

  • assumption that companies or assets compared are comparable
  • doesnt account for unique characteristics or conditions that can affect the value of the company
  • not suitable for rapidly changing industries
  • can be influenced by short term market fluctuations
66
Q

pros and cons of precedent transactions valuation method

A

+ more reliable as based on actual transactions that have taken place

  • relies on availability of comparable transactions
  • doesnt account for unique characteristics or conditions that affect value of the company or asset
  • doesnt account for changes in the market
67
Q

What is synergy

A

increased value generated by combining 2 or more companies in an M&A transaction

68
Q

what are defence tactics in M&A

A

strategies used by companies to avoid hostile take over - take over by going directly to the companys shareholders

69
Q

4 defense tactics

A
  1. Poison pills - issue new shares to dilute existing shareholders
  2. golden parachutes - agreement where emloyees will recieve financial payouts in a hostile takeover
  3. Shareholders rights plans - give existing shareholders right to buy more shares at discount to defend
  4. Asset sales - sell key assets to make company less attractive
70
Q

steps in a merger model

A
  1. gather data on companies involved
  2. forecast pro forma financial statements (statements for combined company)
  3. determine synergies
  4. establish discount rate - rate of return investors require to invest
  5. calculate present value of future cash flows
  6. determine enterprise value
  7. calculate equity value
  8. compare equity value of combined company to the market value
71
Q

Walk me through the role of an IB on the sell side of an M&A deal?

A
  1. preeration - work with seller to understand objectives and gather info about the company
  2. market assesment - assess potential pool of buyers
  3. marketing - confidentailly market oppurtunity to potential buyers
  4. negotiation
  5. checks to make sure all info etc is correct
  6. finalize transaction
72
Q

stock vs asset purchase

A

cash is buying stock or equity in company with cash

asset is buying specific assets of company

73
Q

pros and cons of cash purchase

A

+ simplicity
+ value of companies reputation is acquired
+ integration process usually easier

  • all liability is taken on by buyer
  • usually higher price
74
Q

Pros and cons of asset purchase

A

+ can choose specific assets you want
+ less liability
+ usually cheaper

  • more complex
  • integration challenges
  • value of companies reputation is not acquired
75
Q

what is an LBO

A

Leveraged buyout - debt is used to acquire all/most of a company

76
Q

when is an LBO suitable

A
  • profitable company with stable cash flow
  • company shares undervalued
  • company has lots of assets that can be used as collateral
77
Q

when do we not use DCF

A

unstable or unpredictable cash flow or a startup where cash flow will be negative for a while

78
Q

what is an IPO

A
  • Initial public offering
  • private company goes public to be traded on stock market
79
Q

how are 3 financial statements related

A
  • info on one statement affects info on next
  • eg - net income on income statement affects company’s shareholder equity on the balance sheet
  • changes in cash flow impact company’s ability to pay debt, shown on balance sheet

Structural mechanics (3 decks)

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