MBAs are a useful people, if for no other reason than the help they can provide to the investment bankers of future. Below are a collection of real questions that were asked of investment banking candidates at the MBA level, along with suggested answers that they later put together. If you find yourself on a ‘superday’ interview at a big bank, you can bet that you’ll be asked at least of few of these questions. Disagree with an answer? Let us know in the comments below.

An LBO is a transaction in which a party purchases a business and brings it private.  The transaction is funded using a large portion of debt.  Three main characteristics of LBOs – 1) high debt, which is intended to be paid down, 2) incentives, managers are given greater stake in business, 3) private ownership, many LBOs go public again once debt has been paid down.

1) Whether they will generate enough cash flows to cover interest obligations. How many multiples in excess of current interest payments is their operations generating in cash flow?

2) What is their current capital structure and can they bring on more debt and leverage the company further without being too levered versus industry and peers so that their credit rating and stock price isn’t negatively impacted.

3) What is the current equity value? If the stock price is appropriately valued or has a potentially high value, then equity might be better.

The FED can adjust the Federal Funds Rate which is the interbank overnight rate at which the FED lends money.  The lower the Federal Funds Rate, the lower real interest rates. The FED can also adjust the money supply through the purchase or sale of government bonds, whereby affecting inflationary expectations which will adjust nominal interest rates.

Interest coverage rate is operating income divided by interest expense (EBIT/interest).  This basically measures how much leadway a company has between its earnings and interest payments (a hurdle they must keep jumping to avoid default).

In event of bankruptcy, the senior debt would have to be paid before the junior. However, when using the interest coverage ratio to analyze a company’s ability to keep up with their debt payments, I would look at the EBIT divided by ALL forms of debt as a failure to make payments for any form of debt results in default.

The Net Income on the bottom line of the income statement gets added into the retained earnings on the balance sheet.  The net income from the income statement is also the starting line of the statement of cash flows.

There are five common valuation methodologies.

• Trading Range (the range the stock has been trading in during the past 52‐weeks). If we trust the market we should assume this is a reasonable place to start our analysis.
  

• Discounted Cash Flow (DCF), also called Intrinsic Value, seeks to find a present value of all future cash flows of the firm that are available to stakeholders. This can be done using WACC (weighted average cost of capital) or APV (adjusted present value).
  

• Public Comparables looks at peer companies to determine how the market values companies in the same or similar businesses using multiples including P/E and EV/EBITDA.
• Acquisition Comparables, also called Deal Comps or Precedent Transactions, looks to see how much acquirers recently paid for similar businesses.
• Asset Value, also called liquidation or breakup value, examines what you can sell the company’s assets for (including real estate).
  

In addition, valuation can be framed through:

• Leveraged Buyout looks at what a financial sponsor could pay considering a target IRR (internal rate of return) and the debt capacity of the firm.
  

• Merger Consequences Analysis is actually an affordability analysis (what can an acquirer pay) rather than an analysis of the value of a target.
  

Valuation for a private company is the same as the valuation of a public company with some complications, particularly as it relates to DCF (discounted cash flow).  Because a private company has no publicly traded equity, a beta cannot be directly computed.

To find the cost of equity (KE)

1. Estimate the total value of the private company based on comparables (use average EV/EBITDA)

2. Deduct the value of the debt to get estimated “market” value of equityor internal use only

3. Get the average levered beta from the comparables and unlever it

4. Re-lever the beta for the private company based on the target D/E (debt-to-equity) ratio

5. Calculate Ke based on CAPM (capital asset pricing model)

To find the cost of debt (Kd)

1. Some privately held companies have publicly traded debt – so look up trading yields to estimate Kd

2. Alternatively, estimate what the credit rating of the company would be based on comparables (look at credit statistics)

3. For estimated credit ratings, use current market yields for similarly rated companies to determine Kd

Then calculate WACC as normal and DCF as normal

First, you must define what you think is significant excess cash. For companies that are in cyclical industries, paying out large amounts of cash might leave the company unprepared for a subsequent market downturn. Once you have established that your client does indeed have excess cash on the books, there are a few tried and tested uses for excess cash.

• Invest in positive net present value (NPV) projects (acquisitions, CapEx, R&D)
  

• Return money to shareholders in the form of share repurchases, dividends, and debt repayments
  

• Must take into account Kd, Ke, WACC, and tax considerations