Investment Banking Technical Interview Workshop Thursday, January 15, 2009 Presented by: Jessica Delfino With contributions by Mike Hudgin & Ekaterina Petrovitch Introduction Jessica Delfino Investment Banking Full-Time Analyst Deutsche Bank, Toronto firstname.lastname@example.org Agenda • Interview Format • Valuation ▫ DCF ▫ Public Comparables ▫ Precedent Transactions • Sample Technical Questions • The Infamous Accounting Question • General Interviewing Tips Deutsche Bank’s Interview Tips http://www.youtube.com/watch?v=3CsL1rcENH0 Interview Format • First Round • 30-45 minutes • Behavioural and lots of technical • One to six interviewers • Second Round • 3-4 hours • Expect even more technical (reactions under fatigue/pressure) • One, two, or panel interviewers How would you value a company? Three General Ways to Value a Company: 1) Discounted Cash Flow 2) Public Comparables Analysis (Relative Valuation) 3) Precedent Transaction Multiples For each method, interviewees should address: • Basic overview (why this method is used) • How it’s practically used (mechanics) • Pros & cons of method DCF – Overview • DCF is the method of valuation that allows for the most flexibility (and possibly precision) in coming up with the intrinsic value of a firm ▫ The DCF method that we use is FCFF (you might know it as WACC method, but refrain from calling it this…) • Mapped on many assumptions • Based on future expectations of a firm’s cash flows (numerator), and the risks associated with those cash flows (denominator) DCF – Basic Steps • First determine WACC = D/V * Rd (1-T) + E/V * Re ▫ Effect of capital structure Use target (optimal) D/E ratio Beta CAPM Rd (1-T) discuss importance of tax shield Explain that CAPEX and NWC are all cash sources/uses that don’t affect EBIT, therefore we must adjust. • Mechanics of FCFF ▫ FCFF = EBIT(1-T) – CAPEX + NCC +- Δ NWC • Analyze historical performance to come up with future set of assumptions (COGS, SG&A, R&D, “DEP”, “CAPEX”, “NWC” as a % sales) ▫ Therefore, we need to use revenue as a driver, and determine its growth from year to year during our explicit forecast period (5-10 yrs) DCF – Basic Steps (cont’d) • Determine FCFF’s each year using assumptions driven off of revenue • Determine TV at last year of forecast period ▫ 2 methods Growing perpetuity ▫ Assumes constant growth rate (2-3%) – not really used Terminal multiple ▫ Assumes an exit multiple of an operating metric like EBITDA or FCFF, to determine a value for the enterprise at that point in time • Bring everything back to present value at WACC DCF – Basic Steps (cont’d) • Now we have the value of the enterprise (Enterprise Value = Net Debt + Equity + Minority Interest) • In order to determine Equity value, we must first subtract Net Debt & Minority Interest • At this point we have Equity Value ▫ Divide by Shares Outstanding to obtain PPS • Sensitivity analysis provides for flexibility in model ▫ WACC / Growth Rates / Terminal Multiples DCF – Pros & Cons Too many assumptions • The model only as good as your assumptions Allows for flexibility • Firm can improve margins over time • Industry outlook can change, and DCF model can reflect that Public Market Comparables (Relative Valuation) – Overview • Relative Valuation is a reality check to see how investors in the marketplace are valuing similar companies like the one in question • Public Market Comparables (EV/Sales, EV/ EBITDA, P/E) are used to determine typical public market valuation with respect to certain operating metrics Relative Valuation – Basic Steps • Determine the target company’s EPS, EBITDA, or Sales for current year and possibly forward year (using analyst estimates) • Determine the set of comparable companies (comp universe) and their trading multiples ▫ Similar companies based on industry, size, business model, risk, capital structure – anything you can control for • Multiply average industry multiple by current or forward performance to determine the relative value of the firm Relative Valuation – Pros & Cons Stock prices are determined by relative values Don’t have to make assumptions that are necessary for DCF Not a gauge of intrinsic value Often difficult to find exact comparables • Only values companies if they were valued the same way as their peers • Can use sum-of-the-parts valuation, which is a weighted-average of each division under specific industry multiples Precedent Transactions – Overview • Value of a company if it were to be taken over by another company (i.e. take-out value) • Precedent transaction values