Investment Banking - Finance Technicals Mock Interview
Summary
TLDRIn this mock interview, the candidate delves into financial concepts, explaining the process from revenue to free cash flow and the calculation of the weighted average cost of capital (WACC). They discuss the use of WACC for public companies and alternative discount rates for private companies. The interview covers enterprise value, equity value, and the implications of negative values. The candidate also shares investment strategies, thoughts on business acquisition, and admiration for a company focused on educational consulting and diversity.
Takeaways
- 📈 The process of deriving free cash flow from revenue involves subtracting costs, adding back non-cash items, and accounting for capital expenditures and changes in working capital.
- 💼 For public companies, the weighted average cost of capital (WACC) is the standard discount rate used in financial modeling.
- 🧮 Calculating WACC involves the cost of equity, debt, preferred stock, and their respective proportions in the company's capital structure, adjusted for taxes.
- 📊 The cost of equity is determined by the risk-free rate, beta, and the market risk premium, reflecting the stock's volatility relative to the market.
- 💡 Using leveraged free cash flow in a discounted cash flow (DCF) analysis would affect the cost of equity calculation, as it considers the impact of debt repayments.
- 🏦 Private companies may not use WACC as easily due to the lack of a public market capitalization; instead, they might rely on auditors or public market comparables.
- 🔢 Beta is an intuitive measure of a stock's price volatility in comparison to the overall market volatility.
- 🏢 Enterprise Value (EV) is calculated by considering the market capitalization, debt, preferred stock, minority interest, and cash, offering a broader view of a company's value.
- 🤔 Equity value cannot be negative as it is based on the number of shares outstanding and their price, whereas Enterprise Value can be negative if cash exceeds the sum of debt and market capitalization.
- 💼 The interviewee suggests a diversified investment strategy with a focus on venture capital, real estate, public equities, and angel investments, particularly suitable for a younger investor.
- 💡 When considering an acquisition offer, factors such as the price, form of payment, and the acquirer's plans for the business are crucial for decision-making.
- 🌟 The admired company, Early Admit, stands out for its focus on affordability and diversity in the educational consulting market, aiming to assist college students in securing jobs in finance and consulting.
Q & A
What is the process of calculating free cash flow from revenue in financial projections?
-To calculate free cash flow from revenue, you start with revenue, subtract the cost of goods sold and operating expenses to get operating income. Then, apply the tax rate to this operating income to find net income. Add back depreciation and other non-cash expenses, and subtract capital expenditures and changes in working capital.
What is the typical discount rate used for a public company's financial projections?
-For a public company, the weighted average cost of capital (WACC) is commonly used as the discount rate in financial projections.
How is the weighted average cost of capital (WACC) calculated?
-WACC is calculated by taking the cost of equity times the percentage of equity, plus the cost of debt times the percentage of debt times (1 minus the tax rate), plus the cost of preferred stock times the percentage of preferred stock.
What is the formula for calculating the cost of equity?
-The cost of equity is calculated by taking the risk-free rate, adding it to beta times the market risk premium.
What is the effect of using leveraged free cash flow instead of unlevered free cash flow in a discounted cash flow (DCF) analysis?
-Using leveraged free cash flow in a DCF analysis would affect the cost of equity calculation and the free cash flows, as it implies the company is effectively repaying debt through interest payments.
What discount rate would you use for a private company's financial projections?
-For private companies, since there is no market capitalization, a common approach is to use a discount rate similar to that of a public market comparable, which can be found in their public filings.
What does beta intuitively represent in finance?
-Intuitively, beta measures a stock's price volatility in relation to the overall market volatility.
What is the formula for calculating Enterprise Value?
-Enterprise Value is calculated by taking the market capitalization, adding debt, preferred stock, and minority interest, and then subtracting cash and cash equivalents.
Why is it important to look at both Enterprise Value and Equity Value?
-Enterprise Value represents the value of the entire firm, including both equity and debt holders, while Equity Value is attributed only to shareholders. Comparing both provides a more comprehensive view of a company's value.
Can a company have a negative equity value and what would it mean?
-No, a company cannot have a negative equity value because shares outstanding and share prices cannot be negative.
Is it possible for a company's Enterprise Value to be negative and what would cause this?
