Technical Investment Bank Questions You Can't Get Wrong (with Answering Tips)
1️⃣ What’s an LBO and why do firms need it? Deal examples?
💡A leveraged buyout is the acquisition of another company using a significant amount of borrowed money to meet the acquisition cost. Often, assets from both the firms are used as loan collateral. LBOs are conducted for 3 key reasons; to take a public company private, to spin-off a portion of an existing business by selling it, and to transfer private property.
Hilton Hotels LBO (2007): Blackstone bought it for $26 billion, financed through $5.5 billion in cash and $20.5 billion in debt.
Examples include RJR Nabisco's acquisition by private equity giant KKR using a combination of debt and equity (deal size $25 billion) and TXU Energy's acquisition by a consortium of KKR, Goldman Sachs and TPG Capital ($45 billion)
2️⃣ How can a firm with positive EBITDA go bankrupt?
💡Bankruptcy occurs when a firm can’t make its interest or debt payments. Since EBITDA is Earnings BEFORE Interest, if an interest payment exceeds a firm's EBITDA and they have insufficient cash on hand, they'd soon default on debt and need bankruptcy protection.
3️⃣ How are convertible bonds accounted for in calculating enterprise value?
💡If the convertible bonds are 'in the money' meaning the conversion price is below the current market price, then account for the bonds as additional dilution to the Equity Value. If the bonds are out of the money, then account for them as debt at their face value.
4️⃣ How are the 3 financial statements linked?
💡The bottom line of the income statement is net income. Net income links to both the balance sheet and cash flow statement. In the balance sheet, net income flows into stockholder’s equity via retained earnings. Retained earnings is equal to the previous period’s retained earnings plus net income from this period less dividends from this period. In the cash flow statement, net income is the first line as it’s used to calculate cash flows from operations. Any non-cash expenses or non-cash income from the income statement (depreciation and amortization) flow into the cash flow statement and adjust net income to arrive at cash flow from operations.
Any balance sheet items that have a cash impact (working capital, financing, PP&E, etc.) are linked to the cash flow statement as it is either a source or use of cash. The net change in cash on the cash flow statement and cash from the previous period’s balance sheet comprise cash for this period.
💡It's a mathematical equation used to price European-style options. It takes into account factors such as the underlying stock price, the option's strike price, the time until expiration, the risk-free interest rate, and the stock's volatility.
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