Technical Interview Overview Harsh Naik

Accounting
Income Statement:
- Shows a company’s revenue, expenses and profitability for a given period
- Revenue, COGS, operating expenses, other income/expenses, and taxes & net income
- Line items have to correspond to period shown in IS and affect company’s taxes
Balance Sheet:
- Shows a company’s resources (assets) and how it acquired them (liabilities and shareholders’ equity)
at a specific point in time
- Key assets:
o Cash: amount of cash a company has
o Short-term investments: less liquid than cash (e.g. CDs and money-market accounts)
o Accounts Receivable: company has recorded this as revenue but not yet received cash yet
o Prepaid Expenses: company has paid these expenses in cash but hasn’t yet recorded it as an
expense yet
o Inventory: what the company needs to manufacture their products
o PP&E: factories, buildings, land, equipment, and anything else that will last for over a year
and contribute to the company’s core business
o Other intangible assets: patents, trademarks, and IP; this balance gets amortized over time
o Long-term investments: less liquid but longer-lasting investments than ST or cash
- Key liabilities:
o Revolver: company uses it to borrow money as needed and repays it quickly
o Accounts payable: company has recorded it as expense but not yet paid it out in cash; used
for one-time events with invoices (e.g. legal)
o Accrued expenses: company has recorded it as expense but not yet paid it out in cash; use
for recurring events without invoices (e.g. employee wages)
o Deferred revenue: company has received cash but hasn’t produced/delivered the
product/service; will recognize it as revenue over time
o Deferred tax liability: the company has paid lower taxes than it owes, has to make up for it in
the future
o Long-term debt: debt that is due and must be repaid in over a year’s time
- Key equity items:
o Common stock: represents market value of shares at the time they were issued; does not
change with changes in share price
o Treasury stock: represents the cumulative value of shares repurchased by company; does not
change with changes in share price
o Retained earnings: represents company’s saved up, after-tax profits (minus dividends)
Cash Flow Statement:
- Cash flow from operations: net income at top, adjusted for non-cash items and changes in working
capital items
- Cash flow from investing: anything related to the company’s investments, acquisitions and PP&E
- Cash flow from financing: anything related to debt, dividends and issuing or repurchasing shares
How to link statements:
1. Net income from the bottom of the IS shows up at the top of the CFS
2. Add-back any non-cash items from the IS (e.g. D&A, stock-based compensation, and gains & losses)
3. Reflect changes in working capital; if asset goes up then cash goes down, if liabilities go up then cash
goes up)
Technical Interview Overview Harsh Naik

4. Reflect purchases and sales of investments and PP&E in CFI

5. Reflect dividends, debt issued or repurchased, and shares issued or repurchased in CFF
6. Calculate net change in cash and link this into cash at the top of the next period’s BS
Non-Controlling Interest / Investments in Equity Interests
- NCI (e.g. minority interest) is when you own 50%+ of a company and the portion you don’t own
shows up in liabilities
- IEI is when you own 20%-50% of a company and shows up in assets
Negative SE:
1. In LBO’s when the sponsor takes out a large amount of equity in the form of a dividend
2. When a company has been performing poorly and has had negative RE
Working Capital:
- Working capital = current assets – current liabilities
- Operating working capital = (current assets – cash & STI) – (current liabilities – STD)
- Company can have negative working capital if it has high deferred revenue (cell phone carrier
companies), high AP (retail companies like McDonalds), or if they’re going bankrupt
Cash-Based vs. Accrual Accounting:
- Cash-based accounting: recognize revenue and expenses when cash is received or paid out
- Accrual accounting: recognize revenue when payment is reasonably certain and expenses when they
are incurred
Cons of using EBITDA:
- EBITDA excludes interest, investment/capex (and D&A) of long-term assets, and non-recurring
charges
- All of these can represent huge cash expenses and thus can even bankrupt a company that has
positive EBITDA
Goodwill:
- Represents the premium to book value that a company paid for its acquisitions
- Can be impaired if the company finds out that the assets it purchased aren’t worth what they thought
they were, if a buyer overpays for the seller, or if a company discountinues part of its operations and
must impair the associated goodwill
Effect of an increase of $10 in depreciation:
1. IS: Operating income down by $10, net income down by $6
2. CFS: Cash at top down by $6, add-back $10 because non-cash, net cash up by $4
3. BS: Cash up by $4, PP&E down by $10, SE down by $6
Effect of an increase of $10 in accrued expenses:
1. IS: Operating income down by $10, net income down by $6
2. CFS: Cash at top down by $6, increase $10 because liability went up, net cash up by $4
3. BS: Cash up by $4, accrued expense up by $10, SE down by $6
Effect of a decrease of $10 in accrued expenses:
1. IS: No changes as you’ve already recorded the expense earlier
2. CFS: Cash down by $10 because liability went down, net cash down by $10
Technical Interview Overview Harsh Naik

