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value of a company is equal to
the value of a company is equal to
the value of its assets, and that:
Value of Assets = Debt (liabilities) + Equity
If I buy a company, I buy its stock (equity) and assume its debt (bonds and
loans).
Buying a company’s equity means that I actually gain ownership of
the company—if I buy 50 percent of a company’s equity, I own 50 percent
of the company. Assuming a company’s debt means that I promise to pay
the company’s lenders the amount owed by the previous owner.
The value of debt is easy to calculate:
since the market value of debt is
difficult to ascertain for our purposes, we can safely use the book value of
debt
The four most commonly used techniques to determine the market value of
equity are:
1. Discounted cash flow (DCF) analysis
2. Multiples method
3. Market valuation
4. Comparable transactions method
There are four basic financial statements that provide the information you
need to evaluate a company:
• Balance Sheets
• Income Statements
• Statements of Cash Flows
• Statements of Retained Earnings
Here are the
types of long-term financing on the balance sheet that you might normally
see, in order of seniority (high to low):
1. Senior secured debt (corporate loans and bonds)
2. Senior unsecured debt (corporate loans and bonds)
3. Mezzanine debt (a blend of debt/equity)
4. Preferred stock
5. Common stock
Operating income is usually referred to as
EBIT (Earnings Before Interest and Taxes).
The statement of retained earnings is a reconciliation of the
retained earnings account from the beginning to the end of the year. When
a company announces income or declares dividends, this information is
reflected in the statement of retained earnings.
Cash flows from operating activities:
Includes the cash effects of
transactions involved in calculating net income
• Cash flows from investing activities:
Basically, cash from nonoperating
activities or activities outside the normal scope of business.
This involves items classified as assets in the balance sheet and includes
the purchase and sale of equipment and investments.
• Cash flows from financing activities:
Involves items classified as
liabilities and equity in the balance sheet; it includes the payment of
dividends as well as issuing payment of debt or equity.
Net income from the income statement is shown in the section
“cash
flows from operating activities.”
• Dividends from the statement of retained earnings is shown in the section
“cash flows from financing activities.”
• Investments, accounts payable and other asset and liability accounts from
the balance sheet are shown in
all three sections.
is the simplest way to value a publicly traded firm
market valuation
The 10Ks
(annual financials) and 10-Qs (quarterly financials) for publicly traded
firms are available online through
the SEC Edgar database, www.edgaronline.
com or www.sec.gov
The value of a publicly traded firm is easy to calculate.
All you need to do
is find the company’s stock price (the price of a single share), multiply it by
the number of shares outstanding, and you have the equity market value of
the company. (This is also known as market capitalization or “market
cap”).
........ is the most thorough way to value a company
The DCF analysis
There are two ways to value a company using the
DCF approach:
• Adjusted Present Value (APV) method
• Weighted Average Cost of Capital (WACC) method
Both methods require calculation of a company’s free cash flows (FCF) as
well as the net present value (NPV) of these FCFs
In general, a dollar today is worth more than a dollar tomorrow for two
simple reasons.
First, a dollar today can be invested at a risk-free interest
rate (think savings account or U.S. government bonds), and can earn a
return. A dollar tomorrow is worth less because it has missed out on the
interest you would have earned on that dollar had you invested it today.
Second, inflation diminishes the buying power of future money.
discount rate can be understood as
the
expected return from a project that matches the risk profile of the project in
which you'd invest your money
In order to find the appropriate discount rate used to discount the company’s
cash flows,
you use the Capital Asset Pricing Model or (CAPM). This is a
model used to calculate the expected return on your investment, also
referred to as expected return on equity, It is a linear model with one
independent variable, Beta.
Beta represents
relative volatility of the given
investment with respect to the market. For example, if the Beta of an
investment is 1, the returns on the investment (stock/bond/portfolio) vary
identically with the market returns. A Beta less than 1, like 0.5, means the
investment is less volatile than the market
A Beta of greater
than 1, like 1.5, means....
the investment is more volatile than the market. A
company in a volatile industry (think Internet company) would be expected
to have a Beta greater than 1
Equity Beta is given
in various sources like Value Line or internet sites like
Yahoo! Finance. If the firm you are valuing is not publicly traded, then you
need to find a firm with a similar balance sheet and income statement that
is publicly traded.
Free cash flow is essentially
all of the extra cash a firm has after its
operations and other areas (i.e., working capital, such as accounts
receivable and accounts payable and regular capital expenditures) to invest
in what it chooses.
To capture the characteristics of an all-equity firm we
recalculate a company’s cash flows as if the firm had no debt. The free cash
flow (FCF) of an all-equity firm in year (i) can be calculated as:
While historical financial
statements are helpful in constructing projections, DCF analysis can only be
done with
future cash flow projections
The terminal year represents the year
(usually 10 years in the future) when
the growth of the company is considered stabilized.
The cash flows of the first 10 years are determined by company
management or a financial analyst, based on
predictions and forecasts of
what will happen. Then, a terminal year value needs to be calculated
assuming that after year 10 the cash flows of the company keep growing at
a constant “g.” Values of “g” are typically not as high as the first 10 years
of growth, which are considered unstabilized growth periods. Instead, “g”
represents the amount the company can feasibly grow forever once it has
stabilized (after 10 years)
Adding the discounted value of the first 10 year FCFs, and the terminal year
FCFs (CFs after year 10 into perpetuity) gives us the value of the company
under
the DCF analysis
We’ll now look at the two most popular methods of discounted cash
flow (DCF) analysis tested in finance interviews:
the WACC (weighted
average cost of capital) and APV (adjusted present value).
For WACC, we calculate the discount rate for
leveraged equity (reL) using the capital asset pricing model (CAPM);
for APV,
we calculate the discount rate for an all-equity firm (reU).
We’re basically thinking about WACC as a firm’s
average financing cost.
Basically, this answers the question: At what cost does a firm acquire its
financing?
The terms (E)/(D + E) and (D)/(D + E) represent the
“target” equity and
debt ratios (also referred to as the equity-to-debt and debt-to-equity ratios).
Thus, we see the key difference between WACC and APV.
With the APV
calculation, we take the unleveraged equity discount rate (the discount rate that
assumes that a company has no debt), rather than a leveraged (historical)
discount rate that the WACC calculation uses
Hence, to find the value of a company using APV
we add
in the value of the debt tax shield, or the amount of money a company saves
by not having to pay interest on debt. To compensate for this difference we
add a value for the debt tax shield separately to arrive at an overall valuation
of the company
What discount rate should be used for
calculating the present value of the DTS?
The answer is the discount rate
that would best capture the risk associated with the DTS. If you assume
that the ability to use the tax shield is as risky as the cash flows to an allequity
firm, we would use the reU. If you assume that the tax shield is as
risky as the ability to repay the debt, then the discount rate should be the
average interest rate, or rD.
The main difference between the WACC and APV methods is that
the
WACC takes the “target” debt-to-equity ratio to calculate the discount rate.
However, a target debt-to-equity ratio is not reached until a few years in the
future. Hence the method is not “academically complete.” The APV
method takes this into consideration and looks at an “all-equity” firm.
The APV and WACC methods make slightly different assumptions about
the value of
interest tax shields, resulting in slightly different values.
To use the “comparable transactions” technique of valuing a company, you
need to look at
the “comparable” transactions that have taken place in the
industry and accompanying relevant metrics such as “multiples” or ratios
With the comparable transactions method, you are looking for a key valuation
parameter.
That is, were the companies in those transactions valued as a
multiple of EBIT, EBITDA, revenue or some other parameter? If you figure
out what the key valuation parameter is, you can examine at what multiples
of those parameters the comparable companies were valued. You can then use
a similar approach to value the company being considered.
Quite often, there is not enough information to determine the valuation
using the comparable transactions method. In these cases, you can value a
company based on
market valuation multiples, which you can do by using
more readily available information.
Notice above that enterprise value is divided by sales or EBITDA to
ascertain the sales and EBITDA multiples, while equity value is divided by
net income to ascertain the price-to-earnings multiple.
What is the difference between the income statement and the
statement of cash flows?
The income statement is a record of revenue and expenses while the statement
of cash flows records the actual cash that has either come into or left the
company. The statement of cash flows has the following categories: operating
cash flows, investing cash flows and financing cash flows.
Interestingly, a company can be profitable as shown in the income
statement, but still go bankrupt if it doesn’t have the cash flow to meet
interest payments. Both statements are linked by Net Income.
What is the link between the balance sheet and the income
statement?
The main link between the two statements is that profits generated in the
income statement get added to shareholder’s equity on the balance sheet as
retained earnings. Also, debt on the balance sheet is used to calculate
interest expense in the income statement.
What is the link between the balance sheet and the statement of cash
flows?
The statement of cash flows starts with the beginning cash balance, which
comes from the balance sheet. Also, cash from operations is derived using
the changes in balance sheet accounts (such as accounts payable, accounts
receivable, etc.). The net increase in cash flow for the prior year goes back
onto the next year’s balance sheet .
What is EBITDA?
A proxy for cash flow, EBITDA is earnings before interest, taxes,
depreciation, and amortization. It can be found on the income statement by
starting with EBIT and adding depreciation and amortization back
6. Walk me through the major line items on a cash flow statement.
The answer: first the beginning cash balance, then cash from operations,
then cash from investing activities, then cash from financing activities and
finally the ending cash balance.
7. What happens to each of the three primary financial statements
when you change a) gross margin, b) capital expenditures, c) any other
change?
Think about the definitions of the variables that change. For example, gross
margin is gross profit/sales, or the extent to which sales of sold inventory
exceeds costs. Hence, if

