Aspiring investment bankers, listen up.
You know how competitive Wall Street internships are — so if you land an interview with a bank, you want to come prepared.
To help you out, we spoke with a former analyst at a bulge-bracket bank who has been through the whole process.
He told us the five most common technical questions he encountered in investment-banking internship interviews.
The good news is, each question is answered in-depth in the Mergers and Inquisitions “Breaking into Wall Street” guide.
“Don’t waste your time with any other prep services,” the former analyst said.
He has no affiliation with Mergers and Inquisitions.
He recommended studying all the basic-level questions from the M&I guide in addition to these five questions. (If you’re pressed for time, don’t worry about the advanced questions, he said. They’re not as essential for internship-level interviews.)
We got the answers from Mergers and Inquisitions. If they make no sense to you and you want to work on Wall Street, you’ve got some background reading to do.
1. If a company incurs $ 10 (pretax) of depreciation expense, how does that affect the three financial statements?
“Depreciation is a non-cash charge on the Income Statement, so an increase of $ 10 causes Pre-Tax Income to drop by $ 10 and Net Income to fall by $ 6, assuming a 40% tax rate.
On the Cash Flow Statement, Net Income is down by $ 6 but you add back the $ 10 of Depreciation since it’s a non-cash expense, so cash at the bottom is up by $ 4.
On the Balance Sheet, cash is up by $ 4 on the Assets side, but PP&E has declined by $ 10 due to the added Depreciation, so the Assets side is down by $ 6.
On the L&E side, Retained Earnings is down by $ 6 because of the reduced Net Income on the Income Statement, so both sides of the Balance Sheet are down by $ 6 and it remains in balance.”
2. Please walk me from Enterprise Value to Equity Value (or the other way around).
“Equity Value represents the value of all the assets a company has, but only to common equity investors (i.e., shareholders) in the company. Enterprise Value represents the value of only the company’s core business assets, but to all investors in the company (equity, debt, preferred, etc.).
So to move from Equity Value to Enterprise Value, you subtract non-core assets, and you add items that represent other investor groups.
In practice, this means starting with Equity Value and subtracting cash (technically excess cash, but usually simplified to just cash) and other non-core assets such as short-term/long-term investments, and then adding debt, preferred stock, non-controlling interests, and other items that represent other investor groups in the company.
To move from Enterprise Value to Equity Value, you do the opposite and subtract all those items representing other investor groups and add the non-core assets such as cash, investments, etc.”
3. Please walk me from revenue to free cash flow.
“First, clarify what type of Free Cash Flow they want. Unlevered? Levered? Something else?
Assuming it’s Unlevered FCF — or what’s available to all investors in the company (which pairs with Enterprise Value):
Start with revenue and subtract COGS and Operating Expenses to get to Operating Income, or EBIT. Multiply by (1 – Tax Rate) to get to Net Operating Profit After Taxes, or NOPAT.
Then, add back the non-cash charges that appear on the Cash Flow Statement, primarily Depreciation & Amortization, and reflect the Change in Working Capital, which may be either positive or negative (follow the sign used on the company’s CFS). And then subtract Capital Expenditures (CapEx).”
4. Please walk me through a DCF.
“A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value.
First, you project a company’s financials using assumptions for revenue growth, margins, and the Change in Working Capital; then you calculate Free Cash Flow for each year, which you discount and sum up to get to the Present Value of Free Cash Flows. The Discount Rate is usually the Weighted Average Cost of Capital.
Once you have the present value of the Free Cash Flows, you determine the company’s Terminal Value, using either the Multiples Method or the Gordon Growth Method, and then you discount that back to its Present Value using the Discount Rate.
Finally, you add the two together to determine the company’s implied Enterprise Value, after which you may then back into the implied Equity Value and implied share price.”
5. Please walk me through an LBO.
“In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt, and other variables; you might also assume something about the company’s operations, such as Revenue Growth or Margins, depending on how much information you have.
Step 2 is to create a Sources & Uses section, which shows how the transaction is financed and what the capital is used for; it also tells you how much Investor Equity (cash) is required.
Step 3 is to adjust the company’s Balance Sheet for the new Debt and Equity figures, allocate the purchase price, and add in Goodwill & Other Intangibles on the Assets side to make everything balance.
In Step 4, you project out the company’s Income Statement, Balance Sheet and Cash Flow Statement, and determine how much debt is paid off each year, based on the available Cash Flow and the required Interest Payments.
Finally, in Step 5, you make assumptions about the exit after several years, usually assuming an EBITDA Exit Multiple, and calculate the return based on how much equity is returned to the firm.”
One more thing …
This list of technical questions is not exhaustive. And in recent years, interviewers have started to ask more conceptual questions as well.
So an interviewer might present a concept like Equity Value or Enterprise Value and ask you to explain how different adjustments and calculations fit in with the underlying concepts.
There also tend to be more questions related to current events. So be prepared to talk about a recent deal, too.