3. BS: Cash down by $10, accrued expense down by $10

Effect of an increase of $10 in AR:
1. IS: Revenue is up by $10, net income up by $6
2. CFS: Cash up by $6, reduce by $10 because asset went up, net cash down by $4
3. BS: Cash down by $4, AR up by $10, SE up by $6
Effect of a decrease of $10 in prepaid expenses:
1. IS: Operating income down by $10, net income down by $6
2. CFS: Cash down by $6, increase cash by $10 because asset went down, net cash up by $4
3. BS: Cash up by $4, prepaid expenses down by $10, SE down by $6
Effect of an increase of $10 in inventory:
1. IS: No changes as the inventory has not been produced/sold yet
2. CFS: Cash down by $10 because asset went up, net cash down by $10
3. BS: Cash down by $10, inventory up by $10
Effect of a $120 sale of PP&E that’s worth $100 on the BS:
1. IS: Record gain on sale of $20, operating income up by $20, net income up by $12
2. CFS: Cash up by $12, reduce by $20 because non-cash, CFI up by $120, net cash up by $112
3. BS: Cash up by $112, PP&E down by $100, SE up by $12
Effect of a $100 asset write-down:
1. IS: Write-down reduces operating income by $100, net income down by $60
2. CFS: Cash down by $60, add-back $100 because non-cash, net cash up by $40
3. BS: Cash up by $40, asset down by $100, SE down by $60
Effect of issuing shares worth $100:
1. IS: No changes as this doesn’t effect taxes
2. CFS: CFF up by $100, net cash up by $100
3. BS: Cash up by $100, SE up by $100
Effect of issuing stock-based compensation worth $100:
1. IS: Operating income down by $100, net income down by $60
2. CFS: Cash down by $60, add-back $100 because non-cash, net cash up by $40
3. BS: Cash up by $40, SE up by $100, net income down by $60
Effect of issuing dividends worth $100:
1. IS: No changes as this doesn’t effect taxes
2. CFS: CFF down by $100, net cash down by $100
3. BS: Cash down by $100, SE down by $100
Effect of a $10 increase in deferred tax liability:
1. IS: No changes, income tax expense only changes if the total amount of taxes change
2. CFS: Cash up by $10 as you add-back non-cash, net cash up by $10
3. BS: Cash up by $10, DTL up by $10
Effect of a $100 write-down of debt:
1. IS: Write-down of liability increases operating income by $100, net income up by $60
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2. CFS: Cash up by $60, reduce by $100 because non-cash, net cash down by $60
3. BS: Cash down by $60, debt down by $100, SE up by $60
LIFO vs. FICO:
- LIFO = last in, first out, FIFO = first in, first out
- They are both different ways of recording the value of inventory and COGS
- With LIFO, you use the value of the most recent inventory purchases
- With FIFO, you use the value of the oldest inventory purchases
- In inflationary periods, LIFO will produce higher values for COGS and lower ending inventory
values, reducing the operating profit and net income
- The opposite is true in deflationary periods
Effect of buying PP&E worth $100 with debt at start of year 1:
1. IS: No changes as nothing has occurred as of yet
2. CFS: CFF up by $100, CFI down by $100, no change in net cash
3. BS: PP&E up by $100, debt up by $100
Effect of prior question at the end of the year (high-yield debt with 10% interest, depreciation at 10%):
1. IS: Operating income down by $20 ($10 from interest, $10 from depreciation), net income down by
$12
2. CFS: Cash down by $12, add-back $10 because non-cash, net cash down by $2
3. BS: Cash down by $2, PP&E down by $10, SE down by $12
Effect of PP&E from prior questions breaking down after year 2 and debt being repaid:
1. IS: Operating income down by $100 ($10 from interest, $10 from depreciation, $80 from write-
down), net income down by $60
2. CFS: Cash down by $60, add-back $90 because non-cash, CFF down by $100, net cash up by $70
3. BS: Cash down by $70, PP&E down by $90, debt down by $100, SE down by $60
Effect of company purchasing inventory worth $10 at start of year 1:
1. IS: No changes as nothing has occurred yet
2. CFS: Cash down by $10 because asset went up, net cash down by $10
3. BS: Cash down by $10, inventory up by $10
Effect of company from prior question selling inventory for revenue of $20 and cost of $10:
1. IS: Revenue up by $20, operating income up by $10, net income up by $6
2. CFS: Cash up by $6, increase by $10 because asset went down, net cash up by $16
3. BS: Cash up by $16, inventory down by $10, SE up by $6
Effect of a company raising debt worth $100 (10% repayment, 5% interest) to purchase short-term securities worth $100 (10%
interest) at the start of year 1:
1. IS: No changes as nothing has occurred
2. CFS: CFI down by $100, CFF up by $100, no change in net cash
3. BS: Assets up by $100, debt up by $100
Effect of company in prior question after year 1:
1. IS: Operating income up by $5 (up $10 from interest income, down $5 from interest expense), net
income up by $3
2. CFS: Cash up by $3, CFF down by $10, net cash down by $7
3. BS: Cash down by $7, debt down by $10, SE up by $3
Technical Interview Overview Harsh Naik

Effect of company from prior question selling its securities for $110 and using proceeds to repay $90 of debt outstanding after year
1 (effects only from this change):
1. IS: Operating income up by $10 due to gain on sale, net income up by $6
2. CFS: Cash up by $6, reduce by $10 because of non-cash, CFI up by $110, CFF down by $90, net
cash up by $16
3. BS: Cash up by $16, short-term security is down by $100, debt down by $90, SE up by $6

Enterprise Value / Equity Value

Equity Value:
- The “ticker” price of a company, also known as market capitalization; corresponds to equity
investors only
- Equity value = shares outstanding * share price
Enterprise Value:
- Represents how much a company is actually worth; corresponds to all investors
- EV = equity value – cash & cash equivalents + debt + non-controlling interest + preferred stock
- Subtract anything that will reduce how much you have to pay in the short-term (cash) or long-term
(NOL)
- Add anything that will increase how much you have to pay in the short-term (debt, preferred stock),
long-term (pension obligations, capital leases) and for comparability purposes (minority interest)
Diluted Shares Outstanding:
- You take the basic S/O and add the effects of dilutive instruments such as call options, convertible
debt, convertible preferred stock, warrants, etc.
- Calculate it by taking converting any in-the-money securities and using treasury stock method to
determine final shares outstanding
- For convertible debt and preferred stock, there is no treasury stock method required (either or)
- Calculate this to determine true value of company; purchase agreements often state that any in-the-
money dilutive securities get cashed out or converted to the purchaser’s equivalent securities; both of
which increase the effective price
Why do you add non-controlling interest?
- When you control over 50% of a company, you have to report 100% of its financial performance in
your statements
- Thus the equity value only represents the portion you own but the denominator (e.g. EBITDA)
includes 100% so you need to make an apples-to-apples comparison by adding in the portion you
don’t own so the numerator and denominator both represent 100%
Should you always add debt / subtract cash?
- Always add debt unless the buyer doesn’t have to payoff the outstanding debt (very rare)
- Always subtract cash (you can also subtract only cash in excess of minimum amount needed for
operations)
Negative Equity Value / EV:
- Company can have negative EV if it has a low market cap or high cash balance but it can never have
a negative equity value
Why do you add preferred stock?
Technical Interview Overview Harsh Naik

