MOST Common Technical Finance
Interview Questions - Wall Street PREP
m How do you value a company? - (1) Intrinsic value = DCF; (2) Relative Value = comparables/multiples
What is Intrinsic Value? - More academically respected approach = DCF Valuation.
DCF says value of a productive asset equals the PV of its cash flows.
"1) Project FCFs for 5-20 years and then calculate a terminal value.
2) Discount both the FCF projections and TV by an appropriate cost of capital (WACC for unlevered DCF;
Cost of equity for levered DCF).
3) In an unlevered DCF (more common) this will yield the company's enterprise value (aka firm and
transaction value), from which we subtract net debt to arrive at equity value.
4) Divide equity value by diluted shares outstanding to arrive at equity value per share."
What are relative valuations? - The second approach involved determining a comparable peer group =
companies in the same industry with similar operational, growth, risk, and return on capital
characteristics.
Truly identical companies do not exist, but find as close as comparable as possible.
Calculate the appropriate industry multiples. Apply the MEDIAN of these multiples on the relevant
operating metric of the target company to arrive at a valuation.
What are the common relative multiples? - EV/Rev ; EV/EBITDA ; P/E ; P/Book
Some industries place more emphasis on some multiples vs. others, while other industries use different
valuation multiples altogether.
Good idea = research an industry or two (read industry report by a sell-side analyst) before an interview
to anticipate follow-up questions like "tell me about a particular industry you are interested in and the
valuation multiples commonly used"
, Tell me about a particular industry you are interested in and the valuation multiples commonly used. -
Biotech = EV/REV bc not profitable so use cash burn analysis (how long cash can last in regards to
operation... lots of equity offerings)
HC Services = EV/EBITDA, Rent or EV/EBITDA, CAPEX/Maintainance CAPEX ... if they have a facility or
large rental expenses etc
Hospitals = key performance index = Rev/Bed, Rev/Head
Medtech & Pharma = EV/EBITDA
What is the appropriate discount rate to use in an unlevered DCF analysis? - Cash flows in unlevered DCF
are pre-debt (as if has no debt = no interest expense, no tax benefit from interest expense).
Therefore, cost of CFs relate to both the LENDERS and EQUITY PROVIDERS of capital.
Discount rate = WACC to all providers of capital (D+E).
Cost of debt readily observable in the market as the YIELD ON DEBT with equivalent risk
What is the appropriate discount rate to use in a levered DCF analysis? - Cost of Equity (more difficult to
estimate).
Estimate using the capital asset pricing model (CAPM), which links the Expected Return on Equity to its
sensitivity to the overall market.
What is typically higher - Cost of debt or Cost of equity? - Cost of equity is higher than the cost of debt
because the cost associated with borrowing debt (interest expense) is tax deductible, creating a tax
shield. Cost of equity as no guaranteed fixed payments, and are last in line at liquidation.
How do you calculate the cost of equity? - CAPM is the predominant method used.
CAPM links the expected return of a security to its sensitivity to the overall market basket (often proxied
using the S&P 500)
The formula:
Re = rfr + beta * market risk premium (rm-rf)
Interview Questions - Wall Street PREP
m How do you value a company? - (1) Intrinsic value = DCF; (2) Relative Value = comparables/multiples
What is Intrinsic Value? - More academically respected approach = DCF Valuation.
DCF says value of a productive asset equals the PV of its cash flows.
"1) Project FCFs for 5-20 years and then calculate a terminal value.
2) Discount both the FCF projections and TV by an appropriate cost of capital (WACC for unlevered DCF;
Cost of equity for levered DCF).
3) In an unlevered DCF (more common) this will yield the company's enterprise value (aka firm and
transaction value), from which we subtract net debt to arrive at equity value.
4) Divide equity value by diluted shares outstanding to arrive at equity value per share."
What are relative valuations? - The second approach involved determining a comparable peer group =
companies in the same industry with similar operational, growth, risk, and return on capital
characteristics.
Truly identical companies do not exist, but find as close as comparable as possible.
Calculate the appropriate industry multiples. Apply the MEDIAN of these multiples on the relevant
operating metric of the target company to arrive at a valuation.
What are the common relative multiples? - EV/Rev ; EV/EBITDA ; P/E ; P/Book
Some industries place more emphasis on some multiples vs. others, while other industries use different
valuation multiples altogether.
Good idea = research an industry or two (read industry report by a sell-side analyst) before an interview
to anticipate follow-up questions like "tell me about a particular industry you are interested in and the
valuation multiples commonly used"
, Tell me about a particular industry you are interested in and the valuation multiples commonly used. -
Biotech = EV/REV bc not profitable so use cash burn analysis (how long cash can last in regards to
operation... lots of equity offerings)
HC Services = EV/EBITDA, Rent or EV/EBITDA, CAPEX/Maintainance CAPEX ... if they have a facility or
large rental expenses etc
Hospitals = key performance index = Rev/Bed, Rev/Head
Medtech & Pharma = EV/EBITDA
What is the appropriate discount rate to use in an unlevered DCF analysis? - Cash flows in unlevered DCF
are pre-debt (as if has no debt = no interest expense, no tax benefit from interest expense).
Therefore, cost of CFs relate to both the LENDERS and EQUITY PROVIDERS of capital.
Discount rate = WACC to all providers of capital (D+E).
Cost of debt readily observable in the market as the YIELD ON DEBT with equivalent risk
What is the appropriate discount rate to use in a levered DCF analysis? - Cost of Equity (more difficult to
estimate).
Estimate using the capital asset pricing model (CAPM), which links the Expected Return on Equity to its
sensitivity to the overall market.
What is typically higher - Cost of debt or Cost of equity? - Cost of equity is higher than the cost of debt
because the cost associated with borrowing debt (interest expense) is tax deductible, creating a tax
shield. Cost of equity as no guaranteed fixed payments, and are last in line at liquidation.
How do you calculate the cost of equity? - CAPM is the predominant method used.
CAPM links the expected return of a security to its sensitivity to the overall market basket (often proxied
using the S&P 500)
The formula:
Re = rfr + beta * market risk premium (rm-rf)
