BofA Interview Questions Technical Flashcards
Tell me about financial statements and why they are important.
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.
What is enterprise value versus equity value?
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
what is the formula for enterprise value
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
What are the main components of WACC and how do you calculate it?
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))
what is each symbol in WACC formula
- 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.
Do an example question calculating enterprise value
do an example question calculating WACC
What is EBITDA
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.
what is amortization
the gradual payment of debt over a certain period of time
3 way to value a company
- Comparable company analysis
- Discounted cash flow analysis
- Precedent Transaction analysis
short description of comparable company analysis
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.
short description of DCF
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
Short description of precedent transaction analysis as a valuation method
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.
What is Terminal Value
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.
Two ways to calculate TV
- 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.
Walk through a DCF calculation
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.
Perform a DCF worked calculation
What is the discount rate you should use in an unlevered DCF analysis?
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).
What is Beta
an estimate of how volatile an asset is compared to the overall market. anything above 1 holds more risk than the market
Why would you unlever beta
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
Which is more expensive: the cost of debt, or the cost of equity?
- 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
6 main factors that can cause the need for mergers and acquisitions
- 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
When should a company issue debt instead of equity
- 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
What is Net working capital and what is the formula
NWC - how much company has if all short term debts are paid off
NWC = Current assets - current liabilities
liabilities - short term debts
what is an IPO
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
benefits of going public for a company
- Raise capital
- allow investors, original owners and employees cash out some of their investments
Explain the process of helping a company complete an M&A from the buy-side.
- Research potential companies
- filter options based on feedback from the client (buyer)
- figure out if potential companies are interested in being bought
- discussing offer price with buyer and seller
- negotiating the purchase agreement
- announcing the transaction
what is a P/E value
- ratio of price to earnings
- used for valuing a company by measuring current share price against the earnings per share
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?
- P/E demonstrates the cost per unit of earnings
- Choose company B as has lower price/earnings so is cheaper and better investment
Why are manhole covers round
- cannot fall into hole
- can be easily roller around
- round covers are easy to fit and design
how do interest rates affect bond prices
- 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
what is a bond
A fixed income instrument that represents a loan made by an investor to a borrower
Explain Internal rate of return
- 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.
what does NPV stand for and what is it
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
What is the formula for NPV
google it
What is discount rate
the interest rate charged to commercial banks and other financial institutions for short term loans they take from the federal bank
What is capital structure
the mix of debt and equity that is used to finance an operation or asset
what is a healthy capital structure
low levels of debt and large amounts of equity
what is an aggressive capital structure
higher debt to equity ratio
what is a high leverage ratio
company uses mostly debt to finance an operation - leads to higher potential growth rates
Pros of debt (5)
- 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
cons of debt (6)
- 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.
Pros of equity
- Less burden as no loan
- No credit issues.
- Can learn or gain from partners.
Cons of equity
- Share profit with investors.
- Loss of control as diluted.
- Conflict due to shared ownership
why is money today worth more than money tomorrow
- 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
What are financial statements
records that show business activities or a company and their financial performance
3 types of financial statements
- Balance sheet
- Income statement
- Cash flow statement
what is an income statement
overview of revenues, expenses, net income, earnings per share
over a specific period of time
what does a balance sheet show
overview of companies assets, liabilities and shareholders equity at a point in time
what does cash flow statement show
shows the inflow and outflow of cash in a business over a specific period of time
Name 3 valuation metods
- DCF
- Comparable Analysis
- Precedent Transactions
5 steps of performing a DCF
- Calculate stage 1 cash flow
- Calculate terminal value (stage 2) using either method
- discount stage 1 and stage 2 at weighted average cost of capital
- subtract debt and add cash to find equity value from enterprise value
- divide equity value by number of diluted shares to find price per share
how do you perform step 1 of a DCF
EBIT (profit) - Taxes + deprication and amortization - capital expenditures +/- changes in net working capital
what is capital expendature
investments made by the company into long term assets
what is net working capital
difference between a companies assets and liabilities (debts)
how do you perform step 2 of a DCF
Calculate terminal value using either perpetuity growth method or exit multiple - formulas can be googled
how do you perform step 3 of a DCF
- 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
Formula for WACC
how do you perform step 4 of a DCF
Equity value = enterprise value - debt + cash
how do you preform step 5 of a DCF
price per share = equity value/number of shares
what is comparable analysis valuation method
compare to similar companies of similar size in similar industries
what is the precedent transactions valuation method
price paid for similar companies in the past is used to indicate a companies value
pros and cons of DCF as a valuation technique
+ 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
what is meant by macroeconomics
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.
pros and cons of comparable analysis valuation method
+ 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
pros and cons of precedent transactions valuation method
+ 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
What is synergy
increased value generated by combining 2 or more companies in an M&A transaction
what are defence tactics in M&A
strategies used by companies to avoid hostile take over - take over by going directly to the companys shareholders
4 defense tactics
- Poison pills - issue new shares to dilute existing shareholders
- golden parachutes - agreement where emloyees will recieve financial payouts in a hostile takeover
- Shareholders rights plans - give existing shareholders right to buy more shares at discount to defend
- Asset sales - sell key assets to make company less attractive
steps in a merger model
- gather data on companies involved
- forecast pro forma financial statements (statements for combined company)
- determine synergies
- establish discount rate - rate of return investors require to invest
- calculate present value of future cash flows
- determine enterprise value
- calculate equity value
- compare equity value of combined company to the market value
Walk me through the role of an IB on the sell side of an M&A deal?
- preeration - work with seller to understand objectives and gather info about the company
- market assesment - assess potential pool of buyers
- marketing - confidentailly market oppurtunity to potential buyers
- negotiation
- checks to make sure all info etc is correct
- finalize transaction
stock vs asset purchase
cash is buying stock or equity in company with cash
asset is buying specific assets of company
pros and cons of cash purchase
+ simplicity
+ value of companies reputation is acquired
+ integration process usually easier
- all liability is taken on by buyer
- usually higher price
Pros and cons of asset purchase
+ can choose specific assets you want
+ less liability
+ usually cheaper
- more complex
- integration challenges
- value of companies reputation is not acquired
what is an LBO
Leveraged buyout - debt is used to acquire all/most of a company
when is an LBO suitable
- profitable company with stable cash flow
- company shares undervalued
- company has lots of assets that can be used as collateral
when do we not use DCF
unstable or unpredictable cash flow or a startup where cash flow will be negative for a while
what is an IPO
- Initial public offering
- private company goes public to be traded on stock market
how are 3 financial statements related
- 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
