In this article, we have listed down important Q&A on Investment Banking topics. I hope it helps you learn some essential concepts to help you crack Investment banking interviews.
Q&A on Investment Banking Topics – Merger & Acquisition (M&A)
Q1. Briefly explain the process of a buy-side M&A deal
- Analysts spend a lot of time researching potential acquisition targets, and multiple cycles of selection and filters are applied.
- Narrow down the list and decide which ones are to be further approached.
- Meetings are conducted to gauge the receptivity of potential sellers.
- Serious discussions with the seller occur, calling for in-depth due diligence and determining the offer price.
- Negotiate the price and other key terms of the purchase agreement.
- Announce the M&A deal/transaction.
Q2. Briefly explain accretion and dilution analysis
- Accretion and dilution analysis is undertaken to gauge the impact of an acquisition on the acquirer’s Earnings per share (EPS) and compare it with the company’s EPS if the acquisition has not been executed.
- In simple words, we could say that in the scenario of the new EPS being higher, the transaction will be called “accretive,” while the opposite would be called “dilutive.”
Q3. Given a situation where a company with a low P/E acquires a company with a high P/E in an all-stock deal, will the deal likely be accretive or dilutive?
- Other things being equal, when a company with a low P/E acquires a company with a high P/E, the transaction would be dilutive to the acquirer’s Earnings per Share (EPS).
- The acquirer will have to shell out more for each dollar of earnings than the market values its earnings. Therefore, in such a situation, the acquirer would have to issue proportionally more shares in the transaction.
Q4. What are synergies and their types?
- Synergies are where the buyer gets more value out of an acquisition than the financials would predict. There are two types of synergies:
- Revenue synergy: the company can cross-sell products to new customers or upsell new products to existing customers. Because of the deal, it could be possible to expand into new geographies.
- Cost synergies: the combined company could amalgamate buildings and administrative staff and lay off redundant employees. The company could also position itself to close redundant stores or locations.
Q&A on Investment Banking Topics – Valuation
Q1. Describe the ways through which a company is valued
- Precedent transaction analysis: This is when you look at how much others have paid for similar companies to determine how much the company is worth. To use this method effectively, you need to be highly familiar with the industry of the company you are valuing, as well as the standard premiums paid for such a company.
- Comparable Company Analysis: it is similar to Precedent Transactions Analysis, except you are using the whole company as an assessment unit, not the purchase of a company. So, to use this method, you would also look for similar companies to the one you value and look at their price vs. earnings, EBITDA, stock price, and any other variables you think would be a pointer to the health of a company.
- Discounted Cash Flow Analysis: This is when you use future cash flow, or what the company will make in the upcoming years, to determine what the company is worth now. To calculate DCF, choose a company’s probable or future cash flow for the next ten years. Then, work out how much that would be in today’s terms by “discounting” it at the rate that would give a return on investment. Then, you add the company’s terminal value, which will tell you how much the company is worth.
Q2. What are the situations in which we do not use a DCF in the valuation?
- We will not use a DCF in the valuation if the company has an unstable or unpredictable cash flow or when debt and working capital serve a fundamentally different role.
- For example, financial institutions like banks do not re-invest debt, and working capital forms a significant part of their balance sheets- so we do not use a DCF for such companies.
Q3. List the most common multiples used in valuation
- EV/Revenue
- EV/EBITDA
- EV/EBIT
- P/E
- P/BV
Q4. Explain the PEG ratio.
This stands for the Price/earnings to growth ratio, takes the P/E ratio, and then accounts for how fast the EPS for the company will grow. A stock that is increasing will have a higher PEG ratio. A fine-priced stock will have the same P/E ratio and PEG ratio. So if a company’s P/E ratio is 20 and its PEG ratio is also 20, some might argue that the stock is too expensive if another company with the same EPS has a lower P/E ratio, but that also means that it’s growing faster because the PEG rate is 20.
Q5. Give the formula for Enterprise Value.
The formula for enterprise value is the market value of equity (MVE) + debt + preferred stock + minority interest – cash.
Q6. Why do we consider both enterprise value and equity value?
Enterprise value signifies the company’s value attributable to all investors, whereas equity value represents the portion available to equity shareholders. We consider both because equity value is the number the public sees, while enterprise value represents its actual value.
Q7. What does it signify if a company has a negative enterprise value?
The company could have negative enterprise value when the company has substantial cash balances, extremely low market capitalization, or both. This could occur in companies that are:
- On the brink of bankruptcy
- Financial institutions, such as banks, have large cash balances.
Q&A on Investment Banking Topics – Initial Public Offer (IPO)
Q1. Briefly describe what you would do if you were working on an IPO for a client
- First, we would meet the client and gather all the necessary information, such as their financial details and customers, and learn about the sector they belong to.
- After this, you would meet other bankers and lawyers and the registration statement, which would describe the company’s business and market to its investors.
- Next, you would receive comments from the SEC and keep revising the document until it is acceptable. Now, you would spend the coming weeks organizing road shows to present the company to the institutional clients and convince them to invest in them.
- After raising client capital, the company would start trading on the exchange.
Miscellaneous
Q1. What is in a pitchbook?
The pitchbook depends on the kind of deal the company is pitching for, but the standard structure would include the following:
- Bank credentials to prove their expertise in completing similar deals before.
- Summary of company’s options
- Appropriate financial models and valuation
- Potential acquisition targets or potential buyers
- Summary and key recommendations
Q2. Explain what makes up a cash flow statement.
When looking at a cash flow statement, the beginning cash balance is the place to start. Then, it would be best to look at cash from operations, the money made from any investments, and cash from financing. All of that will make up the ending cash.
Q3. Why do private equity firms use leverage when buying a company?
- The private equity firm reduces the amount of equity in the deal by using significant leverage (debt) to help finance the purchase price.
- Doing this will increase the private equity firm’s rate of return substantially when exiting the investment.
Q4. What is convexity?
- Convexity is a more accurate measure of the relationship between yield and price changes in bonds about the change in interest rates.
- Duration calculates this as a straight line when it is a convex curve, hence the name. This is used as a risk calculation because it can tell how a bond yield will respond to interest rate changes.
Q5. Define risk-adjusted rate of returns
- When looking at an investment, you cannot simply look at the projected return. If investment A’s profit is greater than investment B’s, you may immediately want to go with investment A.
- But investment A might have a greater chance of a total loss than investment B, so even though the profit may be more significant, it is a lot riskier and, therefore, not necessarily a better investment.
- Adjusted rate of return is when you not only look at the return that an investment may give you but also measure the risk of that investment.
- The adjusted rate of return is usually denoted as a number or rating. If you are technically minded, you may also want to mention how risk is measured: beta, alpha, the Sharpe ratio, r-squared, and standard deviation.
Q6. Briefly explain the leveraged buyout.
- A leveraged buyout (LBO) is when a company or investor buys another company mainly using borrowed money, loans, or even bonds to be able to make the purchase.
- The company’s assets being acquired are usually used as collateral for those loans. Sometimes, the debt-to-equity ratio in an LBO can be 90-10. Any debt percentage higher than that can lead to bankruptcy.