- Preferred stock pays out a fixed dividend and shareholders have higher claim on assets than equity
shareholders and thus this is treated as debt and must be added for EV (also it must be repaid)
How do you factor convertible bonds (or convertible preferred stock) in EV?
- If they are in-the-money, add all the shares that would get created (no treasury stock needed)
- If they are out-of-the-money, count the face value of the convertibles as part of the company’s debt
Equity value vs. shareholders’ equity:
- Equity value is the market value and SE is the book value
- Equity value can never be negative but SE can
- For healthy companies, equity value far exceeds SE because market value of the stock is greater than
book value
Multiples:
- Use EV for any metrics which exclude the impact of interest (e.g. UFCF) as it’s the value of the
company for all shareholders, use equity value for metrics which include impact of interest (e.g.
LFCF) as it’s the value of the company for equity shareholders only
Equity Interests:
- When you own 20%-50% of a company, your equity value represents this portion
- However, this portion is not reflected in any metrics on the IS other than net income
- So if you’re using EV/EBITDA for example, you want to subtract out the equity interest from equity
value so the numerator and denominator are representing the same thing
Restricted stock units and performance shares:
- You add RSU to S/O as they are simply shares (which have to be held for a period of time)
- If performance shares are in-the-money, you treat them like convertible bonds; if they’re out-of-the-
money you simply ignore them
Options exercisable vs. options outstanding:
- Options outstanding are all options but companies usually put restrictions on how many are
exercisable, both methods are used in valuations (depends on the banker)
Company has 100 S/O at share price of $10 each and 10 options outstanding at an exercise price of $5 each; what is the
diluted equity value?
- The shares are in-the-money so they get exercised; company receives $50 and issues 10 new shares
- Company then uses $50 to repurchase 5 shares at $10 each; final share count 105
- Diluted equity value is 105 * $10 = $1,050
Company has 1,000,000 S/O at a value of $100 per share and also has $10,000,000 of convertible bonds with par value of
$1,000 and conversion price of $50; what is the diluted shares outstanding?
- The shares are in-the-money so they get exercised (not treated as debt)
- Number of bonds is $10,000,000 / $1,000 = $10,000
- Number of shares per bond is $1,000 / $50 = 20
- Number of total shares is 20 * $10,000 = 200,000, thus diluted S/O is 1,200,000

Valuation
Relative Valuation:
Technical Interview Overview Harsh Naik

- You look at other public companies (comparable companies analysis) or recent M&A deals
(precedent transactions analysis) based on industry, financial performance, time period and/or
geography to estimate what your company is worth
- Doesn’t work well when market data is spotty or the company you’re valuing is unique (e.g. high-
tech)
Intrinsic Valuation:
- You estimate a company’s future cash flows and discount them back to their present value to
determine how much the company is worth
- You can also use a NAV or liquidation model to determine a company’s worth based on its assets
- Doesn’t work well when free cash flow is not a relevant metric for the company or if the industry is
asset-centric (e.g. commercial banks, O&G, REIT)
Other Methodologies:
- Liquidation valuation: value a company’s assets, assume they are sold to repay its liabilities, and
whatever remains goes to equity investors (used primarily in O&G or in bankruptcy scenarios)
- M&A premiums analysis: select precedent transactions, but instead of looking at multiple paid you
look at the premium paid
- Future share price analysis: project a company’s future share price based on the P/E of comparable
companies and discount it back to present value
- Sum of the parts: split company into different segments, pick comparables and precedents for each,
assign each segment a different multiple, and calculate a weighted average valuation (used when a
company, like GE for example, has completely different, unrelated divisions and each needs to be
valued differently)
- LBO analysis: assume that the PE firm acquires a company and needs to achieve a certain IRR and
work backwards to calculate how much they can pay to achieve that return (used when trying to
determine how much a PE firm would be willing to pay)
Types of Multiples:
- EV/EBIT: used for many types of companies, most useful for ones where capex is important to
factor in (since D&A and capex track closely)
- EV/EBITDA: used for many types of companies, most useful for ones where capex and D&A are
not important to factor in as they are both excluded
- P/E: used for many types of companies (most relevant for FIG), distorted by non-cash charges,
capital structure, and tax rate
- Equity value/levered FCF: not very common as it requires more work to calculate and may produce
wildly different numbers depending on capital structure
- EV/unlevered FCF: used when capex or changes in working capital have a large impact; also critical
in DCFs
Public Comps
- Pros: based on real data as opposed to future assumptions
- Cons: there may not be true comparables, less accurate for thinly traded/volatile companies
- Valuation: usually lower than precedent transactions due to lack of control premium
- Methodology: chose comp set based on industry, financial performance and geography, calculate the
median of the set and apply to your company
Precedent Transactions:
- Pros: based on what real companies have actually paid for other companies
Technical Interview Overview Harsh Naik

- Cons: data can be spotty (especially for private acquisitions), there may not be truly comparable
transactions
- Valuation: usually higher than public comps because of control premium
- Methodology: chose precedent transactions based on industry, financial performance, geography and
time-period, calculate the median of the set and apply to your company
DCFs:
- Pros: not as subject to market fluctuations, theoretically sound since it’s based on ability to generate
cash flow
- Cons: subject to far-in-the-future assumptions, less useful for fast-growing, unpredictable companies
- Valuation: usually the most variable methodology due to it being largely dependent on assumptions
- Methodology: see DCF section
Unlevered FCF:
- Unlevered FCF = EBIT * (1-T) + non-cash charges – change in NWC – capex
- You’re excluding the impacts of interest income/expense and mandatory debt repayments, used to
get directly to EV
Levered FCF:
- Levered FCF = Net income + non-cash charges – change in NWC – capex – mandatory debt
repayments
- You’re including the impacts of interest income/expense and mandatory debt repayments, used to
get directly to equity value
What explains higher/lower multiples?
- Correlation between growth and valuation multiple; higher growth companies usually have higher
multiples
- Math also plays a role; companies with higher margins will have lower multiples because of a larger
denominator
- Also other non-financial factors play a role; this includes things like IP, legal/regulatory factors,
competitive advantages, earnings above expectations, larger market share, etc.
Flaws of EBITDA:
- Ignores the amount of debt principal and interest, as well as capex that a company is spending each
year, which all could be large and cause cash flow to be negative
- Also ignores working capital requirements, which can also be very large for some companies
- A lot of companies add-back a lot of charges and expenses, so it may not even be a true measure of
cash flow
- Mostly used because it has become the norm and is easy to calculate and compare companies
EV/EBITDA vs. P/E:
- EV/EBITDA is capital structure neutral (better for comparability purposes for most companies)
- P/E is capital structure dependent (better for companies where interest is critical and capital
structures are similar)
Industry-Specific Multiples:
- Internet (tech): EV/unique visitors, EV/page views, EV/daily (or monthly) average users
- Retail/Airlines: EV/EBITDAR (includes effect of rental expense which some companies capitalize
and some expense)
Technical Interview Overview Harsh Naik