a) gross margin were to decrease, then gross profit decreases relative to
sales. Thus, for the income statement, you would probably pay lower
taxes, but if nothing else changed, you would likely have lower net
income. The cash flow statement would be affected in the top line with
less cash likely coming in. Hence, if everything else remained the same,
you would likely have less cash. Going to the balance sheet, you would
not only have less cash, but to balance that effect, you would have lower
shareholder’s equity.

b) If capital expenditure were to say, decrease, then first, the level of
capital expenditures would decrease on the statement of cash flows. This
would increase the level of cash on the balance sheet, but decrease the
level of property, plant and equipment, so total assets stay the same. On
the income statement, the depreciation expense would be lower in
subsequent years, so net income would be higher, which would increase
cash and shareholder’s equity in the future.

c) Just be sure you understand the interplay between the three sheets.
Remember that changing one sheet has ramifications on all the other
statements both today and in the future.
How do you value a company?
One basic answer to this question is to discount the company’s projected cash
flows using a “risk-adjusted discount rate.” This process involves several
steps. First you must project a company’s cash flows for 10 years. Then you
must choose a constant growth rate after 10 years going forward. Finally, you
must choose an appropriate discount rate. After projecting the first five or 10
years performance, you add in a “terminal value,” which represents the
present value of all the future cash flows another 10 years. You can calculate
the terminal value in one of two ways:

a) you take the earnings of the last year you projected, say year 10, and
multiply it by some market multiple like 20 times earnings, use that as
your terminal value; or

b) you take the last year, say year 10, and assume some constant growth
rate after that like 10 percent. The present value of this growing stream of
payments after year 10 is the terminal value. Finally, to figure out what
“discount rate” you would use to discount the company’s cash flows, tell
your interviewer you would use the “capital asset pricing model” (or
“CAPM”). (In a nutshell, CAPM says that the proper discount rate to use
is the risk-free interest rate adjusted upwards to reflect this particular
company’s market risk or “Beta.”) For a more advanced answer, discuss
the APV and WACC methods.