-Yes, a company's Enterprise Value can be negative if it has excessive cash on its balance sheet compared to its debt and market capitalization.
What factors would you consider if approached by a larger company for an acquisition?
-Factors to consider include the price of the acquisition, the form of payment (cash, stock options, or debt), and the acquirer's future plans for the company.
Can you name a company that you admire and explain why?
-One admired company is Early Admit, which operates in the educational consulting market, focusing on affordability and diversity, particularly in helping college students secure jobs at top finance and consulting firms.
Outlines
📊 Financial Projections and Discount Rates
The first paragraph delves into the technical aspects of finance, specifically the process of deriving free cash flow from revenue and the use of weighted average cost of capital (WACC) as a discount rate for public companies. The interviewee explains the steps to calculate net income, including subtracting costs, taxes, and adding back non-cash expenses. The discussion then shifts to the calculation of WACC, involving the cost of equity, debt, and preferred stock, and the impact of using leveraged free cash flow in a discounted cash flow (DCF) analysis. The paragraph concludes with a brief mention of how to handle discount rates for private companies, suggesting the use of public market comparables or an auditor's assistance.
🏢 Enterprise Value, Equity, and Investment Strategies
The second paragraph continues the financial theme by discussing enterprise value and its calculation, emphasizing the difference between equity value and enterprise value. It highlights the importance of considering both to understand the value of the entire firm. The conversation explores the possibility of negative equity and enterprise values, explaining why a company cannot have a negative equity value but can have a negative enterprise value if it holds more cash than its debt and market capitalization. The paragraph concludes with the interviewee's personal investment strategy, which includes a diversified portfolio with a focus on venture capital, real estate, public equities, and angel investments, and their thoughts on a hypothetical business acquisition scenario.
Mindmap
Keywords
💡Free Cash Flow
💡Cost of Goods Sold
💡Operating Income
💡Net Income
💡Depreciation
💡Capital Expenditures
💡Working Capital
💡Discount Rate
💡Weighted Average Cost of Capital (WACC)
💡Beta
💡Enterprise Value
💡Equity Value
💡Acquisition
💡Early Admit
Highlights
Interview begins with a list of technical questions on finance.
Explanation of the process from revenue to free cash flow in financial projections.
Use of net income, depreciation, and capital expenditures in cash flow calculations.
Discussion on the use of weighted average cost of capital (WACC) as a discount rate for public companies.
Formula for calculating the weighted average cost of capital (WACC).
Method to calculate the cost of equity, involving risk-free rate and beta.
Impact of using leveraged free cash flow instead of unlevered in a Discounted Cash Flow (DCF) analysis.
Considerations for selecting a discount rate for private companies.
Definition and calculation of Enterprise Value in finance.
Reasoning behind examining both Enterprise Value and Equity Value.
Explanation of why a company cannot have a negative equity value.
Conditions under which a company's Enterprise Value could be negative.
Personal investment strategy with a $10 million hypothetical investment.
Factors to consider when faced with a business acquisition offer.
Admiration for a company operating in the educational consulting market, focusing on affordability and diversity.
Reflection on the interviewee's performance and the conclusion of the mock interview.
Recommendation to view a more extensive list of questions in a written guide.
