Advanced Technical Questions #

1. “Walk me through an accretion/dilution analysis for a merger.” #

Detailed Response:

“Let me provide a comprehensive walkthrough of accretion/dilution analysis:

Step 1: Basic Framework

• Accretion: Deal increases acquirer’s EPS
• Dilution: Deal decreases acquirer’s EPS
• Formula: Pro Forma EPS vs. Standalone EPS

Step 2: Detailed Analysis Process

1. Calculate Pre-Deal Metrics:

   • Acquirer’s standalone EPS
   • Target’s standalone EPS
   • Both companies’ P/E ratios

2. Determine Deal Parameters:

   • Purchase price and premium
   • Payment method (cash, stock, or combination)
   • Financing structure
   • Expected synergies
   • Integration costs
   • Transaction costs

3. Model Pro Forma Entity:

   • Combined income statement
   • Interest expense adjustments
   • Share count changes
   • Synergy implementation
   • Tax considerations

Example Calculation:

Acquirer:

• EPS: $2.00
• Shares: 100M
• P/E: 15x

Target:

• EPS: $1.50
• Shares: 50M
• P/E: 12x

Deal Terms:

• 40% premium
• 50% cash/50% stock
• $100M annual synergies
• 35% tax rate

Pro Forma Impact:

• New shares issued
• Additional interest expense
• Synergy benefits
• Integration costs
• Net impact on EPS

Key Considerations:

1. Timing:

   • Phase-in of synergies
   • Integration cost schedule
   • Financing costs

2. Sensitivity Analysis:

   • Premium variations
   • Synergy achievement
   • Interest rate changes
   • Integration cost overruns”

2. “How do you calculate Free Cash Flow?” #

Comprehensive Answer:

“Let me break down the different approaches to calculating Free Cash Flow:

1. Unlevered Free Cash Flow (FCFF)

Starting Point Method:

EBIT(1-t)

• Depreciation & Amortization

• Capital Expenditures
• Changes in Working Capital = Unlevered Free Cash Flow

Alternative Method:

Net Income

• Interest Expense(1-t)
• Depreciation & Amortization

• Capital Expenditures
• Changes in Working Capital = Unlevered Free Cash Flow

2. Levered Free Cash Flow (FCFE)

Net Income

• Depreciation & Amortization

• Capital Expenditures
• Changes in Working Capital

• Net Borrowing = Levered Free Cash Flow

Working Capital Calculations:

Change in Working Capital =

• Δ Accounts Receivable
• Δ Inventory
• Δ Prepaid Expenses

• Δ Accounts Payable
• Δ Accrued Expenses

Important Considerations:

1. One-time Items:

   • Exclude non-recurring expenses
   • Adjust for extraordinary items
   • Consider restructuring costs

2. Operating vs. Non-operating:

   • Focus on core business activities
   • Exclude non-operating income/expense
   • Consider impact of asset sales

3. Growth Implications:

   • Sustainable vs. temporary changes
   • Impact on working capital needs
   • Maintenance vs. growth capex”

3. “What are the pros and cons of issuing debt versus equity?” #

Structured Analysis:

“Let me break down the advantages and disadvantages of each:

Debt Financing:

Advantages:

1. Tax Benefits

   • Interest is tax-deductible
   • Reduces effective cost of capital
   • Enhances shareholder returns

2. Retention of Control

   • No dilution of ownership
   • Maintained voting rights
   • Preserved upside potential

3. Lower Cost of Capital

   • Generally cheaper than equity
   • Fixed payment obligations
   • Predictable cash flows

4. Market Signal

   • Can indicate financial strength
   • Shows confidence in cash flows
   • May improve market perception

Disadvantages:

1. Fixed Obligations

   • Mandatory interest payments
   • Principal repayment schedule
   • Default risk

2. Financial Constraints

   • Debt covenants
   • Reduced financial flexibility
   • Impact on credit rating

3. Financial Distress Risk

   • Increased bankruptcy risk
   • Higher cost of financial distress
   • Impact on operations

Equity Financing:

Advantages:

1. No Fixed Obligations

   • No mandatory payments
   • Flexible dividend policy
   • Reduced financial risk

2. Financial Flexibility

   • No covenant restrictions
   • Improved credit metrics
   • Enhanced borrowing capacity

3. Permanent Capital

   • No repayment requirement
   • Long-term funding source
   • Strategic flexibility

Disadvantages:

1. Ownership Dilution

   • Reduced earnings per share
   • Shared future upside
   • Potential control issues

2. Higher Cost

   • Expected returns higher than debt
   • No tax deductibility
   • Perpetual cost

3. Market Signal

   • Can indicate overvalued stock
   • Potential negative perception
   • Market timing concerns

Practical Considerations:

1. Current Market Conditions

   • Interest rate environment
   • Equity market valuations
   • Investor sentiment