- Oil & Gas: EV/EBITDAX (includes effect of exploration expense which some companies capitalize
and some expense), EV/proved reserves
- REITs: Price/FFO per share (funds from operations is a better measure of normalized cash flow as
gains/losses on property sales as well as depreciation are large line items for REITs), Price /AFFO
(adjusted FFO)
LBO vs. DCF:
- LBO will usually give a lower valuation as it’s only valuing a company based on the value of its final
year/exit year while a DCF is valuing a company based on its cash flows between the first year and
final year
Where do you use valuation models?
- Pitch books and client presentations: when you provide updates and inform client of what you think
they’re worth
- Parts of other models: defence analyses, merger models, LBO models, DCFs, etc.
- Fairness opinion: right before a deal with a public seller closes, its financial advisor creates a fairness
opinion that justifies the acquisitions price and directly estimates the company’s valuation
Would you pay a higher multiple for a company that leases or owns its equipment?
- A company that owns its equipment will incur D&A but this won’t be factored into EBITDA
whereas a company that leases their equipment will incur higher operating expenses lowering their
EBITDA
- Thus the company that owns its equipment will have a higher EBITDA and consequently a lower
EV/EBITDA multiple; you should pay a higher multiple for the company that leases its equipment
What can cause lower/higher multiples for precedent transactions?
- The competitive nature of the processes can dictate the premium that’s paid
- One company may have had recent bad news and a depressed share price
- Two companies can be in different industries which have different median multiples
- Two companies can have different accounting standards and thus calculate EBITDA differently
How do you value companies with no revenue or profit?
- You can use unique multiples such as EV/unique visitors or EV/page views (better for internet
companies)
- You can use a far-in-the-future DCF to project a company’s financials until it starts generating
revenue/profit (better for biotech/pharma companies where you can more reasonably predict
market share and prices for new drugs)
What happens when a company engages in a 2-for-1 stock split?
- Nothing happens – the S/O double and the share price decreases in half but the equity value and
earnings stay the same so the EPS decreases in half
- Thus the P/E remains the same as both the numerator and denominator decreased in half
- In reality though, a stock split is often seen as a good thing and the value of the company tends to
increase
Calendarization:
- You calenderize when analyzing multiple companies because each can have different fiscal periods
and you want to compare them based on the same calendar period
- TTM = most recent FY + new partial period – old partial period
Technical Interview Overview Harsh Naik

How do you value private companies?

- You can still use public comps, precedent transactions, and DCFs, but there are some differences
- You should apply a 10-15% discount to the public comp multiples because the private company is
not as liquid as the public comps
- You can’t calculate an implied per-share price or use premiums analysis or future share price analysis
- DCF is tricky as the private company doesn’t have a market cap or beta
Walk me through an IPO valuation:
- Chose a public comp set and apply relevant multiples to our company and estimate EV based on that
- Once you have EV, you can work backward to equity value and also add in proceeds from IPO (as
this is cash that the company gets)
- Then divide by the total number of shares (old and new) to get its per-share price

Discounted Cash Flow

Why use a DCF?
- To value a company based on its cash flows and discounting them back to present value due to the
time value of money
Walk me through a DCF:
- Project a company’s free cash flow over a 5-10 year period
- Calculate the company’s discount rate (usually WACC)
- Discount and sum the company’s FCF
- Calculate the company’s terminal value (exit multiple or perpetuity growth method)
- Discount the terminal value to its present value
- Add the discounted FCF to the discounted terminal value
WACC:
- WACC is a common discount rate and incorporates the time value of money as well as the return
that investors require before they can invest (thus representing the equity risk the investor is taking
on)
- Smaller companies, companies in riskier industries as well as companies in emerging markets all have
larger WACCs as there’s a greater risk (and also return) that investors are expecting
- WACC = (cost of equity * % of equity) + (after-tax cost of debt * % of debt) + (cost of preferred
stock * % of preferred stock)
- Cost of equity = risk-free rate + (equity risk premium * levered beta)
- Risk-free rate is the interest rate you can generate by investing in risk-less assets (e.g. US treasury
notes)
- Equity risk premium is the percentage by which stocks are expected to out-perform risk-less assets
- Beta refers to the riskiness of the company compared to all other companies in the stock market
- If you’re using levered FCF, you just use cost of equity as the discount rate because you’re only
calculating the equity investor return
- In economic downturns, WACC increases as the increases in beta, equity risk premium, cost of debt
and cost of preferred stock all combine to outweigh the risk-free rate; thus company’s values
decrease
Levered Beta:
Technical Interview Overview Harsh Naik