You should also mention other methods of valuing a company, including
looking at “comparables”—that is, how other similar companies were valued
recently as a multiple of their sales, net income or some other measure. Or
you might also consider the company’s “breakup value,” the value of
breaking up all of its operations and selling those to other firms.
Why might there be multiple valuations for a single company?
As this chapter has discussed, there are several different methods by which one
can value a company. And even if you use the rigorously academic DCF
analysis, the two main methods (the WACC and APV method) make different
assumptions about interest tax shields, which can lead to different valuations.
This is the basic principle in corporate finance and one of the many reasons
that market capitalizations fluctuate.
Why are the P/E multiples for a company in London different than
that of the same company in the States?
The P/E multiples can be different in the two countries even if all other
factors are constant because of the difference in the way earnings are
recorded. Overall market valuations in American markets tend to be higher
than those in the U.K.
What are the different multiples that can be used to value a company?
The most commonly used multiple is price-to-earnings multiple, or “P/E
ratio.” Other multiples that are used include revenue, EBITDA, EBIT and
book value. The relevant multiple depends on the industry. For example,
internet companies are often valued with revenue multiples; this explains why
companies with low profits can have such high market caps. Many companies
are valued using EBITDA. Furthermore, P/E ratios come under scrutiny
because net income is the “E” and net income includes interest and tax
payments, which might not be the same post-acquisition.
As discussed in the section on valuation, not only should you be aware of the
financial metric being used, you should know the time period the metric used
represents: for example, earnings in a P/E ratio can be for the previous or
projected 12 months, or for the previous or projected fiscal year
15. How do you get the discount rate for an all-equity firm?
You use the capital asset pricing model, or CAPM.
17. How much would you pay for a company with $50 million in
revenue and $5 million in profit?
If this is all the information you are given you can use the comparable
transaction or multiples method to value this company (rather than the DCF
method). To use the multiples method, you can examine common stock
information of comparable companies in the same industry, to get average
industry multiples of price-to-earnings. You can then apply that multiple to
find the given company’s value.
18. What is the difference between the APV and WACC?
WACC incorporates the effect of tax shields into the discount rate used to
calculate the present value of cash flows. WACC is typically calculated using
actual data and numbers from balance sheets for companies or industries.
APV adds the present value of the financing effects (most commonly, the
debt tax shield) to the net present value assuming an all-equity value, and
calculates the adjusted present value. The APV approach is particularly
useful in cases where subsidized costs of financing are more complex, such
as in a leveraged buyout
19. How would you value a company with no revenue?
First you would make reasonable assumptions about the company’s
projected revenues (and projected cash flows) for future years. Then you
would calculate the net present value of these cash flows.
20. What is Beta?
Beta is the value that represents a stock’s volatility with respect to overall
market volatility.
Walk me through the major items of an income statement.
Know all the items that go into the three major components: revenue,
expenses and net income. Know that depreciation and amortization are
non-cash expenses.
Is 10 a high P/E ratio?
The answer to this or any question like this is, “it depends.” P/E ratios are
relative measurements, and in order to know whether a P/E ratio is high or
low, we need to know the general P/E ratios of comparable companies.
Generally, higher growth firms will have higher P/E ratios because their
earnings will be low relative to their price, with the idea that the earnings
will eventually grow more rapidly that the stock’s price.
26. Describe a typical company's capital structure.
A company’s capital structure is just what it sounds like: the structure of the
capital that makes up the firm, or its debts and equity (refer to the balance
sheet section earlier). Capital structure includes permanent, long-term
financing of a company, including long-term debt, preferred stock and
common stock. The statement of a company’s capital structure as expressed
above reflects the order in which contributors to the capital structure are
paid back, and the order in which they have claims on company’s assets
should it liquidate. Debt has first priority, then preferred stock holders, then
common stock holders. Be sure to understand the difference between
“secured” and “unsecured.”
What is meant by the current ratio? What is meant by the quick
ratio?
The current ratio measures the ability of a company to pay its short-term
obligations. The higher, the better. It is current assets /current liabilities.
The quick ratio also measures the ability of a company to meet its shortterm
obligations. The higher, also the better. However, the quick ratio
doesn’t include inventory, as this is often considered a non-liquid current
asset. So, the formula is (current assets-inventory)/current liabilities. For
more financial ratios, fast-forward to the Investment Management section
of this book.
What is Chapter 7? What is Chapter 11?
Both Chapter 7 and Chapter 11 are forms of corporate bankruptcy.
Technically speaking, they are the chapters of the U.S. Bankruptcy Code.
Chapter 7 is the section of the code that covers the liquidation of a company.
Chapter 11 is the section of the code that outlines how a company can be
protected by the U.S. Court system under a Plan of Reorganization.
Generally speaking, companies in distress declare Chapter 11 and seek advice
from investment banks (namely, restructuring groups within investment
banks), who advise them on the best course of action. As mentioned earlier,
the capital structure of a firm is exceptionally important during these
proceedings, in order to determine how much the firm is worth and what
percentage of initial investment that investors in each piece of the capital
structures can expect.
What is a coverage ratio? What is a leverage ratio?
Coverage Ratios are used to determine how much cash a company has to
pay its existing interest payments. This formula usually comes in the form
