Investment Banking Interview Questions 1695196425

Investment Banking
Technical Interview
Questions.
Source: CFI, The Valuation School, Investopedia, YouTube, Etc.

01
Q. How do you value a company?
Intrinsic Value (DCF):
The DCF says that the value of a going concern company

is equal to the present value of its future cash flows.
We have to find the company’s free cash flows to firm for

5-20 years, depending on the availability and reliability of
the information, and then calculate a terminal value.
A growth rate is added to the FCFF. The factors to

consider here are previous growth, business cycle, macro
factors, company’s potential, Analyst’s estimate and Top
down approach.
Discount both the FCFFs projections and terminal value

by an appropriate cost of capital which is weighted
average cost of capital. (10yr Govt Bond Yield - Default
Spread + ERP * Beta)
In an unlevered DCF this will yield the company’s

enterprise value (aka firm and transaction value), from
which we need to subtract net debt to arrive at equity
value.
To arrive at the equity value per share, divide the equity

value by the company’s diluted shares outstanding.
02
Relative Valuation:
Comparable Company (Multiples):
It involves determining a comparable peer group –

companies that are in the same industry with similar
operational, growth, risk, and return on capital
characteristics.
Truly identical companies of course do not exist, but

you should attempt to find as close to comparable
companies as possible. Calculate appropriate industry
multiples.
Apply the median of these multiples on the relevant

operating metric of the target company to arrive at a
valuation.
Common multiples are EV/Rev, EV/EBITDA, P/E, P/B,

although some industries place more emphasis on
some multiples vs. others, while other industries use
different valuation multiples altogether.
03
Comparable Transaction:
The valuation is based on any a Similar and

Comparable company which is sold in the near term.
The comparable company must be in the similar

business sector and the size of the company should be
relevant
We have to check the valuation metric, Whether it is

relevant in today’s dynamics or not.
Selling Company - Similar & Comparable to match the

size and the business sector.
Buyer - Must be a public company or else you wont

have any deal information.
% of Stake - The stake must be >50% hence the

acquisition.
04
Q. Tell me about a particular industry you
are interested in and the how will you
value it?
Do prepare a research report and a financial model for
a company to go deep in the business and the industry.
You will learn a lot about the macroeconomic factors
and the company’s business model.
Do research about an industry or two (read an industry

report by a sell-side analyst) before the interview.
Pick the industry about which you are genuinely

interested in and which is easy to understand.
Read one or two year of Annual report and 2-3 Con

Calls of the company to go deep.
This will give you a lot of things to talk about the

industry and the company, And then explain the
valuation using any method (Go DCF).
Be reasonable and logical with your reasons behind the

numbers specifically Growth Rate.
05
Q. What is the appropriate discount rate
to use in an unlevered DCF analysis?
Since the free cash flows (FCFF) in an unlevered DCF
analysis are pre-debt (Think as unlevered cash flows as
the company’s cash flows as if it had no debt – so no
interest expense, and no tax benefit from that interest
expense),
The cost of the cash flows relate to both the lenders

and the equity providers of capital.
Thus, the discount rate is the weighted average cost of

capital to all providers of capital (both debt and equity).
Cost of Debt: The cost of debt is readily observable in

the market as the yield on debt with equivalent risk
reducing the country and company (If emerging)
default spread.
Cost of Equity: The cost of equity is typically estimated

using the capital asset pricing model (CAPM), which
links the expected return of equity to its sensitivity to
the overall market but do take the country equity risk
premium into consideration too.
06
Q. What is typically higher – the cost of
debt or the cost of equity?
The cost of equity is higher than the cost of debt
because the cost associated with borrowing debt is
less since they are taking less risk while giving out the
capital hence the lower return.
The equity shareholders took a lot more risk while

investing hence the higher return.
Also the interest expense is tax-deductible, creating a

tax shield which further reduces the cost of debt..
Additionally, the cost of equity is typically higher

because, unlike lenders, equity investors are not
guaranteed fixed payments, and are last in line for
liquidation.
07
Q. How do you calculate the cost of
equity?
There are several competing models for estimating the
cost of equity, however, the capital asset pricing model
(CAPM) is predominantly used on the street.
The CAPM links the expected return of a security to its

sensitivity to the overall market basket (often proxied
using the S&P 500 or Nifty 50).
CAPM Cost of Equity (Ke) = Risk Free Rate (rf) + β x

Market Risk Premium (rm-rf ).
Risk Free Rate: It should reflect the YTM of default-free

government bonds of equivalent maturity to the
duration of each cash flows being discounted.
Market Risk Premium: MRP (rm-rf) represents the

excess returns of investing in stocks over the risk-free
rate.
Beta (β): It provides a method to estimate the degree of

an asset’s systematic (non-diversifiable) risk. It means
the risk in investing in a company instead of the market.
Beta of 1.0 is “as risky” as the overall stock market.
08
Q. How would you calculate β (Beta) for a
company?
Calculating raw betas from historical returns and even
projected betas is an imprecise measurement of future
beta because of estimation errors (i.e. standard errors
create a large potential range for beta).
It is recommended that we use an industry beta. Of

course, since the betas of comparable companies are
distorted because of different rates of leverage, we
should unlever the betas of these comparable
companies as such:
β Unlevered = β(Levered) / [1+ (Debt/Equity) (1-T)]
Then, once an average unlevered beta is calculated,

relever this beta at the target company’s capital
structure:
β Levered = β(Unlevered) x [1+(Debt/Equity) (1-T)]

