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Technical Interview Questions and Solutions

Table of Contents
1. DCF Analysis
a. WACC
b. APV
2. Comparables
a. Precedent Transactions
b. Companies
3. Merger Analysis / Strategy
4. WACC / CAPM / Beta
5. Discount Rates / Perpetuities
6. Accounting
7. Debt / Equity Markets
8. Stock Market / Personal Finance

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Valuation Techniques

1. DCF Analysis
Definition: Project the companys future operating cash flows for 5 years or more and calculate the present
value of those cash flows and the terminal value using an appropriate cost of capital and terminal value
methodology.
Cons
Many assumptions (constant D/E,
terminal value, growth)
Heavily dependent on cash flows
Forecasting the future
Management overestimates
projections
Comparables
DOES include control premium
Very few
Transactions (precedent
Trends become clear (many deals
Degree of comparability
Transaction Analysis)
means industry consolidation)
Relative S&D for a certain type of
asset at the time of the transaction
Market cycles and volatitlity may
effect valuation
Not forward looking
Comparables
Primary measure for IPOs
Difficult to find truly comparable
Companies
Based on public information
cos it is impossible to adjust for
Market efficiency implies that the
differences in the underlying
trading valuation should reflect all
businesses
available information (risk, trends, etc.) Does NOT include control premium
Gives good value of minority interest
or synergies
Not good for thinly traded stocks
Stock market can be irrational
Break-up analysis value different business segments based on other valuation techniques
LBO value determine the max value you can pay using a max leveraged structure this helps assess the
amount of initial debt possible
DCF

Pros
Free from manipulation (unlevered
FCFs)
Good rough estimate
No market volatility

Use valuations for: acquisitions, divestitures, fairness opinion, public equity offerings, restructurings.
Equity Value vs. Enterprise (Asset, Aggregate) Value:
Enterprise: Takes Equity value and adds other sources of capital. This is the return to all sources of
capital. Appropriate multiples: Sales, EBITDA, EBIT. Also industry specific multiples: Sales/Retail
Sales space

Equity: Market cap. Appropriate multiples: Net income to common shareholders (NI2C) (after tax,
interest, preferred dividends).

High-Level problem:
Which of the three methods is the most robust?
SOLUTION:
Depends on the information available. The one you have the most influence over is the DCF, because you
add the details to the model. However, sometimes simpler is better.

a) WACC method

Qualitative definition: Expected return on a portfolio of all the securities the company holds

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WACC assumes a constant capital structure over time and incorporates the tax shield benefits into the
discount rate
Discount the projected CFs by the companys risk-adjusted discount rate.
Project out 5 to 10 years.
Add a terminal value (which represents the cash flows beyond the last year that are too far in the future
to project) two ways: 1) take the last years earnings and multiply it by a market multiple (eg 20X
earnings), or 2) take the last year and assume a constant growth rate (like 10%) and the present value
of this constant growth rate is the terminal value (perpetuity) 3) or a non-growing perpetuity.
Unlevered Free Cash Flows = cash flows generated by all assets, without considering interest,
dividends, etc., and leave all capital structure considerations to the denominator (WACC)
= EBIT (1-T) + Depreciation Change in Net Working capital CapEx
If using this approach to value a stock, then once you have the Enterprise value (what the WACC
method produces) need to subtract the Debt and divide by # of shares outstanding to get a stock price.
Three Problems w/ WACC: 1) assume constant capital structure ratio; 2) Hard to estimate a good
growth rate in terminal value calc; 3) in theory DCF is for valuing the firms projects; - its a leap of
faith to say that all the projects of the firm (i.e. the whole firm) should be valued the same way.

Give the four methods for calculating terminal value.