of EBITDA/interest. Leverage ratios are used to determine the leverage of
a firm, or the relation of its debt to its cash flow generation or equity. There
are many forms of this ratio. A standard leverage ratio would be
debt/EBITDA or net debt/EBITDA. Debt/equity is another form of a
leverage ratio, yet it measures the relation of debt to equity that a company
is using to finance its operations.
What is net debt?
Net debt is debt—cash and cash equivalents, or the true amount of debt that
a firm has, after it uses its existing cash to pay off current outstanding debt.
Is accounts receivable a source or use of cash? Is accounts payable
a source or use of cash?
This type of question is important, because it taps your understanding of
how a company can use its cash, credit and collections. Accounts
receivable is a use of cash, because for every dollar that should be coming
in the door from those that owe money for goods/services, that cash has
been delayed by a collection time period (i.e., a company is waiting to
“receive” money). Conversely, accounts payable (think: a credit card), is a
source of cash, because companies have the ability to purchase items
without immediately paying cash.
What is goodwill?
Goodwill is an asset found on the balance sheet. However, unlike many
other assets, it is intangible. It can be the premium that one firm pays for
another over the current market valuation. It can also reflect the value of
other things, such as a corporate brand. If Coca-Cola were purchased by
Pepsi, one could expect Pepsi to pay a large premium over Coca-Cola’s
existing assets and a massive Goodwill entry on Pepsi’s balance sheet, to
reflect the Coca-Cola global brand.
If you were to advise a company to raise money for an upcoming
project, what form would you raise it with (debt versus equity)?
As with earlier questions, the right answer is “it depends”. First and
foremost, companies should seek to raise money from the cheapest source
possible. However, there might exist certain conditions, limitations or
implications of raising money in one form or another. For example,
although the cheapest form of debt is typically the most senior (corporate
loans), the loan market might not have any demand for a company to issue
a new loan. Or the company might not have the cash flow available to make
interest payments on new debt. Or the equity markets might very well
receive a new offering from this company, more than the debt markets (thus
equity is cheaper than debt). Or the cost of raising an incremental portion
of debt might exceed that of raising equity. All of this should be considered
when answering this question. Be prepared to ask more clarifying
questions—your interviewer will most likely be glad you did.
What are deferred taxes?
In short, deferred taxes take either the form of an asset or liability. They arise
for many reasons, but from an interviewing perspective, it’s important that you
understand they are kept on the balance sheet and are meant to hold the place
for future tax adjustments. In essence, if you paid more in taxes than you owe,
you’d have a deferred tax asset that you could use to offset future taxes. If you
paid less in taxes than you owed, you would have a deferred tax liability, of
which you would add to future tax payments.
There are two main categories of buyers of companies: strategic buyers and
financial buyers.
Strategic buyers are corporations who want to acquire
another company for strategic business reasons. Financial buyers are
buyers who want to acquire another company purely as a financial
investment. Financial buyers are typically LBO (leveraged buyout) Funds
or other private equity funds
When you prepare a valuation
analysis for a strategic buyer, your projected
cash flows will usually be different (that is, higher) than the cash flows for
the company as a “stand alone” entity. You will prepare a “pro forma”
financial model that typically assumes faster revenue growth and reduction
of certain costs because the acquiring company will be able to derive
strategic efficiencies from the acquired company
Stock swaps occur more often when there is
a strong stock market, because
companies with a high market capitalization can acquire companies with
that more valuable stock
In a cash deal, shareholders must
pay taxes when they receive the cash. The
tax rate for their earnings is at the ordinary income marginal tax rate (your
tax rate increases as the income bracket you are in goes higher), which is 35
percent for wealthy individuals in 2008. By contrast, in a stock swap, no
taxes are paid at the time of the swap. But when the swapped stock is sold
in the market, the shareholder must pay capital gains tax at a marginal tax
rate of 15 percent, if it is a long-term gain.
Tender offers are associated with
hostile takeovers. In a tender offer, the
hostile acquirer renders a tender offer for the public’s stock at a price higher
than the current market in an attempt to gather a controlling interest in
(majority ownership of) a company
When two companies of relatively equal size decide
to combine forces
it is referred to as a merger of equals
On
the other hand, if one company buys out another, the deal is considered
a purchase or acquisition.
A merger can be either accretive or dilutive.
A merger is accretive when
the acquiring company’s earnings per share will increase after the merger.
A merger is dilutive when the acquiring company’s earnings will fall after
a merger
The rule is as follows (accretive/dilutive):
When a company with a higher price to
earnings ratio (we’ll call the company “Company 1,” and label it’s P/E ratio
“P/E1”) acquires a firm, “Company 2” of a lower P/E ratio (which we will
label P/E2), it is an accretive merger.
Your client is a privately held human resources software company.
You are advising the company in the potential sale of the company. Who
would you expect to pay more for the company: Oracle Software (a
competitor), or Kohlberg Kravis Roberts (an LBO fund)?
Oracle. A strategic buyer like Oracle would typically pay more than a
financial buyer like KKR.
Are most mergers stock swaps or cash transactions and why?
In strong markets, most mergers are stock swaps, largely because the stock
prices of companies are so high.
What is a dilutive merger?
A merger in which the acquiring company’s earnings per share decreases as
a result of the merger. Also remember the P/E rule: A dilutive merger
happens when a company with a lower P/E ratio acquires a company with
a higher P/E ratio.
What is a hostile tender offer?
If company A wants to acquire company B, but company B refuses,
company A can issue a tender offering. In this offer, company A will take
advertisements in major newspapers like The Wall Street Journal to buy