should always yield higher values than relative valuation ▫ Historical take-over premiums are 20-30% • Not relevant if company is under some scenarios (company is family-controlled and not looking to sell, etc.) Precedent Transactions – Basic Steps • Find historical take-overs in industry ▫ Again, look for similar size if possible, and most recent first • Try to cover at least on economic cycle in terms of precedent transactions, as some takeover premiums might reflect a take-over boom in an industry • Multiply relevant multiple (P/E, EV/EBITDA, EV/Sales, etc.) by company’s figure to obtain firm’s value in event of a take-over Precedent Transactions – Pros & Cons Often very relevant, especially for undervalued firms Often used when firm is selling off a division Only useful if firm will consider takeover Precedent transaction values are often higher than intrinsic value (reflect over-payment in precedent transactions) Current Events • Interest in Finance will be tested during the interview • Be prepared to discuss current events that you are following and able to respond to questions • Case: Credit crisis in general • Case: $700 billion bailout [September 2008] • Case: GM and Chrysler bailout [December 2008] Sample Technical Questions • If a company with a higher P/E acquires a company with a lower P/ E, is this an accretive or dilutive merger? • Why would an acquirer be willing to pay a premium to the current trading price? • What method of valuation would result in the highest value? Why? • What is minority interest? Why do we add it to the Enterprise Value formula? • Can you walk me through a cash flow statement? • How do you find a firm’s beta? How do you find a firm’s cost of debt? • What are some different ways of calculating a firm’s cost of equity? Sample Technical Questions Cont. • What are some common valuation metrics? • Why can’t you use EV/Earnings or Price/EBITDA as valuation metrics? • Why do you subtract cash in the enterprise value formula? • How would you calculate the return on equity for a private firm with no comparables? • What is cheaper, debt or equity? • If you own a start-up mining company in Canada and you require additional capital, would you rather finance your company with debt or equity? Why? • What would have a greater impact on the value of a firm: a $1,000,000 rise in FCFF for the next five years, or a $500,000 rise in the terminal value FCFF? Brainteasers • Interviewers are not looking for you to answer the question immediately, it’s not a test of smarts • Do not panic! • Logically think through the question, interviewers are analyzing your capacity to think logically in stressful situations • Think out loud, don’t sit in silence • Ask questions if you’re confused but totally stumped (but make sure to listen to the question well) • Sometimes thinking backwards is the key to many brainteasers • Don’t feel rushed, work through everything and they may help you along the way • Speak confidently and clearly The Infamous Accounting Question … If you are able to land interviews, particularly final rounds, you will be asked this question! Question: A company makes a $100 purchase of equipment on Dec. 31. Half of this amount is paid for with cash, the other half is financed by debt. How does this impact the three financial statements this year and next year? Key Points: • Equipment Capital expenditure • Order of financial statements 1) Income Statement 2) Cash Flow Statement 3) Balance Sheet (most difficult is to balance) • Assume the company’s fiscal year end is Dec. 31 • This year and next year • The numbers are not important, but use them when learning the important underlying concepts First Year Income Statement: • A purchase of equipment is considered a capital expenditure which does not impact earnings. • Further, since the fiscal year end is Dec. 31, we are assuming no depreciation in the first year, and there is no impact to net income, thus no impact to the income statement. • This holds true regardless of whether the capital expenditure is financed by debt or equity. Cash Flow Statement: • No change to net income so no change to cash flow from operations. • $100 increase in capital expenditure: therefore a $100 use of cash in cash flow from investing activities. First Year Cash Flow Statement Cont.: • In our cash flow from financing section, we have an increase in debt of $50 (source of cash). • Net effect is a use of cash of $50 (-$100 + $50) Balance Sheet: • Cash (asset) down by $50 • PP&E (asset) up by $100 • Debt (liability) up