SOLUTION
1. Take the last years free cash flows and multiply it by a multiple
2. Growing perp (Last years FCF(1+g)/k-g)
3. Stable perpetuity, no growth rate (FCF/k)
4. Liquidation value (firesale)

b) APV method
Discount the unlevered cash flows by an unlevered discount rate (Re) and then value the debt tax shield
separately. Re is derived using an unlevered Beta in the CAPM
Debt Tax Shield = (Tax Rate)* (Rd)*(Total debt for that year) requires a tax schedule
or
APV approximation = APV w/o tax shield * (Tax Rate)*(D/D+E) approximates the debt level
APV Shortcoming
APV shortcoming difficult to project cost of financial distress
When would you use the APV method?
SOLUTION:
When you expect a change in capital structure and want to value the tax benefits separately
What is option value when valuing a company?
Often DCFs fall short of market value of the firm. This can be explained by the fact that the firm often has
the option to utilize other resources (e.g. oil reserves; patents) if it needs to. If you think this you can use
Black Schoales this option, and add it to the DCF valuation.

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What changes when you are valuing a private company?
Use DCF, but need to consider the following:
Beta will be harder to get and might need to use and accounting Beta 1) determine quarterly
accounting earnings; 2) regress earnings to a market index; 3) estimate slope obviously this is error
prone
Make sure to reflect the new WACC that youll get if its a public firm buying
Check to see if they do different accounting (no GAAP) that needs to be considered
If a private company is buying, will need a illiquidity discount cannot buy and sell as easily
usually around 20%
Might want to increase the Beta b/c the firms equity is not as diversified as if it was a public
company (the owners usually own most, and nothing elsemore risky).

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2. Comparables
a) Precedent Transactions
Find historical transactions that are similar to the current deal on the table. Then apply multiples derived
from similar or comparable precedent M&A transactions to the companys operating data. Make sure to
identify unique assets to that firm.

b) Companies
Provides the companys implied value in the public equity markets through analysis of comparable
companies trading and operating statistics. Then apply the multiples derived from these companies to the
targets operating statistics. Good for IPOs to id trading ranges if M&A youd need to assess the control
premium.
Identify comparable companies using business (products, product mix, customers, geo, SIC codes) and
financial (size, profitability, leverage) chars and then rank according to relevance (Tier I: Pure-play, Tier II:
Relevant)
Example industries:
Manufacturing P/E; and P/E relative to Market
High tech PEG (P/E)/Growth rate in earnings
Growth industries (no earnings) P/S: Price / Sales; V/S: (Mkt cap + Debt Cash)/ Sales
Heavy infrastructure (losses early on and diff levels of dep) V / EBITDA
REITS P / Cash Flow
Financial Svcs P/BV (BV of equity is regularly marked to market)
Retailing (if sim D/E) P/S
Retailing (if diff D/E) V/S
What should you consider when using comparables to value an international company?
When possible use local companies to value local companies (duh)
With cross border comparisons: different accounting rules, different interest rates (lower interest rates
mean higher valuations and higher P/Es), and different risk (e.g. emerging markets vs US).
What should you consider when using DCF to value an international company?
Pay attention to diff accounting rules
Keep in local currency, then translate when done
Rd - If no cost of debt can be found in the usual way look at US firms w/ similar interest coverage
(EBITDA/Debt expense) and add the default spread difference between a US treasury yield and
that countrys gov yield.
Re Bond Rating method: Risk Premium US + Default Spread on sovereign bonds; or the Relative
Equity method: Risk Premium US (Stand Dev of Country Equity/ Stand Dev of US Equity); or Bond
Method: Risk Premium US (Stand Dev Local Equity Index / Stand Dev Local Bond Index)

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3. Merger Analysis / Strategy