stock in company B at a price much above the market price. If company A
is able to get more than 50 percent of the stock that way, it can officially run
and make all major decisions for company B—including firing the top
management. This is something of a simplistic view; there are scores of
rules and regulations from the SEC governing such activity.
What is a leveraged buyout? How is it different than a merger?
A leveraged buyout occurs when a group purchases a company using largely
borrowed money, as well as personal equity investment (often at a 75/25
ratio). LBOs are typically accomplished by either private equity groups such
as KKR or company management (where they are called management
buyouts), whereas M&A deals are led by companies in the industry.
If Company A buys Company B, what will the balance sheet of the combined company look like?
In this accounting, simply add each line item on the balance sheet.
The most important thing to remember about
brainteasers, guesstimates or even simple math questions that are designed to
be stressful is
to let your interviewer see how your mind works.
There are two wrong answers for these types of questions: 1) the random
guess and 2) giving up. Interviewers want to see that you are thoughtful,
creative and rational. By all means, they do not expect for you to get the
right answer. More often than not, they too have no idea what the right
answer is. Thus, the best approach for a guesstimate question is to think of
a funnel. You begin by thinking broadly, then slowly narrowing down the
situation towards the answer
How do you think the credit crisis happened?
Although this can’t be summed up in a sentence, paragraph, chapter, or
even a book, there were a number of important events that caused and/or
fueled the crisis. First, over the past few years, consumer and corporate
borrowing reached record levels due to low interest rates and friendly
borrowing conditions. This led to a significant expansion in corporate
growth from personal spending. In this expansionary cycle, many
individuals and corporations were lent money they should not have been,
which led to a massive amount of supply in the new-issue securities
markets, most notably the mortgage market and the credit markets. People
were buying new homes at record rates and companies were completing a
record number of deals.

