Accounting
Walk me through a $10 increase in A/R.
A $10 increase in Accounts Receivable means $10 of additional revenue is recorded on the income statement. Pre-tax income increases by $10, income tax expense increases by $4 assuming a 40% tax rate, and net income increases by $6. On the cash flow statement, net income starts higher by $6 in cash flow from operations. Then the $10 increase in Accounts Receivable is recorded as a negative $10 change in working capital, reducing cash flow from operations by $10. As a result, total cash flow decreases by $4, and cash is down $4. On the balance sheet, cash decreases by $4 and Accounts Receivable increases by $10, so total assets increase by $6. Liabilities do not change. Equity, through retained earnings, increases by $6 due to the higher net income. The balance sheet remains in balance, with assets up $6 and equity up $6.
What is the formula for Equity Value and Enterprise Value.
Equity Value (Market Cap) = Share Price × Fully Diluted Shares.
Enterprise Value = Equity Value + Debt + Preferred Stock + Non-controlling Interest − Cash & Cash-Equivalents (and often − restricted cash / non-core investments).
Walk through a DCF at a high level
Project the company’s unlevered Free Cash Flows for 5–10 years.
Discount those FCFs back at WACC to get their Present Value.
Estimate a Terminal Value (exit multiple or Gordon Growth) and discount that back.
Sum PV of FCFs + PV of Terminal Value = Enterprise Value, then bridge to Equity Value and per-share value.
What is a merger model?
A merger (accretion/dilution) model evaluates the financial impact of an acquisition on the buyer’s EPS. It asks: “After we buy this company, will our EPS go up (accretion) or down (dilution), and by how much, under certain assumptions about synergies, financing, and accounting?”
What is an LBO and why so much debt?
A leveraged buyout is when a PE firm buys a company using a large amount of debt financing, with the company’s assets and cash flows securing the debt. Heavy leverage amplifies equity returns (IRR) because a smaller equity check controls a larger asset base, and debt gets paid back with the company’s cash flows over time.
Walk me through the sale of an asset for $120 that had a book value of $150. Assume a 40% tax rate.
Income Statement: PTI down 30, Tax = 12, Net Income: Down 18
Cash Flow Statement: NI down 18, Add back loss on sale of 30, Cash Proceed from sales of 120, Change in Cash = +132
Balance Sheet: Cash up 132, PP&E down 150 (Assets down 18), Retained Earnings down 18
Why is EV/EBITDA a valid multiple, but Equity Value/EBITDA is generally considered “apples to oranges”?
EV/EBITDA is valid because both EV and EBITDA are capital-structure-neutral (before interest), so you’re comparing the value of the whole business to a metric for the whole business. Equity Value is after Debt is accounted for, while EBITDA is before interest; Equity Value/EBITDA mixes an equity value with a pre-interest metric and depends heavily on leverage, so it’s “apples to oranges.”
Starting from Revenue, walk me through how you get to Unlevered Free Cash Flow in the projections.
Start with Revenue → subtract operating expenses and D&A to get EBIT. Multiply EBIT by (1 − tax rate) to get NOPAT. Add back non-cash charges (D&A, maybe SBC if you’re treating it that way), subtract Capex and increases in working capital → that result is Unlevered Free Cash Flow (cash available to all capital providers).
In an all-stock deal where the buyer’s P/E is 20x and the seller’s P/E is 15x, is the deal more likely accretive or dilutive to the buyer, and why?
All else equal and ignoring synergies, if the buyer’s P/E (20x) is higher than the seller’s P/E (15x), issuing stock to buy the seller is usually accretive because you’re effectively “paying” with a more expensive currency (your high-multiple stock) to buy earnings at a lower multiple. You’re trading stock valued at 20x for earnings valued at 15x, so EPS tends to go up. Or can think in terms of cost of acquisition vs seller yield (1/15 vs 1/20).
Describe the key differences among Revolver, Term Loan A, Term Loan B, Senior Notes, Subordinated Notes, and Mezzanine in an LBO (tenor, interest, amortization, covenants).
Revolver: Like a credit card; can draw/repay repeatedly; floating rate; used for working capital; usually lowest cost and tight covenants.
Term Loan A: Amortizing, bank debt, floating rate; moderate covenants; shorter tenor.
Term Loan B: Institutional loan; minimal amortization (bullet-ish), higher spread; looser covenants; longer tenor.
Senior Notes: Fixed-rate bonds; longer maturity; generally no amortization; less restrictive covenants; higher coupon.
Sub Notes / Mezz: Even higher coupon, often PIK features and equity kickers (warrants); subordinated in priority and most expensive.
A company records a $100 tax-deductible goodwill impairment. Tax rate is 40%. Walk through the three-statement impact in the year of the impairment.