Reasons to merge
Horizontal merger take on competition (strategic)
Vertical merger up or down the supply chain (strategic)
Conglomerate merger buy unrelated businesses (strategic)
Synergies / inefficiency reduction overhead; cost of funds, mgmt
Financial motives buying up tax losses
Why are the drawbacks/disadvantages of mergers?
Many dont actualize the potential synergies and cost savings
Clash of different cultures disrupts organizations at times
Financially, can be dilutive if pay above and beyond the price to earnings of your company or if
dont realize synergies initially identified. Dilution has an adverse effect on stock price.
Accretive/Dilutive Problem:
What happens when a company with a 55 P/E ratio acquires a company with a 33 P/E ratio?
When a higher P/E company buys a lower one, the acquirers EPS will rise. The deal is said to be
accretive, as opposed to dilutive, to the acquirers earnings per share.
Logic: With a higher P/E, the market value per dollar of earnings of the acquiring company is higher
so it is cheaper for them to buy a firm with a lower market value per dollar of earnings? Or the
acquiring firms equity is more valuable so it needs to issue fewer shares to purchase it?
Have an M&A Idea Ready
Pick an industry, acquisition target, reasons behind it, synergies that exist
How does an acquisition flow through the financials of the acquirer?
Pooling of interest simply combine the financials and not have to account for goodwill (now illegal)
Purchase method:
I/S: Goodwill amortization expense affects earnings; and will lower taxes
B/S: Cash drops (if cash used to buy), underlying assets (at market value), goodwill increases (if you
have it), add liabilities at market value, and common stock (in shareholders equity) increases for equity
needed to finance transaction [shareholder equity of the target is erased]
Goodwill = purchase price (market value of assets - liabilities)
CFS: NO CASH FLOW IMPACT OF GOODWILL add it back yes, but its reflected in lower net
income already. There will still be a tax difference though so slightly less CFO. If cash is paid out, it
comes out of the Cash Flow from Investing, issuing common stock and debt increases cash from
Financing
Tax Implications of purchase accounting:
1. Selling shareholders recognize a gain/loss on the sale of their shares, even if they have received shares
in exchange
2. For the company, the basis of assets and liabs of the acquired firm is changed from original cost to fair
value, reflecting the price paid
Why would two companies merge? What major factors drive mergers and acquisitions?
Strategic Value: Competitive positioning, Synergies (Economies, Management, geography
Financial Value: LBO, lower cost of capital, debt tax shield, etc.
Major factors: Break-up opportunity, depressed valuations, growth and consolidation opportunities
Real business and real revenues
Can use products to add breadth to the existing product line

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Leverage each others products and business models to insulate against declining gross and operating
margins
Value creation in some way (end-to-end solution, best of breed, etc.)
Integration risk mitigated by management team cultures

Things to consider when evaluating a target

1. Valuation
2. Strategic fit with company
3. Regulatory (particularly with international deals)
4. Structure of transaction (how will we buy)
5. Market trends in the industry being considered
6. Management team
What are some common anti-takeoever tactics?
Two categories make difficult from a corporate government standpoint and from a stock price
standpoint
Staggered Boards takes longer to take over a Board (strategic)
Poison pills (written in the by-laws of the company can issue shares to a shareholder to dilute the
stake) defensive mechanism upon a takeover attempt that dilutes raiders position by issuing
discounted shares to existing shareholders
Change by-laws of corporation
Taking on a lot of debt
Find a White Knight
Golden Parachute lucrative severance packages for management team upon buyout so overly
expensive to force them out
Pacman turn around and try to take them over
What is minority interest?
Its the remaining claim on the assets and income of a controlled subsidiary by the minority
shareholders. I.e. its the flip side of the make a minority investment coin.
It is a liability and the original investment counts as a Financing Cash Flow.
The minoritys claims on earnings comes out of the Income Statement
What is a minority investment?
Catch-all account that sums up all ownership in subsidiaries
Portion of the share that flows through to Net Income
Portion of net Assets and Liabilities on the B/S
What is a P/E ratio and why do analysts use it?
P/E = Market Price / EPS
EPS is usually trailing, or for the last 12 months.
Can also be a forward P/E using the forecasted EPS for the year. this if preferable b/c youre
interested in valuing the firms future earnings potential
Analysts use this figure to look at how the market values a particular company with respect to the earnings
Analysts use it to perform a comparable company analysis
High P/E ratio (relative to peers) signifies that market has faith in management
Provides basis for comparison
Can also use a PEG rate or (P/E)/ growth rate. This adjusts for differences in growth rates amongst firms
When doing a comparative company analysis, which ratios would you use?
Enterprise Value/EBIT
Price/Equity
Price/Earnings