However, as demand from investors for these new types of assets evaporated
and the economy slowed, a massive amount of new supply that had not yet
been sold (new mortgages, LBOs, etc.) was stuck in the system. These new
deals were then sold at a discount (or never even sold at all), thus depressing
market values. Furthermore, this over-supply and the effects of the slowing
economy led to increased consumer defaults on mortgages, increased
corporate defaults on loans and bonds, massive write-downs by financial
institutions, and significant losses in the financial markets.
The true difference between this and other cycles was the record amount of
consumer and corporate leverage, as well as the creation of significant
investor value that led to a period of insatiable demand and new innovative
financial products. However, once the demand slowed in 2007, the markets
were left to deal with the repercussions.
What is meant by recovery value?
Recovery value is the amount an investor receives in bankruptcy liquidation
from his investment in a particular financial instrument (and recovery rate
is the associated percentage). For example, if an investor received 40 cents
on the dollar for every bond that she purchased in a particular company, the
recovery value would be 0.40 and the recovery rate would be 40 percent.
Distressed credit investors are particularly concerned with recovery values.
It is also important to note that the more “senior” the investment an investor
makes in an company's capital structure (debt vs equity), the more likely the
investor will recover his investment in bankruptcy
What is a NINJA loan?
NINJA is a standard acronym for a type of loan to a homeowner that
requires “no income, no job and no assets.” It’s often categorized as a
subprime loan, as it is typically made with little to no paperwork, generally
to borrowers with less than an average credit score. Many economists
pointed to these types of loans as a sign of the impending subprime
meltdown and the deterioration of lending standards by banks and mortgage
originators. These, as well as other types of loans were packaged (i.e.
grouped together) and sold to investors as CDOs (technically,
Collateralized Mortgage Obligations). The fundamental argument in favor
of CDOs is that these mortgages were well diversified across different
geographies, loan sizes, and income levels, such that the only way they
would all default is if there was a major collapse in the mortgage market in
general, due to oversupply and a widespread economic slowdown. This is
precisely what happened in late 2007.
What are some examples of defensive stocks?
In general, a defensive stock is one that performs well during a period of
economic slowdown, such as that of a basic goods company or even a
discount retailer. These stocks do not generally outperform the market during
periods of rapid economic growth, and thus they typically trade at lower P/E
ratios than many competitors, as well as have significantly lower volatility.
Defensive stocks are often mature, dividend-paying stocks.
What is meant by mark-to-market? Why is this important to hedge
funds, banks, etc.? Why is it relevant now, more than ever?
Mark-to-market is the process by which securities are recorded on financial
statements using current market prices, as opposed to purchase prices or
accounting values. As the credit crisis unraveled, many banks and investors
were forced to write-down assets to current market values. This had a
dramatic impact for a multitude of reasons. For example, many banks and
investors used these assets as collateral to borrow against, in order to makeother investments. As the value of the assets declined, so did the amount
these investors and banks could borrow. Secondly, as assets are marked
down, investors are often likely to sell (and/or forced to sell) their assets so
that they don’t keep losing value. Selling naturally depresses market values
further, causing a ripple effect: as more and more is sold, more and more is
unraveled. As we saw in late 2008, this can cause a panic, where people seek
to move personal investments into cash and are willing to sell at any cost.
What is meant by bid/ask or bid/offer spread?
Those in sales and trading or investing roles are very likely to see this
question. Those in internal corporate finance roles are not likely to. The
complete answer would encompass the following: a bid is a quoted trading
level of a security, where someone would be willing to purchase the
security. For example, a bid of 98.50 for one of IBM’s bond would mean
that someone is willing to purchase the bond at a price of 98.50.
Conversely, an offer (or ask) at 99.50 is the stated amount by what someone
would be willing to sell these same bonds. Therefore, this bid/offer would
appear as 98.5/99.5 and the bid/offer spread is 1. In very liquid securities,
these spreads can be razor thin, trading at 1/32 or smaller. Those who make
bid/offer spreads are signaling to the market the levels at which he/she
would buy/sell a certain security. As expected, these bid/offer levels can
change in a matter of seconds.
What is the main difference between private equity and hedge funds?
Although you are unlikely to get asked this question in an interview, it’s
something that you should be prepared to answer (and should just know for
general finance knowledge). Broadly speaking, both are investors, both raise
money from investors and institutions and both are active in the financial
markets. However, private equity shops typically purchase whole companies
whereas hedge funds typically purchase securities. Thus, private equity
groups can be seen as more operational in nature (they buy a company and
operate it for a period of time), whereas hedge funds are more transactional
in nature (placing trades in a variety of securities, usually based on a set
strategy). A solid answer to this question would capture the information
above, as well as mention a headline or two about either in The Wall Street
Journal. It should also be noted that there are firms that crossover and do
both types of investing.
Who is the chair of the Fed? Who is the Secretary of the Treasury?
Who is Alan Greenspan?
Although common knowledge to the well prepared interviewee, these very
important individuals should be known for anyone interviewing in a finance
position. Ben Bernanke is the chairman of the Board of Governors of the
Federal Reserve and has been since 2006, when he took over from Alan
Greenspan. Henry Paulson Jr. is the secretary of the U.S. Treasury and
took over in 2006, after having served as the chairman and CEO of
Goldman Sachs.
What is the Chinese Wall in finance? Why is it important?
The Chinese Wall is a figure of speech used to separate the sides of
investment banks that have access to private information (i.e. M&A
advisory work) from those that do not (research, sales and trading, etc). As
you know, it would not be fair for those bankers working on a major
acquisition transaction to buy the stock of a target company, etc. This
would be considered insider trading, as the bankers have unfair access to
material information. However, the Chinese Wall also prevents these
bankers from talking to their research or trading counterparts. Essentially,
this barrier prevents those with material non-public information from
disclosing it to others
Do you think the financial markets are efficient?
This is a trick question, but one that comes up often and usually results in