Transcripts
foreign
thank you for coming in I will be your
interviewer today and I just have a list
of technical questions for you that we
can just run through today does that
work perfect that works for me awesome
uh let's start with just general Finance
technicals um can you walk me through
how you go from revenue to free cash
flow in the projections yeah of course
so with starting with Revenue you
subtract cost of goods sold minus
operating expenses which brings you down
to operating income at operating income
you multiply that by one minus the tax
rate to take you to net income net
income will be the first line item on
your cash flow statement you will add
back depreciation and other non-cash
expenses and then you will subtract
Capital expenditures and changes in
working capital and then what do you
usually use for the discount rate
for the discount rate assuming we're
talking about a public company is it
okay to make that assumption yes for a
public company I would use the weighted
average cost of capital for the discount
rate okay and uh how do you calculate
that
the equation to calculate the weighted
average cost of capital and I'll use
whack from here on forward is the cost
of equity times the percentage of equity
plus the cost of debt times the
percentage of debt times one minus the
tax rate plus the cost of preferred
stock times the percentage of preferred
stock
and then how do you calculate the cost
of equity
that's a great question the cost of
equity is calculated by taking the
risk-free rate adding it to Beta times
the risk-free premium
okay and let's say that you use the
leverage free cash flow rather than the
unlevered free cash flow in your DCF
what would be the effect of doing so the
effect of doing so would calculate your
cost of equity
and the free cash flows
uh free cash flows would give you your
cost of equity since you're effectively
repaying your debt back through interest
payments so you mentioned that for
public companies you would use wac as
the discount rate what would you use for
private companies so for a private
company it's fairly difficult to use
whack based on the idea that there is no
private Market or there is no market
capitalization in a private market and
so typically the best way to use a
discounted rate in a in private markets
is to either run it through an auditor
or to take a public market comparable
and to use the whack that they used and
you can find that through some of the
their public filings what does beta mean
intuitively
intuitively beta is measuring a stock
Price's volatility against the
volatility of the market
okay
okay awesome so we finished the finance
portion I want to move on to the equity
value-based interview questions and
let's just start with the first one
which is what is the formula for
Enterprise Value formula for Enterprise
Value is calculated by market
capitalization plus debt plus preferred
stock plus minority interest minus cash
why do we look at both Enterprise Value
and Equity value so the reason we look
at Enterprise Value and Equity value is
because Equity value is attributed only
to shareholders who own Equity if you
were to bring in debt holders debt
holders plus Equity would get you to
Enterprise Value which would represent
the value of the entire firm and then
could a company have a negative equity
value and if so what would that mean
no a company cannot have a negative
equity value because you cannot have a
negative shares outstanding and you also
cannot have a negative share price and
can a company's Enterprise Value ever be
negative
yes the reason why a company's
Enterprise Value can be negative is
because as I mentioned before as part of
the formula you subtract cash so if a
company is has excessive cash on their
balance sheet more so than the debt and
the capitalization of the business you
could have a negative Enterprise Value
cool awesome that concludes it for the
Enterprise value-based questions I have
a few more questions on industry based
and my first one for you is let's say
you had 10 million dollars to invest in
anything that you want what would you
invest it in
it's a really good question I think that
if I was given 10 million dollars I
would create a diversified portfolio
that had a heightened level of risk just
based on the fact that I'm young and so
because I'm young I can increase my risk
level because if I were to lose that I
would have a longer period of time to be
able to make up those losses I would
have 40 percent of my portfolio be
invested in venture capital and private
Equity I would have 20 percent of my
portfolio be invested in private and
public real estate I would have 20
percent of my portfolio be invested in
public equities and the remainder of the
10 million dollars I would spread across
Angel Investments okay
and that if you owned a small business
and you're approached by a larger
company about an acquisition how would
you think about the offer and how would
you make a decision on what to do and
would you just do it yeah well if I was
approached to
um have my business be acquired I would
first be excited about the opportunity
the factors that would
that I would consider in a Cell would be
number one the price of the acquisition
how much was this company looking to buy
my business for the second would be and
what form of payment would this acquire
buy my business for would they give me
stock options would they try to buy me
in form of debt or would they give me a
cash option and then I would look at you
know as I built this business I had a
vision for it originally and so I would
like to see what this acquirer has in
store for the future plans of the
company
sense so I'll close that with a final
question and I just want to know what's
a company that you admire and why
a company that I admire is a company
called early admit and this business
operates in the educational Consulting
Market the value proposition of this
business is twofold one is a focus on
affordability and the second is a focus
on diversity
the business originally went to Market
servicing deferred MBA candidates and
has since focused on the early career
Consulting Market their mission is to
help college students recruit and land
jobs at top finance and consulting firms
and I'm really excited to see the impact
that this business is going to have okay
awesome thank you so much
thank you so much for tuning in to our
investment banking mock interview
I thought that Devon did extremely
extremely well on one side he remained
extremely calm and poised during the
entire interview and then on the second
side he did really well with the finance
technicals he was able to Showcase his
knowledge and explain it in a very
concise manner
as you saw this was a sample of a few
questions and not the entire list but if
you want to see more examples of
questions we've actually linked a much
larger list in our written guide so I
would highly recommend for you to go and
see it but then this is the end of the
course I'll see you next time
foreign
[Music]
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