- You want to find a public comp set, and un-lever their betas so its capital structure neutral (not
factoring in the different company’s debt and tax rate structures)
- Then you calculate the median of this set and re-lever according to your company’s capital structure
because you want to assess the true riskiness of your company
- Unlevered beta = levered beta / (1+(1-T) * (debt/equity))
- Levered beta = unlevered beta * (1+(1-T) * (debt/equity))
Discount Factor:
- Discount factor is the figure you can multiple your FCF by to get the PV FCF
- Discount factor = 1 / (WACC)^(time period)
Terminal Value:
- Exit multiple method:
o You assume that a company will get sold after the projection period
o The terminal value can be calculated by multiplying the exit year EBITDA by an appropriate
multiple (through comps and/or precedent transactions)
o Not applicable for companies who are in very cyclical industries or don’t have reasonable
multiple comps
- Perpetuity growth method:
o You assume that a company will continue to generate cash into perpetuity
o Terminal value = final year FCF * (1 + terminal FCF growth) / (WACC – terminal FCF
growth rate)
o Disadvantage is that it’s hard to predict a growth rate, but you should usually choose a GDP
growth rate
Effects on DCF valuation:
- Additional debt raises the cost of equity because it makes the company riskier for all investors
- Additional equity lowers the cost of equity because the percentage of debt in a company’s capital
structure decreases
- Additional debt reduces WACC because debt is less expensive than equity up until a point
- Once debt becomes too large, the higher debt interest rates will increase WACC because they
increase cost of debt
- If debt/equity is the x-axis and WACC is the y-axis, it will create a U-shape
Why do you use FCF?
- To replicate the CFS but only including recurring, predictable items
- This figure helps determine how much recurring cash a company is generating and thus its value
How long is the projection period?
- Typically, 5-7 years as beyond this is hard to reasonably predict
- It can also be longer than 10 years if the company is in a cyclical industry and/or asset lives are much
longer (e.g. biotech/pharma company)
How do you calculate implied per-share price?
- Calculate EV based on your DCF and then add cash, subtract debt, preferred stock, non-controlling
interests (and any other debt-like items) to get to equity value
- Then divide equity value by number of FDSO to determine implied per-share price
- You should also then sensitize the major drivers in your DCF to determine if the company is truly
undervalued
Technical Interview Overview Harsh Naik

Changes in NWC:
- If a company’s assets are increasing by more than liabilities, the company is spending cash and
therefore reducing its cash flow
- This is why you subtract an increase in NWC (current assets – current liabilities)
Levered FCF:
- If you use levered FCF, you can calculate equity value directly (as debt investors have already been
paid out with interest and principal repayments)
- Your discount rate in this case would simply be the cost of equity
Debt vs. Equity
- Debt is less expensive than equity because it’s tax-deductible, debt investors are senior to equity
investors and will get paid first in liquidation scenarios, and intuitively interest rate on debt is cheaper
than cost of equity and thus will contribute less to WACC
Effect of debt repayment on DCF:
- The repayment of debt has no effect on an unlevered FCF DCF as you’re ignoring the impacts of
interest and debt repayments
- However, in a levered FCF DCF, repaying a large amount of debt lowers the equity value because
the principal repayments each year far exceed the net interest expense
Mid-Year Convention:
- You use it to represent the fact that a company’s cash flow does not arrive 100% at the end of the
year – instead, it comes in evenly throughout each year
- To account for this, divide the first year by 2 and add 1 for each subsequent year (e.g. discount
periods of 0.5, 1.5, 2.5, etc.)
Stub Period:
- You use a stub period when you’re valuing a company before or after the end of its fiscal year and
there are one or more quarters in between the current date and the end of the fiscal year
- For example, if you are still 3 months/1 quarter away, you would use a 0.25 discount period for the
first year and add 1 for each subsequent year
- If you are also using a mid-year convention, you divide the first period by 2 and then simply subtract
0.5 from each subsequent period (e.g. 0.125, 0.75, 1.75, etc.)
Effect of mid-year convention on terminal value:
- Exit multiple method: you add 0.5 to the final year discount number to reflect that you’re assuming
the company gets sold at the end of the year
- Perpetuity growth method: you use the final year discount number as is
When does a DCF not work:
- When a company never generates positive cash flow
- When a company is high-growth and financial performance is hard to reasonably estimate
- For a FIG company as debt and interest are critical to their core business and need to be accounted
for
- For a O&G company as capex needs are enormous and push FCF down to very low levels and
because commodity prices are cyclical making financial performance hard to predict
- For a company in an emerging market as it doesn’t have as many reliable public comps; small market
premium should be added to equity risk premium to account for this
Technical Interview Overview Harsh Naik

Merger Model
Rationale for M&A:
- On a high-level, rationale for an M&A comes down to ROI (if the company thinks it can make more
money from acquiring a company than it spends)
- However, analysts and investors focus specifically on EPS (whether its accretive or dilutive)
- Financial reasons:
o In mature markets, consolidation drives a lot of M&A activity as competitors try to gain
market share
o Geography can also play a role as companies try to grow geographically
o Companies also might be motivated to grow more quickly and sees acquiring a smaller high-
growth company as a way to achieve that goal
o Buyer might also be motivated to gain the seller’s customers, in hopes of cross-selling or up-
selling their products
- Qualitative reasons:
o The seller has a particularly important technology, patent or IP
o The seller poses a threat to the buyer
o The seller has amazing employees and the buyer will pay a premium for that (e.g. tech)
o Other intangible benefits that are projected to materialize over the long-term
Merger Model:
1. Determine purchase price: use a combination of public comps, precedent transactions, and DCF to
come up with a reasonable price (per-share price for public companies and implied equity value for
private companies)
2. Determine how to finance acquisitions: companies can finance acquisitions either through stock,
debt, or cash, all of which have their pros and cons and are usually used in combination
3. Project financials of both companies: project out the income statement of the buyer and seller,
working from revenue to EPS
4. Combine the income statements: add up all the lines on the income statements, use the buyer’s tax
rate, and divide the combined net income number by the buyer’s FDSO plus new shares issued
5. Calculate goodwill and allocate purchase price: when a buyer acquires a seller, the seller’s S/O and
SE are wiped and so the balance sheet is not balanced; this is where you create a new goodwill to act
as the plug
6. Combine the balance sheets and adjust for acquisition effects: you add up all the lines of the BS,
incorporating changes based on the cash, debt, and stock that the buyer is using to finance the
acquisition
7. Adjust the combined income statement for acquisition effects: adjust for synergies (revenue or
expense), D&A (if you’ve adjusted PP&E), foregone interest on cash (cash used * interest rate),
interest rate paid on debt (debt used * interest rate), and shares outstanding (old buyer FDSO + new
shares issued)
8. Calculate accretion/dilution and run sensitivity analysis: analyze the new combined company EPS
and compare it to the old buyer EPS to see if the deal was accretive or dilutive (then run sensitivities
on the major drivers of the model such as purchase price, synergies, transaction structures, etc.)
Cash vs. Debt vs. Stock:
- A deal will generally be dilutive if the amount of extra pre-tax income the seller contributes is not
enough to offset the foregone interest on cash, the cash paid on the debt, and the effects of issuing
shares
Technical Interview Overview Harsh Naik