an interviewee’s imminent dismissal. Why does this happen? Because
interviewees too often reply without thinking about the question. If the
markets were efficient, there would be no way for investors to make money.
All securities would be perfectly priced and all investors would have the
same information (and the same thoughts about the same information). As
this doesn’t happen, the correct answer is “No”. Many finance and
economics classes are taught under the assumption/theory that the markets
are efficient, in order to demonstrate other market principles and theories.
But, as we know from practical application, such is not the case..
What is a hedge fund?
This is obviously a popular question for those candidates interviewing for
the increasingly popular and prestigious hedge fund positions.
Surprisingly, many candidates have no feel for what distinguishes a hedge
fund from other types of funds.
A hedge fund is a private investment partnership which uses aggressive
strategies unavailable to other types of funds, most popularly mutual funds.
Hedge funds are required by law to have less than 100 investors, and
liberally use financial techniques and vehicles such as short-selling, swaps,
risk arbitrage and derivatives Since they are restricted by law to have fewer
than 100 investors, the minimum hedge-fund investment is typically $1
million. Many investment banks have their own investment funds, called,
“principal investing” or “proprietary trading” groups. These funds take risk
on behalf of the bank, much like a hedge fund would for investors
What is the formula for the capital asset pricing model?
The capital asset pricing model is used to calculate the expected return on
an investment. Beta for a company is a measure of the relative volatility of
the given investment with respect to the market, i.e., if Beta is 1, the returns
on the investment (stock/bond/portfolio) vary identically with the market’s
returns. Here “the market” refers to a well diversified index such as the
S&P 500. The formula for CAPM is as follows:
How do you unlever a company’s Beta?
Unlevering a company’s Beta means calculating the Beta under the
assumption that it is an all-equity firm. The formula is as follows:
How do you calculate the terminal value of a company?
Terminal year value is calculated by taking a given year in the future at
which a company is stable (usually year 10), assuming perpetually stable
growth after that year, using a perpetuity formula to come up with the value in that year based on future cash flows, and discounting that value back to
the present day.
Say you knew a company’s net income. How would you figure out
its “free cash flow”?
Start with the company’s net income. Then add back depreciation and
amortization, since these are not cash expenses. Subtract the company’s
capital expenditures (called “CapEx” for short, this is how much money the
company invests each year in plant and equipment). Then, be sure to add/subtract the change in net working capital. The number you get is the
company’s free cash flow:
what is financial restructuring
Financial restructuring is the reorganization of the financial assets and liabilities of a corporation in order to create the most beneficial financial environment for the company. The process of financial restructuring is often associated with corporate restructuring, in that restructuring the general function and composition of the company is likely to impact the financial health of the corporation. When completed, this reordering of corporate assets and liabilities can help the company to remain competitive, even in a depressed economy.
financial restructuring is a strategy that must take place in order for the company to
continue operations. This is especially true when sales decline and the corporation no longer generates a consistent net profit. A financial restructuring may include a review of the costs associated with each sector of the business and identify ways to cut costs and increase the net profit. The restructuring may also call for the reduction or suspension of production facilities that are obsolete or currently produce goods that are not selling well and are scheduled to be phased out.
what is corporate financial restructuring
Corporate restructuring involves any substantial change in a company’s financial structure, or ownership or control, or business portfolio, designed to increase the value of the firm. This course will be taught around several major topics employing in-depth group work on case studies and deal documentation. The focus will be on identifying situations that call for nonstandard corporate finance solutions, and the design and pricing of the situation-specific financing instruments. Examples of such situations include stress-induced financial restructuring, recapitalizations, private equity and leveraged buyouts, mergers and acquisitions, and divestitures. In many cases resolving these issues will require structured finance solutions. Structured finance techniques include the design of debt, equity and hybrid financing techniques in order to resolve particular issuer or investor problems that cannot be solved by conventional methods.
What are some of the bigger deals the FRG has completed
We advised in many of the largest, most complex distressed deals over the past decade. During this period we advised on more than 500 restructuring transactions, valued in excess of $1.25 trillion, including four of the five largest of all time: Lehman Brothers, WorldCom, Enron and Conseco
what is HL FRG group ranked
#1 in the world
We (HL FRG) have often helped clients avoid bankruptcy altogether. A listing of our services includes:
•Out-of-court transactions
•Restructuring existing debt and equity
•Chapter 11 planning through confirmation
•Representing buyers and sellers of distressed companies, divisions and assets
•Bulk sales of assets
•Sales of performing and nonperforming loans
•Business and securities valuation
•Structuring, negotiation and confirmation of plans of reorganization
•Structuring and analysis of exchange offers
•Corporate viability assessment
•Litigation support and expert testimony
•Procuring DIP financing
•Prepackaged and prenegotiated plans of reorganization
We’ve (HL FRG) handled hundreds of transactions for .
distressed corporations involving a change of control, asset sales and other M&A activities. These situations may involve selling a company or its assets quickly, often in contested or litigious settings
Typically, distressed M&A candidates face many of the following challenges:
•Changing industry conditions
•Declining operating performance and cash flow
•Potential loss of key management
•Stretched payables
•Significant liquidity constraints
•Total debt exceeding enterprise value
•Covenant and/or payment defaults on debt instruments
•Conflicts between the various constituents that hold competing claims or interests
•Senior lenders playing hardball and restricting access to capital
•Limited access to new capital
•Commencement or threat of bankruptcy proceedings
For nearly 40 years, Houlihan Lokey has provided
investment banking services and earned international distinction in mergers, acquisitions, financings, financial restructuring, financial opinions and valuations.
We (HL) strive to embody the highest standards of honesty, integrity and client service while being mindful of our personal and corporate responsibilities.