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If a companys stock price is depressed, how do you unlock it?
Stock repurchase
Increase dividends
Structural/Strategic changes
What is an LBO? Why leverage up a firm?
An LBO is buying a company using borrowed funds (retire the equity with debt). Lever up for the tax
benefits, and also, if you believe you can make improvements (increase value of firm later on) dont
have to share that value with equity-holders.
Leverage up a firm if think you earnings will be stable enough to generate an organizational financial
return that exceeds debt interest rates
Debt provides access to additional capital for growth
Debt can be a cheaper source of capital
Value of a tax shields
Company A values B at $400M, but B wants $430M. Company A could use stock to pay the
additional $30M. Under what circumstances might Company A agree to the additional $30M?
Strategic benefit (synergies)
Instead of stock, use debt to purchase company (get value of Debt Tax Shield, which increases value)
How do you calculate the firm value for the firm below?
Shares Outstanding = 100K, p = $20, Debt = $500K, Cash & cash equivalents = $500,000
Market Value of the equity + Market Value of Debt = 100K*20 + $500K = $2.5M
5 Slides for a presentation on an acquisition
1. Why IB Firm 2. Valuation comps 3. Synergies 4. Accretion 5. Industry trends & competitive
environment
5 sections of a pitch for an acquisition
1. Why IB Firm 2. Valuation 3. Synergies / Accretive (product overlap/strategic fit/trends) 4. Deal
structure (stock v. cash v. debt) 5. Risks regulatory issues
WSH combo list:
1. Why IB firm; 2. Industry trends & competitive environment; 3. Target Valuation; 4. Target Synergies / Accretive (product overlap/strategic fit/trends) 5. Deal structure (stock v. cash v. debt) /
Risks regulatory issues
What is this???
Look at analyst reports and historical financials
Comparable Companies
Comparable Transactions
Premiums Paid Analysis
Contribution Analysis
Pro Forma Merger Analysis (Overview,
Tell me about an M&A transaction.

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4. WACC / CAPM / BETA

WACC produces a good rough estimate for discounting cash flows from an investment. It also accounts for
the interest tax shield that results from the investment. However, it is limited in that it assumes a constant
D/E ratio over the life of the projections.
WACC = expected return of weighted portfolio of a companys securities weighted by the percentage of
equity and debt
WACC = cost of debt + cost of equity
[firm specific]
WACC = (E/D+E)(r) + (D/D+E)(1-T)(i)
where r = discount rate for leveraged equity (from CAPM) equity risk premium = 4.5%
and
i = average interest rate on long-term debt (or look at comparably rated firm)
CAPM: r = rf + BL(rm-rf)
where BL = Leveraged Beta for that firm
Levering the Beta: :

BL = BU(1 + (1-T)(D/E))

Levered Beta with projected capital structure (D/E ratio) can be found in research reports and internal
research
Unlevering a companys Beta means calculating the Beta under the assumption that the company is entirely
equity and has no debt. The levered Beta is higher than the unlevered Beta in that it accounts for increased
chance of bankruptcy and distress. NOTE that w/ a comparable company Beta, when you unlever it,
use the D/E ratio of the comparable company not the target companies D/E ratio!
What would you use a companys WACC for?
Discount the cash flows to arrive at a valuation
Qualitative Definition: Expected return on a portfolio of all the securities the company holds
What is beta? Where would you go to find a companys beta? How and why would you unlever a
beta?
Beta is a measure of how changes in the firms stock price deviate from changes in the market. Another
way of saying this is that Beta measures the firms sensitivity to macroeconomic events.
Market B=1. A Beta greater than 1 means the stock is expected to be more volatile than the market.
Can find Betas using Bloomberg, publications of firms that analyze market, conduct regression
analyses
Betas can be calculated using the CAPM model, when CAPM assumptions hold
Unlevered Betas allow comparisons of different organizations (perhaps within the same industry).
Betas that are pulled off Bloomberg are levered Betas, and since different companies have different
capital structures, unlevering the Betas to exclude the effect of debt financing allows for a more applesto-apples comparison. Companies can then be compared on an all-equity level, or can be relevered to
be compared on an overall risk basis.
WACC Problem:
When making a bid on a company, whose WACC do you use, yours or the targets?
You want to use your WACC or the WACC of the newly formed company their WACC is irrelevant
since they are going bye bye