2. Company-Specific Factors

   • Current leverage ratio
   • Growth opportunities
   • Cash flow stability

3. Industry Factors

   • Peer capital structures
   • Industry cyclicality
   • Regulatory environment”

4. “Walk me through a comparable company analysis.” #

Detailed Process:

“Here’s a comprehensive walkthrough of comparable company analysis:

Step 1: Select Comparable Companies

Criteria:

1. Business Model

   • Similar products/services
   • Comparable revenue streams
   • Operating model alignment

2. Financial Characteristics

   • Size range (typically 0.5x-2x)
   • Growth profile
   • Margin structure
   • Capital intensity

3. Market Position

   • Geographic presence
   • Competitive landscape
   • Market share

Step 2: Gather Financial Information

Key Metrics:

1. Income Statement

   • Revenue
   • EBITDA
   • EBIT
   • Net Income
   • Growth rates

2. Balance Sheet

   • Total assets
   • Net debt
   • Working capital
   • Capital structure

3. Cash Flow

   • Operating cash flow
   • Capital expenditures
   • Free cash flow
   • Conversion rates

Step 3: Calculate Key Statistics

Operating Metrics:

• Revenue growth
• EBITDA margins
• EBIT margins
• Net margins
• Return on capital

Trading Metrics:

• EV/Revenue
• EV/EBITDA
• EV/EBIT
• P/E
• P/B

Step 4: Analyze Trading Multiples

Analysis Considerations:

1. Statistical Analysis

   • Mean/median
   • High/low range
   • Standard deviation
   • Outlier analysis

2. Qualitative Factors

   • Growth differences
   • Margin profiles
   • Risk factors
   • Market position

3. Trading Liquidity

   • Volume analysis
   • Shareholder base
   • Float considerations

Step 5: Apply Multiples

Adjustment Factors:

1. Size Differences

   • Scale advantages
   • Market position
   • Operating leverage

2. Growth Variations

   • Historical trends
   • Future prospects
   • Market opportunities

3. Risk Considerations

   • Business model
   • Geographic exposure
   • Customer concentration

4. Quality Factors

   • Management team
   • Market leadership
   • Brand strength

Step 6: Determine Value Range

Process:

1. Select Appropriate Multiples

   • Consider most relevant metrics
   • Weight different multiples
   • Justify selections

2. Apply Adjustments

   • Control premium
   • Liquidity discount
   • Growth adjustments

3. Calculate Range

   • Low end estimate
   • High end estimate
   • Median value
   • Weighted average

Common Pitfalls to Avoid:

1. Poor Comp Selection

   • Too few companies
   • Irrelevant companies
   • Outdated information

2. Mechanical Application

   • Ignoring qualitative factors
   • Missing key adjustments
   • Overlooking context

3. Inconsistent Calculations

   • Different time periods
   • Varying definitions
   • Treatment of one-time items”

5. “What factors affect a company’s beta?” #

Comprehensive Analysis:

“Let me break down the key factors affecting a company’s beta:

1. Business Risk Factors

Operational Leverage:

• Fixed vs. variable costs
• Break-even point
• Capacity utilization
• Cost structure flexibility

Industry Characteristics:

• Cyclicality
• Regulation
• Competition
• Technology change
• Entry barriers

Revenue Stability:

• Contract nature
• Customer concentration
• Product diversity
• Geographic mix

2. Financial Risk Factors

Financial Leverage:

• Debt levels
• Interest coverage
• Fixed charges
• Capital structure

Working Capital:

• Cash conversion cycle
• Inventory management
• Receivables policy
• Payables terms

Capital Intensity:

• Asset base
• Maintenance requirements
• Growth investments
• Replacement cycles

3. Market Factors

Market Correlation:

• Industry positioning
• Economic sensitivity
• Market timing
• Trading patterns

Size Effects:

• Market capitalization
• Trading volume
• Analyst coverage
• Index inclusion

Liquidity:

• Bid-ask spread
• Trading frequency
• Institutional ownership
• Float size

4. Quantitative Considerations

Calculation Period:

• Time frame selection
• Data frequency
• Market conditions
• Structural changes

Market Index:

• Benchmark selection
• Geographic relevance
• Sector alignment
• Size appropriateness

Statistical Significance:

• R-squared
• Standard error
• Sample size
• Outlier impact

5. Risk Management Impact

Hedging Activities:

• Currency hedging
• Commodity hedging
• Interest rate hedging
• Insurance coverage

Diversification:

• Product lines
• Geographic markets
• Customer base
• Supply chain

Operating Flexibility:

• Input substitution
• Production shifting
• Pricing power
• Cost variability”

Advanced Topics for Further Discussion:

• Industry-specific valuation metrics
• Complex merger structures
• Advanced financial modeling techniques
• Deal documentation and process
• Risk arbitrage and trading considerations