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.