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5. Discount Rates / Perpetuities
Perpetuity Problem:
If I gave you $1 a year for the rest of your life, how would you value it?
Assume 50 years of $1/year. However, treat the value as a perpetuity (b/c at a long enough period in
time the added years wont make an impact and this is easier to calculate), and therefore use the
formula: PV = $1/r. Also assume a high discount rate, because the $1 cannot be expected with high
certainty, given that you do not know the individual, etc. Therefore, use a high discount rate of 10%,
producing PV = $1/.1 = $10
If I gave you $1 for 10 years or $1000 today, which one will you choose? If I gave you $1 everyday for
life or $1,000, which would you choose?
$1,000 today because $1,000 > $10 (c/r = $1/10%)

Annuity formula (C/r)[1 1/(1+r)^n]

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6. Accounting
Income Statement:
Revenues and expenses over a period of time
Revenues
- COGS
Gross Profits
- SG&A
EBITDA
- Dep/Amortization
Operating Profit / EBIT
- Interest
- Asset Impairment
- Gain on sale of investment
- Restructuring charge
Pre-tax income
- Provision for Income Tax
Income from Cont Operations
- Discontinued Ops
- Extraordinary Gain
Reported Net Income

Cash Flow Statement:

Shows the sources and uses of cash
Beginning Cash Balance
Cash from Operations
NI + Dep + Changes in Deferred Taxes + net changes
in working capital

Cash from Investing Activities

Cash from Financing Activities
Ending Cash Balance

Balance Sheet:
Snapshot of the firms resources and claims on
the resources
Assets:
Current (incl deferred taxes)
Long-Term
Total Assets
Liabilities:
Current
Long-Term
Total Liabilities
Equity:
R/E
Common Stock
Total Equity

Free Cash Flows:

EBIT (1-T)
- CapEx
+ Depreciation
+/- Changes in Deferred Taxes
+/- Changes in Working Capital
Free Cash Flows

What is EBITDA?
Earnings before Interest Taxes Depreciation and Amortization used in comparable analysis as an
enterprise value multiple (i.e. reflects both equity and debt values)
What are deferred taxes and how do they arise?
Different books for IRS and for financial reporting.
Two types: 1) If Taxes paid on financial reports are > Taxes paid for IRS, a Deferred Tax Liability
2) If Taxes paid on financial reports are < Taxes paid for IRS, a Deferred Tax Asset
Understand PP&E
What is working capital?
Capital used to fund cash conversion cycle of the business from when products are produced to when
they are sold. Component of the capital needs of the company
Net Working Capital = (Current Assets - Cash) - (Current liabilities - Short-term debt)
Subtract cash b/c assume youll use it to pay down debt or mgmt will walk away with it
Subtract short term debt b/c you will need to buy it as part of the transaction price
Depreciation problem:

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If depreciation increases by $10, how does that affect the financial statements? Assume 40% tax rate
I/S: Add $10 to depreciation which lowers pre-tax earnings by $10 and thus tax expense lowers by $4
NI will be lower by $6
B/S: NI from IS lowers Retained Earnings by $6. Taxes payable decreases by $4. Accumulated
Depreciation increases by $10, which reduces Net PP&E by $10 - balancing out the equation A=L+E
CFS: NI from IS starts lower by $6 - Add back $10 for depreciation (now up by $4); Adjust for $4
decrease in Taxes Payable so no change in CF Depreciation has no real impact
Greek Lady problem:
Sells a sandwich to you for $5 that cost her $4 to produce. Walk me through the effect on the
financial statements. Assume tax rate of 40%
I/S: $5 to Revenues and $4 to COGS leaves $0.60 after tax profit (ignoring fixed costs).
CFS: Add $0.60 after tax Net Income from IS to start Cash from Operations; Add the increase in Taxes
Payable of $0.40 Add the decrease in inventories of $4 (up by $4.60); - up by $5
B/S: Increase Cash by $5, remove $4 from Inventory (up $1). Increase Retained Earnings by $0.60
after tax; and increase taxes payable by $0.40 Balanced.
Building Purchase problem:
Your company buys a building for $100K, borrowing 60% and paying the remainder in cash. Walk
me through the effect on the financial statements.
B/S: Add $100K to PP&E; take out $40K from Cash; Add $60K to L-T Liabilities - Balanced
CFS: Add $60K to Cash from Financing Activities; subtract $100K from Investing Activities, leaving a
net cash decrease of $40K - which is subtracted from ending balance on BS
I/S: As time goes on depreciation, interest expense and tax considerations will be impacted.
LIFO/FIFO problem:
What are the effects of using the two different accounting policies?
LIFO, assuming rising costs/inflation, incorporates higher costs lower margins lower net income
This results in lower income taxes paid.
FIFO, assuming rising costs/inflation, results in higher assets, but higher income taxes
Accounting Techniques:
What can a company do to inflate earnings?
Change depreciation accounting policy ex) airlines stating that airplanes have longer lives
Compensate employees with options instead of cash
Recognize revenue more aggressively
Switch from LIFO to FIFO in a rising price environment, or go for a LIFO liquidation
What could a company do with excess cash on the balance sheet?
Pay a dividend
Consider a stock repurchase boost EPS, signal managements positive expectations
Pay down debt
Make investments in various investment vehicles
Use as part of a payment in an acquisition
Additional investment in the organization (R&D)?
Walk me through the major items on a Cash Flow Statement
Cash Flow from Operations
Start w/ NI add Depreciation; adjust for changes [add or (subtract)] in BS accounts: (increase in
inventory), decrease in accounts receivable
Cash Flow from Investing
Cash Flow from Financing