- The buyer usually always prefers to use 100% cash as cash is cheaper than debt and unlike issuing
stock, it doesn’t require the buyer to give up any ownership to the seller
- Sellers also tend to prefer cash because it’s less risky than equity (the buyer’s share price might
plummet and significantly reduce the purchase price) and because they might want to use cash for
another purpose (such as capex or hiring more employees)
- For debt, the buyer will look at the percentage debt used in similar deals, the leverage ratio, and
whether or not it can reasonably meet its interest payments
- For stock issuances, it will look at how much ownership it’s giving up, how much it’s diluting existing
shareholders, and where their stock is trading currently (more incentive to use stock if share prices
are high)
- Cash is cheaper than debt (as interest rates on cash are lower than debt) and stock (as most
companies’ P/E is between 10x – 20x which represents 5% - 10% earnings yield and is higher than
interest rates on cash)
- Cash is less risky than debt (as there’s no chance execution risk in raising sufficient funds from
investors) and stock (as the buyer’s share price can dramatically change once the acquisition is
announced)
All-Stock Deal:
- In an all-stock deal, if the buyer has a lower P/E than the seller, the deal will be dilutive, and if the
buyer has a higher P/E than the seller, the deal will be accretive
- The inverse of the P/E represents the earning yield (or cost of stock) and so if the buyer’s cost of
stock is lower than the seller, it is giving up less (cost of stock) to get more (seller earning yield)
Cash, Debt, and Stock Deal:
- Cost of cash = foregone interest rate on cash * (1 – buyer’s T)
- Cost of debt = interest rate on debt * (1 – buyer’s T)
- Cost of stock = inverse of buyer’s P/E
- Yield of seller – inverse of seller’s P/E
- To determine whether a deal is accretive or dilutive, calculate the weighted average cost of the cash,
debt, and stock used
- If this weighted average cost is lower than the yield of the seller, the deal is accretive and if it’s higher,
then the deal is dilutive
- This formula doesn’t always work; it doesn’t hold up if the buyer and seller don’t have the same tax
rates, if there are other acquisition effects such as new D&A, if there are synergies, and if there are
transaction fees (so basically in any real-world deal)
Acquisition Effects:
- Foregone interest on cash: the buyer loses the interest it would have otherwise earned if it uses cash
for the acquisition
- Additional interest on debt: the buyer pays the additional interest expense if it uses debt
- Additional shares outstanding: if the buyer pays with stock, it must issue additional shares, which
reduce EPS
- Combined financial statement: after the acquisition, the seller’s financial statements are added to the
buyer’s, with a few adjustments
- Creation of goodwill & other intangibles: these BS items represent the premium the buyer paid over
the seller’s SE, and act as a plug for the consolidated balance sheet
- PP&E and fixed asset write-ups: you may write up the assets if you feel that market value exceeds the
book value
- Deferred tax liabilities: normally you write off the seller’s existing DTL, and then create new ones
based on the buyer’s tax rate * (PP&E and fixed asset write-up and newly created intangibles)
- Deferred tax assets: in most deals, you write this off completely
Technical Interview Overview Harsh Naik

- Transaction and financing fees: you expense legal and advisory fees and deduct them from cash and
RE at time of transaction but you capitalize financing fees and amortize them 5-10 years
- Inter-company AR and AP: you eliminate some of the combined AR and AP balances
- Deferred revenue write-down: you can only recognize the profit portion of the seller’s deferred
revenue post-acquisition so you often write down the expense portion of the seller’s deferred
revenue over several years in a merger model
Revenue and Expense Synergies:
- Revenue synergies: this can be modelled by projecting a price increase or volume increase due to the
combined company (much harder to project and execute)
- Expense synergies: this can be broken down into two main buckets, reduction in force (laying off
workers who are now redundant) and building consolidation (getting rid of redundant offices);
modelled by reducing COGS or operating expenses by certain amount
How can an acquisition can fail?
- Integration difficulties: employee bases, supply chains, retail networks, etc.
- Cultural differences: will make it difficult to accomplish common company objectives
- Poor rationale: the original reason for acquisition itself was flawed
- Synergy failures: a lot of the times this is with projected revenue synergies
- Overpaying: this has happened a lot recently, specifically in the tech M&A space where valuations are
unreasonable
Merger vs. Acquisition:
- There’s always a buyer and a seller in a transaction, but in a merger, the two companies are similarly-
sized whereas in an acquisition, the buyer is more than 2-3x larger than the seller
- You also see all-stock deals more commonly in a merger as the two companies usually don’t have
enough cash to buy the other
How do you determine the purchase price?
- Use traditional valuation methodologies to determine the value of the company you’re trying to
acquire and also ensure that you’re paying a sizeable premium (15% - 30%) to win shareholder
approval
When would a company use stock?
- When their shares are trading at a very high level and thus the cost of stock is lower than what it
normally would be
- When it’s a merger and they can’t raise enough cash
Stock vs. Debt:
- You would compare the relative costs of both stock and debt
- If you already have a lot of debt on the BS, you might prefer to use stock to avoid high interest rates
- You might prefer to use debt if you don’t want to upset shareholders by diluting their shares
- You might prefer to use stock if you have expansion/R&D/capex plans and want to conserve funds
Effect of Financing on EV/EBITDA and P/E:
- Regardless of the purchase method, the combined EV for the new entity remains the same
- The seller’s market cap always gets wiped out when it is acquired
- Regardless of purchase method, the combined EV/EBITDA does not change as combined EV stays
the same and combined EBITDA is not affected by changes in interest or additional shares
outstanding
Technical Interview Overview Harsh Naik