09
Q. How do you calculate unlevered free
cash flows for DCF analysis?
The Unlevered FCF for DCF means the The firm’s cash
flows that is available for all the capital investors
whether debt or equity.
The formula for calculating the unlevered free cash flow

metric is as follows.
Unlevered Free Cash Flow = Operating Profit (EBIT) * (1

–tax rate) + Depreciation & Amortization – Change in
Net Working Capital – Capital Expenditures
10
Q. What is the appropriate numerator for
a revenue multiple?
It is Enterprise Value also the Market Cap. It is because
the revenue is earned on everyone’s money so the
numerator should be related.
The question tests whether you understand the

difference between equity value and enterprise value
and their relevance to multiples.
Equity value = Enterprise Value – Net Debt (Net Debt =

Gross Debt and Debt Equivalents – Excess Cash) +/-
Value in Subsidiary Company + Value of any Non
Operating asset.
Enterprise Value Multiples: EBIT, EBITDA, Unlevered

cash flow, and revenue multiples all have enterprise
value as the numerator because the denominator is an
unlevered (pre-debt) measure of profitability.
Equity Value Multiples: Conversely, EPS, after-tax cash

flows, and the book value of equity all have equity value
as the numerator because the denominator is levered –
or post-debt.
11
Q. How would you value a company with
negative historical cash flow?
Given that negative profitability will make most

multiples analyses meaningless, a DCF valuation
approach is appropriate here.
Q. When should you value a company

using a revenue multiple vs. EBITDA?
Companies with negative profits and EBITDA will

have meaningless EBITDA multiples.
As a result, Revenue multiples are more

insightful.
12
Q. Two companies are identical in
earnings, growth prospects, leverage,
returns on capital, and risk. Company A is
trading at a 15 P/E multiple, while the
other trades at 10 P/E. which would you
prefer as an investment?
We would prefer the company with P/E of 10. A
rational investor would rather pay less per unit of
ownership.
In PE of 15 you would have to 15 Rs for 1 Rs of

earning whereas with PE of 10 you will pay 10 Rs
for 1 Rs of earnings.
Posts every alternate Day Faizan Nezami
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Investment Banking

Source: CFI, The Valuation School, Investopedia, YouTube, Etc.

The DCF says that the value of a going concern company

We have to find the company’s free cash flows to firm for

A growth rate is added to the FCFF. The factors to

Discount both the FCFFs projections and terminal value

In an unlevered DCF this will yield the company’s

To arrive at the equity value per share, divide the equity

Comparable Company (Multiples):

It involves determining a comparable peer group –

Truly identical companies of course do not exist, but

Apply the median of these multiples on the relevant

Common multiples are EV/Rev, EV/EBITDA, P/E, P/B,

The valuation is based on any a Similar and

The comparable company must be in the similar

We have to check the valuation metric, Whether it is

Selling Company - Similar & Comparable to match the

Buyer - Must be a public company or else you wont

% of Stake - The stake must be >50% hence the

Do research about an industry or two (read an industry

Pick the industry about which you are genuinely

Read one or two year of Annual report and 2-3 Con

This will give you a lot of things to talk about the

Be reasonable and logical with your reasons behind the

The cost of the cash flows relate to both the lenders

Thus, the discount rate is the weighted average cost of

Cost of Debt: The cost of debt is readily observable in

Cost of Equity: The cost of equity is typically estimated

The equity shareholders took a lot more risk while

Also the interest expense is tax-deductible, creating a

Additionally, the cost of equity is typically higher

The CAPM links the expected return of a security to its

CAPM Cost of Equity (Ke) = Risk Free Rate (rf) + β x

Risk Free Rate: It should reflect the YTM of default-free

Market Risk Premium: MRP (rm-rf) represents the

Beta (β): It provides a method to estimate the degree of

It is recommended that we use an industry beta. Of

β Unlevered = β(Levered) / [1+ (Debt/Equity) (1-T)]

Then, once an average unlevered beta is calculated,

β Levered = β(Unlevered) x [1+(Debt/Equity) (1-T)]

The formula for calculating the unlevered free cash flow

Unlevered Free Cash Flow = Operating Profit (EBIT) * (1

The question tests whether you understand the

Equity value = Enterprise Value – Net Debt (Net Debt =

Enterprise Value Multiples: EBIT, EBITDA, Unlevered

Equity Value Multiples: Conversely, EPS, after-tax cash

Given that negative profitability will make most

Q. When should you value a company

Companies with negative profits and EBITDA will

As a result, Revenue multiples are more

In PE of 15 you would have to 15 Rs for 1 Rs of

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