Investment Banking - Finance Technicals Mock Interview

Summary

In 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

00:00

📊 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.

05:00

🏢 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.

Keywords

💡Free Cash Flow

Free Cash Flow (FCF) is a financial metric that represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. In the script, it is mentioned as a key component in financial analysis, starting from revenue and accounting for various expenses and adjustments to arrive at the cash flow statement. It is a critical indicator of a company's financial health and is used in the Discounted Cash Flow (DCF) method for valuation.

💡Cost of Goods Sold

Cost of Goods Sold (COGS) refers to the direct costs attributable to the production of goods or services. In the script, COGS is identified as the first expense to be subtracted from revenue to calculate the operating income, which is an essential step in deriving the free cash flow.

💡Operating Income

Operating Income is the profit a company generates from its regular business operations, excluding any income from non-operating activities. In the transcript, it is the result of subtracting the cost of goods sold and operating expenses from revenue, and it is a precursor to net income after tax considerations.

💡Net Income

Net Income, also known as net profit or net earnings, is the final amount of profit a company earns after accounting for all expenses, including taxes. In the script, it is derived from operating income and is the starting point for the cash flow statement, which is then adjusted for non-cash items and capital expenditures to calculate free cash flow.

💡Depreciation

Depreciation is a non-cash expense that allocates the cost of tangible assets over their useful life. In the context of the script, depreciation is added back to net income when calculating free cash flow because it reduces the taxable income and thus the tax expense, affecting the company's cash position.

💡Capital Expenditures

Capital Expenditures (CapEx) are funds used by a company to acquire or improve physical assets. In the script, CapEx is subtracted from the adjusted net income to determine free cash flow, as it represents the cash outflow for investments in long-term assets.

💡Working Capital

Working Capital is a measure of a company's short-term financial health, defined as current assets minus current liabilities. In the transcript, changes in working capital are considered when calculating free cash flow, as they affect the company's liquidity and cash flow.

💡Discount Rate

The Discount Rate is the interest rate used to determine the present value of future cash flows. In the script, it is discussed in the context of the Weighted Average Cost of Capital (WACC) for public companies, which is used as the discount rate in the DCF method for valuation.

💡Weighted Average Cost of Capital (WACC)

WACC is the average rate that a company expects to pay to finance its assets, weighted by the proportion of each type of financing. In the transcript, it is used as the discount rate for valuing a company, calculated by taking into account the cost of equity, debt, and preferred stock.

💡Beta

Beta is a measure of the volatility of a stock's returns relative to the returns of the overall market. In the script, it is used in the calculation of the cost of equity, where it represents the systematic risk of the stock compared to the market as a whole.

💡Enterprise Value

Enterprise Value (EV) is a measure of a company's total value, including both equity and debt. In the script, it is calculated by adding market capitalization, debt, preferred stock, and minority interest, and then subtracting cash and cash equivalents. It represents the value of the entire company, as opposed to just the equity value.

💡Equity Value

Equity Value is the value of a company attributable to its shareholders, calculated by subtracting a company's liabilities from its assets. In the script, it is contrasted with Enterprise Value to illustrate the difference between the value of the company's equity and the total value of the company.

💡Acquisition

An Acquisition refers to the purchase of one company by another, which can be for various strategic reasons. In the script, the discussion about a small business being approached by a larger company for acquisition highlights the considerations and decision-making process involved in such a transaction.

💡Early Admit

Early Admit is a company mentioned in the script that operates in the educational consulting market, focusing on affordability and diversity. The company's mission is to help college students secure jobs at top finance and consulting firms, which the interviewee admires for its impact on early career development.

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]