Strategic vs. Sponsor:

- Strategic acquirer can realize revenue and cost synergies that a sponsor can’t (unless they combined it
with a portfolio company), and because of this, often pay higher multiples

Leveraged Buyout Model

What is an LBO?
- In an LBO, a private equity firm acquires a company using a combination of debt and equity (cash),
operates it for several years, possibly makes operational improvements, and then sells the company at
the end of the period to realize a return on investment (IRR)
Why does an LBO work?
- By using debt, the PE firm reduces its up-front cash payment for the company
- Using the company’s cash flows to pay off debt interest and principal also produces a better return
than simply keeping the cash flow
- The PE firm sells the company in the future, allowing to gain back a majority of the funds it spend to
acquire it in the first place
- Secondary benefit is that the PE firm can use less equity and thus has more capital to purchase other
companies, further increasing their returns
Walk me through an LBO?
1. Make transaction and financing assumptions (purchase price, debt/equity ratio, interest rate on debt,
etc.)
2. Create a sources & uses section outlying how the transaction is financed and what the capital is used
for; tells you how much investor equity is required
3. Adjust company’s BS for new debt and equity, allocate purchase price, and add in goodwill & other
intangibles to make it balance
4. Project out the company’s IS, calculating the FCF and debt repayments
5. Make exit multiple assumptions, calculate returns on investor equity, and sensitize key drivers
What makes a good LBO candidate?
- Stable and predictable cash flows (in order to pay down debt)
- Not have much need for ongoing investments such as capex
- Have an opportunity to cut costs and improve margins
- Have a strong management team (PE firm can also insert their own management team)
- Be undervalued relative to peers (lowering the purchase price)
Basic Model Assumptions:
- Assume a purchase price and the amount of debt and equity you’ll be using (using traditional
valuation methodologies and applying a premium if it’s a public company)
- Figure out the debt terms, including interest rates and annual repayment (depends on the type of
debt you’re using as well as debt market conditions)
- Create a sources & uses schedule that tracks where your funds are coming from, and where they’re
going to
Sources & Uses:
- Common sources of funding: debt, investor equity, and debt assumed
Technical Interview Overview Harsh Naik

- Common uses of funding: equity value of company, advisory/legal/financing/other fees, debt

assumed, and refinanced debt
Equity Value vs. Enterprise Value:
- Assume existing debt: in this case, the effective purchase price will be closer to the equity value (but
not the same due to cash)
- Repay existing debt: here, the effective purchase price will be closer to the company’s enterprise
value (but not the same due to cash)
Calculating Free Cash Flow:
- In the context of an LBO model, FCF refers to Cash Flow from Operations – Capex
- This metric is a measure of the amount of cash a company as available to repay debt principal each
year after they’ve paid for normal expenses and for the interest expense on that debt
Repaying Debt:
- Make any mandatory debt repayments first (usually bank debt will have a mandatory amortization)
- Then, with remaining cash flow, make optional repayments (although debt such as high-yield can’t be
repaid early and some companies also have a minimum cash balance)
- If a company has negative FCF and needs to make mandatory debt repayments, it can draw from a
revolver (and then pay that back later)
Interest Payments and Circular References:
- The interest expense on the IS depends on how much debt is paid off over the course of a year
(because the company pays interest each quarter or each month)
- In models, you average the beginning and ending debt balance and calculate interest off of that but
this creates a circular reference (as the ending debt is based on how much cash flow you had after
paying for interest but the interest is based on the ending debt balance)
How to calculate returns:
- The equity (cash) that the PE firm invests at the beginning is a negative
- Any cash or dividends issued to the PE firm throughout the period are positive
- Sale proceeds minus the debt outstanding at the end are also positive and represent what the PE firm
receives when it sells the company
Internal Rate of Return:
- If the PE firm invested and an initial amount of money and got a specific interest rate, compounded
each year, they’d end up with the total amount of money shown in the final year
- So the IRR is the effective interest rate the PE firm is generating on the investment
Mental Math and Rules of Thumb:
- If a PE firm doubles its money in 5 years, that’s a 15% IRR
- If a PE firm triples its money in 5 years, that’s a 25% IRR
- If a PE firm doubles its money in 3 years, that’s a 26% IRR
- If a PE firm triples its money in 3 years, that’s a 44% IRR
- Rule of 72: divide 72 by the number of years to get IRR when equity value doubles
- Rule of 114: divide 114 by the number of years to get IRR when equity value triples
- Rule of 144: divide 144 by the number of years to get IRR when equity value quadruples
What effects IRR:
Technical Interview Overview Harsh Naik

- Changes that increase IRR: lower purchase price, less equity, higher revenue growth, higher EBITDA
margins, lower interest rates, lower capex
- Changes that decrease IRR: higher purchase price, more equity, lower revenue growth, lower
EBITDA margins, higher interest rates, higher capex
Dividend Recapitalization:
- The PE firm has the company raise additional debt and issues a big cash dividend to itself with the
proceeds of that debt
- No changes on the IS, but on the BS, debt goes up and SE goes down to reflect dividend, and on the
CFS, the additional debt from CFF would cancel out the dividend paid out in the CFI
- This boosts returns for the equity investor but is viewed unfavourably by debt investors
Private Company:
- Similar to an LBO of a public company with a couple of exceptions: no premium, valuation based on
implied value of company, the company may not want to sell, and information is more limited
Real-Life Example of an LBO:
- Buying and renting out a house
o Down payment: investor equity in an LBO
o Mortgage: debt in an LBO
o Mortgage interest payments: debt interest expense in an LBO
o Mortgage repayments: debt principal repayments in an LBO
o Rental income from tenants: cash flow in an LBO
o Selling the house: selling the company or taking it public in an LBO
Strategic vs. Sponsor:
- Strategic often prefers to pay for another company with 100% cash while a strategic prefers to use
debt
- This is because the PE does not hold the company for the long-term and so is less concerned about
the higher expense of debt and more concerned about using leverage to boost its return and reduce
its upfront
Why would a PE firm buy a company in a “risky” industry like tech?
- Industry consolidation: buying competitors in a market and combining them to increase efficiency
and win more customers
- Turnarounds: taking struggling companies and improving their operations
- Divestitures: selling off divisions of a company or turning a division into a strong stand-alone entity
Which industry do PE firms usually not buy companies in?
- This would be in industries where companies truly have unstable cash flows – anything based on
commodities, such as oil, gas, and mining, as commodity price fluctuations can have extremely large
impacts on FCF
How to Determine Debt in a Transaction:
- To figure out how much debt a company can take on and the terms of the deb, we’d look at the debt
comps showing the types, tranches, and terms of debt that similarly sized companies in the industry
have used recently
- You’d also look at metrics such as EBITDA/interest expense to ensure the company has the right
amount of leverage in order to boost returns but also not be at risk of bankruptcy
Technical Interview Overview Harsh Naik