Income Statement: Pre-tax income down $100. Taxes down $40. Net Income down $60.
Cash Flow Statement: Start with NI down $60. Add back the $100 non-cash goodwill impairment in CFO. CFO is up $40. No change in CFI/CFF from this impairment alone. Net Cash up $40.
Balance Sheet: Goodwill (intangible asset) down $100. Cash up $40.
Total Assets down $60. Retained Earnings down $60 from lower NI.
A company’s current share price is $10. It has: 100 million basic shares outstanding, 20 million options outstanding with a $5.00 exercise price (all in-the-money), 5 million RSUs outstanding, No convertibles or other dilutive securities
Using the Treasury Stock Method, what is the company’s fully diluted shares outstanding (FDSO)?
Start with basic shares:
Basic shares = 100 million
Options – apply Treasury Stock Method (TSM):
In-the-money options = 20 million
Exercise proceeds = 20 million × $5 = $100 million
Company uses $100 million to repurchase shares at $10:
Shares repurchased = 100 / 10 = 10 million
Net new shares from options = 20 − 10 = 10 million
RSUs:
RSUs generally count one-for-one as additional shares (no exercise price)
Add 5 million shares
Fully Diluted Shares Outstanding (FDSO):
FDSO = Basic shares + net new option shares + RSUs
FDSO = 100 + 10 + 5 = 115 million shares
Your base DCF shows Enterprise Value of $200. The company decides to buy a factory for $100 of cash in Year 4. How do you modify the DCF, and qualitatively what happens to Enterprise Value?
You model the factory as extra Capex (and maybe higher D&A and operating benefits) in Year 4 and onward. That reduces FCF in the year of the purchase but ideally increases FCF in later years via higher revenue or margins; in the DCF, you plug the new FCF stream into the same discounting. EV rises only if the NPV of the incremental cash flows > cost of the factory; if the return equals WACC, EV is basically unchanged, and if it’s lower, EV actually falls.
What is a contribution analysis in a merger model, and in what type of deal is it most useful?
Contribution analysis compares how much each party contributes to the combined company (often % of Revenue, EBITDA, or Net Income) versus what ownership they receive post-deal. It’s most useful in “merger of equals” situations where both sides care a lot about being seen as fairly treated.
Immediately after a sponsor acquires a public company in an LBO, what are the main Balance Sheet and Cash Flow Statement adjustments (debt, equity rolled over, goodwill/intangibles, fees)?
You wipe out the target’s old shareholders’ equity and often refinance its existing debt. On the Balance Sheet, you add new acquisition debt, new equity from the sponsor (and management rollover if any), and create Goodwill/intangibles to plug the purchase price over net assets. Cash falls by the amount used for the purchase and fees. On the Cash Flow Statement, you show the cash inflow from new debt and sponsor equity (CFF) and the outflow to pay target shareholders and fees (CFF/CFI), with fees partly capitalized and partly expensed.
A company grants $100 of stock-based compensation this year. Walk through the impact on the three statements and explain whether stock-based comp is truly “free” from an economic standpoint.
Income Statement: Operating expenses up 100, pretax income down 100; with 40% tax, NI down 60.
Cash Flow: NI down 60 but add back 100 SBC (non-cash) → CFO up 40.
Balance Sheet: Cash up 40; Equity up 40 from the non-cash “credit” (APIC) but RE down 60 from lower NI → net Equity down 20.
Economically it’s not “free” because issuing shares dilutes existing shareholders instead of paying them in cash.
A company trades at a 10x multiple with 100mm in EBITDA. It has 3 tranches of debt. (TLA, TLB, Secured Notes). TLA Par Value = $200mm, TLB = $400mm, Secured Notes = $600mm. Assume TLB and the secured notes are pari passu. What is each tranche of debt trading at? What is equity trading at?
TLA A: Value of 200, Trading at Par (100c)
TLB: Value of 320mm (Trading at 80c)
Unsecured: Value of 480 (Trading at 80c)
Equity: Slightly above 0 due to optionality
Explain the mid-year convention in a DCF. Why might you apply it, and what is its effect on the valuation compared with using end-of-year discounting?
Instead of assuming all cash flows arrive at year-end, the mid-year convention assumes they arrive evenly throughout the year and effectively discounts them by t − 0.5 years instead of t. This slightly increases valuation vs standard year-end discounting because you’re assuming you get cash sooner, which is more realistic for most operating businesses.
