Contents
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
- Calculate Pre-Deal Metrics:
- Acquirer’s standalone EPS
- Target’s standalone EPS
- Both companies’ P/E ratios
- Determine Deal Parameters:
- Purchase price and premium
- Payment method (cash, stock, or combination)
- Financing structure
- Expected synergies
- Integration costs
- Transaction costs
- 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:
- Timing:
- Phase-in of synergies
- Integration cost schedule
- Financing costs
- 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:
- 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
- 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:
- One-time Items:
- Exclude non-recurring expenses
- Adjust for extraordinary items
- Consider restructuring costs
- Operating vs. Non-operating:
- Focus on core business activities
- Exclude non-operating income/expense
- Consider impact of asset sales
- 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:
- Tax Benefits
- Interest is tax-deductible
- Reduces effective cost of capital
- Enhances shareholder returns
- Retention of Control
- No dilution of ownership
- Maintained voting rights
- Preserved upside potential
- Lower Cost of Capital
- Generally cheaper than equity
- Fixed payment obligations
- Predictable cash flows
- Market Signal
- Can indicate financial strength
- Shows confidence in cash flows
- May improve market perception
Disadvantages:
- Fixed Obligations
- Mandatory interest payments
- Principal repayment schedule
- Default risk
- Financial Constraints
- Debt covenants
- Reduced financial flexibility
- Impact on credit rating
- Financial Distress Risk
- Increased bankruptcy risk
- Higher cost of financial distress
- Impact on operations
Equity Financing:
Advantages:
- No Fixed Obligations
- No mandatory payments
- Flexible dividend policy
- Reduced financial risk
- Financial Flexibility
- No covenant restrictions
- Improved credit metrics
- Enhanced borrowing capacity
- Permanent Capital
- No repayment requirement
- Long-term funding source
- Strategic flexibility
Disadvantages:
- Ownership Dilution
- Reduced earnings per share
- Shared future upside
- Potential control issues
- Higher Cost
- Expected returns higher than debt
- No tax deductibility
- Perpetual cost
- Market Signal
- Can indicate overvalued stock
- Potential negative perception
- Market timing concerns
Practical Considerations:
- Current Market Conditions
- Interest rate environment
- Equity market valuations
- Investor sentiment
- Company-Specific Factors
- Current leverage ratio
- Growth opportunities
- Cash flow stability
- 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:
- Business Model
- Similar products/services
- Comparable revenue streams
- Operating model alignment
- Financial Characteristics
- Size range (typically 0.5x-2x)
- Growth profile
- Margin structure
- Capital intensity
- Market Position
- Geographic presence
- Competitive landscape
- Market share
Step 2: Gather Financial Information
Key Metrics:
- Income Statement
- Revenue
- EBITDA
- EBIT
- Net Income
- Growth rates
- Balance Sheet
- Total assets
- Net debt
- Working capital
- Capital structure
- 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:
- Statistical Analysis
- Mean/median
- High/low range
- Standard deviation
- Outlier analysis
- Qualitative Factors
- Growth differences
- Margin profiles
- Risk factors
- Market position
- Trading Liquidity
- Volume analysis
- Shareholder base
- Float considerations
Step 5: Apply Multiples
Adjustment Factors:
- Size Differences
- Scale advantages
- Market position
- Operating leverage
- Growth Variations
- Historical trends
- Future prospects
- Market opportunities
- Risk Considerations
- Business model
- Geographic exposure
- Customer concentration
- Quality Factors
- Management team
- Market leadership
- Brand strength
Step 6: Determine Value Range
Process:
- Select Appropriate Multiples
- Consider most relevant metrics
- Weight different multiples
- Justify selections
- Apply Adjustments
- Control premium
- Liquidity discount
- Growth adjustments
- Calculate Range
- Low end estimate
- High end estimate
- Median value
- Weighted average
Common Pitfalls to Avoid:
- Poor Comp Selection
- Too few companies
- Irrelevant companies
- Outdated information
- Mechanical Application
- Ignoring qualitative factors
- Missing key adjustments
- Overlooking context
- 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:
- 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
- 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
- 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
- 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
- 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”
- Industry-specific valuation metrics
- Complex merger structures
- Advanced financial modeling techniques
- Deal documentation and process
- Risk arbitrage and trading considerations