Bank Debt vs. High-Yield:

- High-yield debt tends to have higher interest rates than bank debt since its riskier for the investors
- High-yield debt interest rates are usually fixed, whereas bank debt interest rates are floating (change
based on LIBOR – London interbank offered rate which is the rate banks charge each other for
short-term loans)
- High-yield debt has incurrence covenants while bank debt has maintenance covenants, main
difference is that incurrence covenants prevent you from doing something (such as selling asset,
buying factory, etc.) while maintenance covenants require you to maintain a minimum financial
performance (for example, the total debt/EBITDA must be below 5x at all times)
- Bank debt is usually amortized (the principal must be paid off over time), whereas with high-yield
debt, the entire principal is due at the end (bullet maturity) and early principal repayments are not
allowed (the debt investors want to be compensated for their risk and so prefer to keep the debt on
the balance sheet for the entire time so they can receive higher interest payments)
- If the PE firm is concerned about the company meeting interest payments and wants a lower-cost
option, or they are planning on a major expansion/capex and don’t want to be restricted by
incurrence covenants, they might prefer bank debt
- If the PE firm intends to refinance the debt at some point, don’t believe their returns are too
sensitive to interest payments, or if they don’t have plans for a major expansion
effort/acquisitions/sell off the company’s assets, they’ll prefer high-yield debt
Refinancing vs. Assuming Existing Debt:
- If the PE firm assumes the debt when acquiring a company, the debt remains on the BS and must be
paid off (both interest and principal) over time; this has no net effect on the funds required as it
shows up in the sources and uses sections
- If the PE firm refinances debt, it pays it off, usually replacing with the new debt that it raises to
acquire the company; this means additional funds are required, so the effectives purchase price goes
up and the existing debt shows up only in the uses section
Transaction and Financing Fees:
- Legal & advisory fees: these come out of the cash and RE immediately as the transaction closes
- Financing fees: these are amortized over time (for as long as the debt remains outstanding); you pay
for them upfront in cash, create a new asset on the BS, and then amortize the asset over time as the
fees are recognized on the IS
Balance Sheet Adjustment:
- New debt is added, and the SE is “wiped” and replaced with however much investor equity the PE
firm is contributing
- The cash is adjusted for any cash used to finance the transaction and for transaction fees, and the
goodwill & other intangibles are used as a plug to make the BS balance (represents the
premium/excess the PE firm paid over the book value of the original SE)
Debt Repayment for Multiple Tranches:
- Normally you pay off the existing debt on the BS
- Then, it depends on the seniority of the debt and also whether or not the debt can even be repaid
early (such as high-yield debt)
- The order is usually existing debt, revolver, senior debt (1st lien for example), and junior debt (2nd lien
for example)
Tax-Shield in an LBO:
Technical Interview Overview Harsh Naik

- The interest that the PE firm pays on debt is tax-deductible, so they save money on taxes and
therefore increase their cash flow as a result of the debt
- The cash flow is still lower than it would have been without the debt (because of interest expenses)
Incurrence vs. Maintenance Covenant Examples:
- Incurrence covenants: company cannot take on more than $2B of debt, proceeds from any asset sale
must be used to repay debt, company cannot make acquisitions over $200M, company cannot spend
more than $100M in capex each year
- Maintenance covenants: total debt/EBITDA cannot exceed 3.0x, senior debt/EBITDA cannot
exceed 2.0x, EBITDA/interest expense cannot fall below 5.0x, (EBITDA – capex)/interest expense
cannot fall below 2.0x
Payment in Kind (PIK) Debt:
- A PIK loan does not require the borrower to make cash interest payments, instead the interest
accrues to the loan principal which keeps going up over time
- A PIK toggle allows the company to choose whether to pay the interest in cash or have it accrue to
the principal
- PIK debt is riskier than other forms of debt and requires higher interest rates
- You include the interest expense on the IS but you need to add it back on the CFS as it’s non-cash
IRR for Debt Investors:
- For debt investors, you calculate the interest and principal payments that they receive from the
company each year
- Initial debt invested is negative, the interest and principal payments each year are the positive cash
flows, and the remaining debt balance in the final year is the exit value
- Debt investors can typically generate 10%-15% (if its high-yield) and thus can actually generate a
higher IRR than the PE firm if the company doesn’t perform as well
Leverage and IRR:
- Increased leverage, past a certain point, can start reducing IRR if the interest payments and principal
repayments exceed the company’s cash flow or if there’s declining growth and/or margins
- Its always better to use debt that has lower interest rates and can be repaid early, although PE firms
will still use high-yield or PIK debt if the company is having cash flow issues or it’s too difficult to
raise funds via term loans
Paper LBO:
- Calculate the purchase price and the respective debt and equity
- Project out the income statement, working from EBITDA to net income and then to levered FCF
- Calculate the ending EV, subtract the net debt (debt outstanding – cumulative levered FCF) to get
the ending equity value
- Calculate returns based on beginning and ending equity value, and the time period