A buyer is considering acquiring a target using a mix of cash, debt, and stock. You’re given the following:
Buyer: Share price: $50, EPS: $2.50, P/E: 20x → earnings yield = 5%
Target: Share price: $40, EPS: $2.50
Deal consideration mix:40% Cash, where the buyer’s cash earns 2% after tax, 40% Stock, 20% Debt, with a 5% pre-tax interest rate and a 40% tax rate
Is this deal EPS accretive or dilutive to the buyer (ignoring synergies)?
The deal is accretive because the target’s earnings yield (6.25%) is higher than the weighted cost of acquisition (3.4%).
Leverage Ratio (Debt/EBITDA) = 5x, Interest Coverage Ratio (EBITDA/Interest Payment) = 5x. What is the interest rate on debt?
Interest Rate = 4%
You buy a 70% stake in another company for $70. Walk through what happens at closing on the three statements (focus on consolidation vs. non-controlling interest, goodwill, and how the minority stake is reflected).
You consolidate 100% of the target’s assets and liabilities on the Balance Sheet. You record Cash down 70 and recognize Goodwill such that: Consideration (70) + Fair Value of NCI (30% of target) ≈ Fair Value of acquired net assets + Goodwill. The 30% you don’t own shows up as Non-controlling Interest in Equity. On the Income Statement going forward, you report 100% of the subsidiary’s revenue and expenses, then subtract Net Income attributable to NCI below the line.
Why do we add Non-Controlling Interest (NCI) to Enterprise Value when using consolidated EBITDA, but we subtract equity-method investments when valuing the parent? What’s the conceptual difference?
f a subsidiary is consolidated (e.g., 70% owned):
The parent’s financials include 100% of the sub’s Revenue & EBITDA.
EV must reflect 100% of the capital structure supporting that EBITDA → parent’s Equity + Debt + NCI.
So we add NCI to EV to match “100% of EBITDA with 100% of capital.”
If a stake is equity-method (e.g., 30–40%):
The parent does not consolidate Revenue/EBITDA; instead, it recognizes one-line “equity income”.
The operations and debt of that entity are not in the parent’s EV base.
So we treat the equity-method stake as a non-core investment and subtract its value from EV.
Walk me through a Dividend Discount Model(DDM) that you would use in place of a normal DCF for a financial institution.
Project the company’s earnings, down to Earnings per Share (EPS).
Assume a Dividend Payout Ratio – what percentage of EPS gets paid out to shareholders in the form of dividends – based on what the firm has done historically and how much regulatory capital it needs.
Use this to calculate dividends over the next 5–10 years.
Do a check to make sure that the firm still meets its required Tier 1 capital ratio and other capital ratios – if not, reduce dividends.
Discount the dividends in each year to their present value based on the Cost of Equity – not WACC – and then sum these up.
Calculate terminal value based on P/BV and book value in the final year, and then discount this to its present value based on the Cost of Equity.
Sum the present value of the terminal value and the present values of the dividends to calculate the company’s net present value per share.
How do Net Operating Losses (NOLs) and deferred tax assets/liabilities affect a merger model’s accretion/dilution, and why does the deal structure (stock vs. asset purchase / 338(h)(10)) matter for their treatment?
NOLs and DTAs reduce cash taxes post-deal, increasing the combined company’s Free Cash Flow and therefore can improve accretion. But how much they help depends heavily on structure: stock deals often limit NOL usage (Section 382 limits, no step-up in asset basis), while asset purchases / 338(h)(10) elections can give you a tax basis step-up and more usable tax shields. So NOLs/DTAs can materially affect EPS and valuation, but only if they’re actually usable under the chosen structure.
(Paper LBO) A PE firm buys a company for $1,000 Enterprise Value, at 10x EBITDA
It funds the deal with 60% Debt and 40% Equity
The company generates $80 of Free Cash Flow to Equity (after interest, capex, and taxes, but before any dividends) each year, and the sponsor uses all $80 to pay down Debt.
This continues for 5 years, EBITDA stays at $100, and the sponsor exits at the same 10x EBITDA multiple (EV at exit = $1,000).
a) What is the Debt balance at exit?
b) What is the Equity Value at exit?
c) What is the sponsor’s MOIC (Multiple of Invested Capital)?
d) Approximately what IRR does the sponsor earn?
Debt at exit:
Starting Debt = 600
Each year pay down 80 for 5 years → total paydown = 5 × 80 = 400
Exit Debt = 600 − 400 = $200
b) Equity Value at exit:
Exit EV = 10 × EBITDA = 10 × 100 = $1,000
Equity Value = EV − Debt = 1,000 − 200 = $800
c) MOIC:
Initial Equity = 400
Exit Equity = 800
MOIC = 800 / 400 = 2.0x
d) IRR (approx):
2.0x over 5 years → IRR ≈ 15% (since 2^(1/5) − 1 ≈ 14.9%).