by $50 • Therefore, we balance! Second Year Income Statement: • Let’s assume straight-line depreciation over 5 years and a 40% tax rate. • Let’s also assume a 10% interest rate on the debt and no debt amortization. • Depreciation is an expense so operating income (EBIT) declines by $20 ($100/5 years). • $5 of interest expense (0.10 * $50). • Net result is a $15 reduction to net income [$25 * (1 – 0.40)]. Cash Flow Statement: • Net income down by $15 and depreciation up $20. • No change to cash flow from investing or financing activities. (If we assumed some debt amortization, we would have a use of cash in financing activities.) Second Year Cash Flow Statement Cont.: • Net effect is cash up $5. Balance Sheet: • Cash (asset) up $5 • PP&E (asset) down $20 • Therefore left-side of Balance Sheet down $15 • Retained earnings (shareholders’ equity) down $15 (remember, net income decreased by $15?) • And we balance! Final Part of the Question … If depreciation is non-cash, explain how this transaction caused cash to increase $5. Answer: Because of the depreciation and interest expenses, the company had to pay the government $5 less of taxes so it increased its cash position by $5 from what it would have been without the depreciation and interest expenses. General Interviewing Tips • Take the time to think about the question before you answer it • The last thing you want to do is go on a tangent or talk too much • If you don’t know the answer right away, walk through your logical thinking process • Always try to work out the problem. Don’t say I don’t know!! • Don’t stress and keep your cool • Be confident and comfortable • Always have questions to ask them • Don’t be cocky or pretend like you know everything about banking. Bankers, especially analysts, find this extremely aggravating and can see through it • Don’t forget to e-mail them after your interview and thank them for their time General Interviewing Tips (cont’d) Tell me about yourself … Have a story (1-2 minutes) Logical flow Progression For everything you did, explain why (i.e. I chose business school because I’ve always been fascinated about what makes a good business) • Be convincing that I-banking is what you want • • • • Super Day Dinners • Everything is part of the interview • DO NOT get drunk • Try not to ask too many nerdy finance questions or talk about how bad the markets are – unless, of course, a banker asks you your opinion • Expect out of the blue questions about the economy and investing • Do not talk about things you don’t know anything about, try to learn from others, don’t be cocky • Try to sneak your interests into conversations that aren’t always relevant in interviews (e.g., interest in art or different cultures) • Goal: Try to come across as an interesting and ambitious person who can also have some fun and be enjoyable to work with • One slight mess up can definitely cost you your offer • Judgment and social skills are extremely important parts of your job as an investment banking analyst, and the Super Day dinner is a quick way to evaluate these General Interviewing Tips (cont’d) Why I-banking? • Many good answers • Suggestions • Being able to learn a boatload in a short amount of time • Being surrounded by intelligent people willing to teach • Interest in financial markets • Like to work on projects and see rewarding results (even see it in the paper …) • Intense environment, fast-paced, pressure • Anything else that suits you … Questions to Ask Them • What made you choose [insert firm’s name]? • Have you seen the current economic turmoil/credit crisis affecting your everyday work? If so, how? • In what industries does your office see the most dealflow? • As a summer analyst will I be placed in one industry group or will I be a generalist? • How would you describe the culture of your office? • What, in your opinion, is the most important aspect or quality that a summer analyst should possess and display? • Finally, ask questions pertaining to your interviewer specifically to show you’ve been listening. For example, “What made you initially switch to private equity and then what drew you back to investment banking?” or, “How did you find the New York/London office compares to the Toronto office?” Resources • CC website: Vault Guide to Finance Interviews ▫ http://www.mcgill.ca/management/career • Damodaran online: more material on valuation ▫ http://pages.stern.nyu.edu/~adamodar/ • News: Wall Street Journal, Bloomberg, Financial Times, etc.
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