If you’re preparing for investment banking recruiting, studying the most common interview questions is one of the best ways to improve your technical skills. Every analyst needs to know these interview questions along with ten other essential investment banking skills to land an investment banking job. Investment banks consistently ask the technical questions below to evaluate your understanding of valuation, accounting, mergers and acquisitions, and financial modeling. The following are the most common interview questions for investment banking, along with concise answers that will help you prepare for your interviews.
1. Walk me through a DCF.
A Discounted Cash Flow (DCF) values a company by projecting its future unlevered free cash flows, discounting those cash flows back to present value using the Weighted Average Cost of Capital (WACC), calculating a terminal value, and adding them together to arrive at Enterprise Value. After subtracting net debt and other claims, you arrive at Equity Value.
2. How are the three financial statements connected?
Net Income from the Income Statement flows into the Cash Flow Statement. The Cash Flow Statement adjusts for non-cash expenses, changes in working capital, and capital expenditures to calculate the change in cash. That ending cash balance flows onto the Balance Sheet, while Net Income also increases retained earnings, balancing the accounting equation.
3. What is WACC?
The Weighted Average Cost of Capital is the average required return expected by a company’s debt and equity investors. It is calculated using the weighted cost of equity, after-tax cost of debt, and preferred stock, if applicable. WACC is commonly used as the discount rate in a DCF because it represents the opportunity cost of investing in the company.
4. Why do we use Enterprise Value instead of Equity Value in a DCF?
A DCF values the operations of the entire business because unlevered free cash flow is available to both debt and equity investors. Since all providers of capital are included, the DCF produces Enterprise Value first. Net debt and other non-equity claims are then removed to calculate Equity Value.
5. Walk me through an accretion and dilution analysis.
An accretion and dilution analysis determines whether an acquisition increases or decreases the buyer’s Earnings Per Share (EPS). The buyer combines its earnings with the target’s earnings, adjusts for synergies, financing costs, and transaction adjustments, then compares the new EPS to the buyer’s standalone EPS. If EPS increases, the deal is accretive. If EPS decreases, it is dilutive.
6. Why might two similar companies trade at different valuation multiples?
Two companies in the same industry can trade at different multiples because of differences in revenue growth, profitability, margins, risk, customer concentration, competitive position, and future growth expectations.
7. Walk me through depreciation.
Depreciation reduces operating income on the Income Statement. Because it is a non-cash expense, it is added back to the Cash Flow Statement. On the Balance Sheet, the value of Property, Plant, and Equipment decreases while cash increases by the tax savings generated from the depreciation expense.
8. Walk me through a Leveraged Buyout (LBO).
An LBO is the acquisition of a company using a significant amount of debt. Investors contribute a smaller amount of equity while financing the remainder with debt secured by the acquired business. The goal is to improve the company’s value, pay down debt over time using its cash flows, and eventually sell the business at a higher valuation to generate a strong return on equity.
9. What happens if depreciation increases by $10?
Operating Income falls by $10, reducing taxes by the tax rate multiplied by $10. Net Income decreases by the after-tax amount. On the Cash Flow Statement, Net Income decreases, but the $10 depreciation expense is added back because it is non-cash, resulting in cash increasing by the tax savings. On the Balance Sheet, cash increases by the tax savings while Property, Plant, and Equipment decreases by $10, with the balance maintained through retained earnings.
10. How do you value a company?
The three primary valuation methods are Comparable Company Analysis, Precedent Transactions Analysis, and Discounted Cash Flow (DCF). Comparable Companies value a business based on how similar public companies trade, Precedent Transactions use acquisition multiples from past deals, and a DCF values a company based on the present value of its future cash flows.
Ready to Break Into Investment Banking?
Learning the most common interview questions is only one piece of the recruiting process. To become a competitive investment banking candidate, you also need a strong resume, an effective networking strategy, technical skills, and preparation for interviews.
We have helped many students break into investment banking through our proven recruiting framework. In our free masterclass, you’ll learn the five steps to becoming an investment banking analyst and how to build the skills that investment banks are looking for. Join today and take the next step toward your investment banking career. Click the link below.