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7. Debt / Equity Markets
What is LIBOR?
London Inter Bank Offer Rate usually just a bit over Fed Funds Rate (UK version), now around
1.33%
Often quoted on lending vehicles.e.g. for Investment grade loans your rate is below LIBOR + 1.5%
Why would a company issue preferred over common stock?
Preferred Stock if effectively and hybrid between CS and a Bond. It provides additional security to
equity investors (Preferred has fixed div payment like a bond) and gets preferential status over CS in
a bankruptcy situations
Note that preferred dividends CAN BE CHANGED
Viewed as being cheaper than equity as it has many more advantages
Can be set up to be viewed as equity for credit rating agencies; and debt for tax authorities
Why might a company issue debt over equity?
Interest/Debt tax shield
Low interest rates, depressed stock price
Debt is cheaper than equity (Rd < Re)
May feel current stock price is undervalued
Firm has stable cash flows and can handle the fixed cash expenditures required
Wants to keep all the upside of the investment (i.e. what you use the funds for) for itself and not dilute
ownership
Wants to change its capital structure in some way (maybe to meet some bank covenantsalthough
usually if would not issue debt for this reason)
However, some companies cannot float bonds b/c leverage ratio is too high / debt too costly
If you have two high-yield bonds with identical coupons and maturities, one from a supermarket and
one from a high tech company. Which one would you buy and why?
Buy the Supermarket b/c less default risk
Why payout dividends
Stable companies pay out dividends, whereas, growth companies re-invest earnings
No projects to pursue then return money to the shareholders
What major factors affect the yield on a corporate bond?
Yield determined by price (inverse) price is influenced by Inflation (key); interest rates; risk (Rd
assessed by the credit agencies)
Yield to Maturity different that Yield. This is the IRR on the cash flows of the bond. Must be
computed by trial and error.
What does the yield curve look like?
Yield curve is a visual representation of the term structure of interest rates
Upward sloping three theories on what the shape tells us:
1) expectations theory are for increasing interest rates in the future (most bought into)
2) liquidity preference theory - investors like liquidity so st bonds can have a lower yield
3) market segmentation diff types of investors like diff ranges of bonds so they trade separately
Approximately: Curve is flat for next 6months. 3mo: 1.2%; 10yr: 3.9%; 30yr: 4.9%
What does the current shape of the yield curve imply about the markets expectation for economic
growth?
Interest rates will rise to cool the expanding economy (and as more company demand funds to
grow) which is done when it is expanding.so expectations are for growth to be robust