Our mission is to achieve this goal while delivering exemplary financial results for our clients and our stakeholders.

Our values guide this mission of excellence.
Leadership: We are a firm of world-class leaders. We support and cultivate leadership, and in turn our people strive to pioneer advancements in investment banking solutions.

Honesty and Integrity: Our roots in providing trusted advice permeate every aspect of our business today. Our clients turn to us when handling even the most sensitive situations.

Global Enterprise: We understand where business fits in the global marketplace while never losing sight of the importance of local relationships. We provide our clients with high-level global accessibility, to get the job done anywhere in the world.

Service: We stand by our commitment to deliver senior advisors, at the table, when ideas are aired and decisions are made — a commitment that consistently shapes the way we serve our clients. We recognize our responsibility to serve, and to help provide appropriate returns for our stakeholders.
For the past eight years, we have consistently been named the
#1 investment bank in our class. Our accolades reflect our commitment to creating value for clients.
Restructuring is the corporate management term for
the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Alternate reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to a crisis or major change in the business such as bankruptcy, repositioning, or buyout. Restructuring may also be described as corporate restructuring, debt restructuring and financial restructuring.
Debt restructuring is a process that allows a private or public company - or a sovereign entity - facing cash flow problems and financial distress, to
reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations.
Out-of court restructurings, also known as workouts, are increasingly becoming a global reality.
A debt restructuring is usually less expensive and a preferable alternative to bankruptcy. The main costs associated with a business debt restructuring are the time and effort to negotiate with bankers, creditors, vendors and tax authorities. Debt restructurings typically involve a reduction of debt and an extension of payment terms.
In a debt-for-equity swap, a company's creditors generally agree to
cancel some or all of the debt in exchange for equity in the company.
Most defendants who cannot pay the enforcement officer in full at once enter into negotiations with the officer to pay by
installments. This process is informal but cheaper and quicker than an application to the court.
Chapter 7:
basic liquidation for individuals and businesses; also known as straight bankruptcy; it is the simplest and quickest form of bankruptcy available
Chapter 11
: rehabilitation or reorganization, used primarily by business debtors, but sometimes by individuals with substantial debts and assets; known as corporate bankruptcy, it is a form of corporate financial reorganization which typically allows companies to continue to function while they follow debt repayment plans
minority interest
1. A significant but non-controlling ownership of less than 50% of a company's voting shares by either an investor or another company.

2. A non-current liability that can be found on a parent company's balance sheet that represents the proportion of its subsidiaries owned by minority shareholders.
pick loan/note
Pick a Payment loans are also known as option arm loans and they afford the borrowers more flexibility in making their monthly payment. Homeowners with Pick a Payment loans literally have the flexibility to pick the payment they want to make in a particular month.

Pick a Payment loans are adjustable rate loans that give the borrower the ability to choose whether they want to make an interest only payment, a minimum payment (as determined by the lender) or one of two or more fixed rate amount payments (e.g. payment based on a 15-year loan or 30-year loan) and that payment can be different each month.
bank vs bond debt
When a company needs money, there are many variables for determining whether or not it should borrow from a bank or do a bond offering. For example, the maturity of the capital markets in the company’s country can determine its choice. The capital markets in the United States and the United Kingdom are much more mature than in countries where banks and other FIs have greater control over financial activity.

When financial markets mature, there is a predominant shift away from bank financing to security financing. A good example of this is Japan, where Japanese companies are using more and more bond offerings to meet their financial needs. They have reduced their ratio of bank debt to total debt from a high of 90% in 1975 to less than 50% as of 1992.
how does depreciation/amort effect cash flow
Depreciation and its related concept, amortization (generally, the depreciation of intangible assets), are non-cash expenses. Neither depreciation nor amortization will directly affect the cash flow of a company, as both are accounting representations of expenses attributable to a given period. In accounting statements, depreciation may neither figure in the cash flow statement, nor be "added back" to net income (along with other items) to derive the operating cash flow.[2] Depreciation recognized for tax purposes will, however, affect the cash flow of the company, as tax depreciation will reduce taxable profits
of the 30 largest restucturing projects in history HL has been involved with
18
Assumptions of DCF analysis
WACC, Terminal Value
option arm loan
Payment Option ARM Mean?
A monthly adjusting adjustable-rate mortgage (ARM) which allows the borrower to choose between several monthly payment options: a 30 or 40-year fully amortizing payment, a 15-year fully amortizing payment, an interest-only payment, a minimum payment or any amount greater than the minimum payment.

The minimum payment option is calculated based on an initial temporary start interest rate. While this temporary start interest rate is in effect, this is the only payment option available. It is a fully amortizing payment. After the temporary start interest rate expires, the minimum payment amount remains a monthly payment option; however, whenever a payment is made which is less than the scheduled interest-only payment, deferred interest is created