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Draw the forward rate curve over the treasury curve and explain which apex occurs first since the
Treasury curve is now inverted?
Bite me
What is the calculation for EPS? Does that include preferred stock? Does preferred stock trade at a
discount or premium to common stock and why? Convertibles?
EPS is the portion of a companys profit allocated to each outstanding share of common stock
Calculated after paying taxes and after paying preferred stock and bondholders, so it traditionally
include preferred stock
Fully diluted EPS includes stock options, warrants, and convertible securities, but basic EPS does
not count these securities
Convertible bonds trade at a premium because investors see value in the convertible nature of the
investment. Also, transaction costs are frequently less than buying stock, and the duration before a
bond can be converted apply upward pressure on the convertible bond
Why is inflation important?
Affects future purchasing power of money and affects real interests rates
Creates uncertainty about the future in terms of buying power
What is the CAPM?
Model of the relationship between expected return and expected risk in financial markets
Based on the assumption that investors demand higher returns for investments that are riskier
States that the expected return of an investment/security is equal to the risk-free rate plus a risk
premium (Beta * market premium)

ra = rf + a( rm rf )
Where:
rf = Risk free rate
a = Beta of the security
rm= Expected market return

The time value of money is represented by the risk-free (rf) rate in the formula and compensates
the investors for placing money in any investment over a period of time. The other half of the
formula represents risk and calculates the amount of compensation the investor needs for taking on
additional risk.

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8. Stock Market / Personal Finance
Tell me about a stock that you have invested in. Whats it trading at? Why have you invested in it?
Where are the markets going?
Up two components to market moves: Fundamental and Psychological
Fundamental: Strong major indicators are positive (Gregor?)
Psychological markets are often irrational and based on investor concerns. Uncertainty is bad for
stock market, and unfortunately weve got a lot of it right now. But if you look at each youll see that
each overstated:
Geopolitical - uncertainty over war with IRAQ. When faced w/ war, investors have a history of
pricing the worst case scenario into the market. Once the event is realized, uncertainty is lifted and
the true impact (in this case minimalbeyond some speculation on oil) can be accounted for. In
reality, this conflict will be short and decisive (before end of Q2).
Data Jeff Applegate Excess Equity Returns (Stock perf Risk free Bond perf) In the prior
Gulf War stock market was down 13% in the yr prior to conflict; rose 34% during the conflict
and rose 11% after the conflict. This is consistent with many prior wars (WWI: 3%; 3%; 25%;
WWII: -12%; 19%; 8% ).
The one bad part of the war is businesses are also being conservative and not spending on
investments prior to resolution.
Geopolitical uncertainty over N. Korea. This is squeaky wheel gets the Economic Aid. History
of pressing the stance and being rewarded, and thats whats happening now.
Corporate confidence Big issue last year, but scandals have died down. Firms/individuals are
being punished (e.g. WS fines; Enron execs going to jail); and structural changes are happening
(e.g. more research independence).
Additional data: 4 straight years of negative excess equity returns has only happened once in US
market (is this really worse than the great depression).
Look for recovery in late Q2 (just in time for interns) What are your thoughts on the taxing of dividends issue?
Great
Abstract: why tax income twice not fair
Practical:
To date companies have consciously not issued dividends b/c of double taxation this will give
them more options in how to use earnings and redistribute value to shareholders
Strong implications for capital gains as well earnings that are retained by the firm will be exempt
from future taxes and create a tax basis for investors, such that when shares are sold, these
amounts will be excluded from Capital Gains tax.
Could also have negative implications for firms that issue of options: if companies switch to
paying dividends instead of stock repurchase (what they often do now with extra cash to avoid
double tax issue) then as options vest ownership will be diluted (more shares on the market) - so
employees will demand more options (b/c they are worth less), which is more expensive (even less
money for share repurchase) and further dilutes ownership.
How do you know if a firm would be a credit risk?
International / political risks
Industry risk (e.g. increased competition)
Company specific risks (e.g. mgmt)
Ratio analysis examine the following vs industry norms
Short Term
Current ratio Current Assets / Current Liab
Quick ratio (cash + marketable sec + accts rec) / CA

THE FOLLOWING IS MEANT AS A GUIDE FOR INTERVIEWING, NOT FOR

ACADEMIC PURPOSES
Inv Turnover; AR Turnover; AP Turnover
Long-term
Debt/Equity
Interest Coverage (most important) EBITDA / Interest Expense
How to get from NI to CF
To Free Cash Flow or on Cash Flow Statement