Investment banking interviews should be attended with a decent level of preparation as interviewers wish to evaluate how fit you are for this premier field of banking and finance. Finance interviews cannot be taken lightly.
Freshers and professionals both must have a certain degree of understanding about mergers & acquisitions, accounting standards, investments, valuation, and banking. The fundamentals of investment banking and finance, in general, must be clear, including financial techniques and formulas.
A master’s program such as upGrad’s Master of Business Administration (MBA) with Liverpool Business School can prove to be highly beneficial when preparing for careers in Investment Banking.
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17 Important Investment Banking Interview Questions & Answers
Here are some recurring questions and their answers that will help you during the interviews with Investment Banking firms or if you are looking to upgrade to better positions in this premium finance segment.
1. What do you understand by ‘Change in Working Capital’?
Change in Working Capital refers to situations where companies need to spend in advance to generate growth or generate more income as a direct result of growth. For instance, for retail businesses, Change in Working Capital is not a positive outcome as they need to spend more money on purchasing products before generating sales.
However, it is beneficial for companies that offer subscription-based products that charge money in advance. This directly results in Deferred Revenue. For both cases, however, Change in Working Capital affects the valuation of the company by increasing or decreasing the Free Cash Flow.
2. What can you tell us about Equity Value and Enterprise Value?
Equity value is the total valuation of all the assets that a company possesses. However, this is only restricted to the common shareholders or equity investors. Enterprise Value can be defined as the valuation of a company’s core business but is the same for every kind of investor. This is a very common Investment Banking interview question.
3. How much are you prepared to spend for a series of future cash flows that will rake in $550 in perpetuity? The cost of the capital is 10%.
$5,500, this is due to Value = Cash Flow / Weighted average cost of capital.
So we get the total value amount of ($550/10%=$550×10=) $5,500. These kinds of investment banking questions can be answered easily by immediately calculating the value using the formula.
4. How can you find out the valuation of a company?
Investment banking follows three main methods for evaluating the total value of a company. There is the Multiples method that multiplies the earnings of companies with their respective industry P/E ratios.
The second approach is the Transactions approach that relies on comparing the company with similar companies recently acquired or sold. The final method is the Discounted Cash Flow method that relies on discounting the value of future cash flows recurringly till the present.
5. How would financial statements be affected if depreciation increases by $200 and tax rates are 40%?
In the cash flow statements, net incomes would go down by $120, but the $200 depreciation would be added back due to being expenses that are non-cash in nature. So, overall operations cash flow would increase by $80. The overall net changes in cash would also increase by $80.
In the income statement, operating income would decrease by $200 and with the 40% tax rate, the net income would decrease by $120. Meanwhile, in the balance sheet, depreciation would go down by $200, and cash would increase by $80 from the changes in statements for cash flows.
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6. How do the Enterprise value and Equity value change when a company issues $50,000 through new shares and uses $25,000 from the proceeds for issuing shareholders with dividends?
The Enterprise value remains the same throughout as cash is not a core business asset. Increase or decrease in cash and Equity value work together to offset one another according to the Enterprise value formula. The Equity value, however, increases by $50,000 initially due to the total assets increasing by $50,000. This change is incurred by the common shareholders. Following this, the Equity value again decreases by $25,000 as cash falls by $25,000 and thus affects the total assets in the same way.
7. Which one out of debt or equity is cheaper, and why?
Debt is cheaper as it is paid before equity and may have security behind it. Debt also ranks much ahead on liquidation.
8. Explain what is meant by the Weighted Average Cost of Capital.
Weighted Average Cost of Capital can be defined as the expected annualised return over a long duration if every part of a company’s capital distribution is invested proportionally. For example, equity preferred stock, debt and all the others.
For companies, the Weighted Average Cost of Capital projects the total cost of funding all the operations through utilising every source of capital, thus allowing the capital structure to retain the same percentage of growth over a longer duration.
Weighted Average Cost of Capital is majorly dependent on the cost of equity, cost of debt and cost of preferred stock. The cost of preferred stock and debt is based upon the Yield to Maturity or the median rates.
The Weighted Average Cost of Capital is calculated using the proportion of debt:total capital multiplied by the debt rate and times 1- the effective tax rate added with the proportion of equity:capital multiplied by the required return on equity.
9. In a 100% Stock deal, a buyer has 10 shares at a share price of $50 with the net income being $10. It is acquired for a Purchase equity value of $300. How accretive can this deal be if the same tax rates apply for both parties?
The EPS of the buyer is $1 ($10/10) and must issue ($300/50=) 6 shares additionally for the deal to be made. So the combined share count would become 16. Since both the parties experience the same tax rates without debt or cash being used, the combined net income would be $20 ($10+$10), and the combined EPS would be $20 divided by 16 shares or $1.25. Thus, the deal is 25% accretive.
10. What is the process behind a Mergers & Acquisitions deal?
First, potential acquisition targets are researched, and multiple companies are selected and filtered in the process. Then, based on research results and feedback, the list is narrowed down, and the ones with the highest potential are approached. Multiple meetings are then conducted to understand how receptive the potential sellers are.
The offer price is figured out and then negotiated alongside speaking about the key terms of this agreement. The deal or transaction is announced, and the purchase is seen through.
11. Without calculating arithmetically, what ranges are expected Combined EV or EBITDA and P/E multiple?
The range would be between the multiples of buyers and sellers purchases. This amount is majorly never a simple average as the relative sizes of the buyer, and seller alongside the P/E multiples have an effect.
12. What are the three financial statements?
The three financial statements required in investment banking are the balance sheet, income statement and cash flow statement. The balance can be defined as the snapshot of a company’s assets versus its Net Worth and liabilities.
The liabilities and assets are listed in the liquidity order and are separated between the current and non-current. Income statements cover a quarter or a year or other periods of time to illustrate a company’s profitability through accounting methods. The income statement starts with revenue lines and after deduction of expenses comes up with the net income.
Cash flow statements are made of cash from the operations, cash from financing and cash used for investments. This statement can be calculated through the reconciliation approach and undoes every accounting principle to show the true cash flow of the company.
13. Companies A and B are similar but A has debt while B does not have any debt. Which of these two companies would own a higher Weighted Average Cost of Capital?
B would have a higher Weighted Average Cost of Capital due to the debt being cheaper than equity.
14. In what kind of situations is DCF not used for valuation?
DCF is not used in situations where the value of the company has unpredictable cash flows or is unpredictable. This is especially true when working capital or debt serves different roles in the company. For instance, banks generally never invest in debt, while working capital holds major importance in the balance sheets. So, DCF is not used for institutes or firms such as banks.
15. What is the PEG ratio?
PEG ratio stands for the Price/Earning:growth ratio that includes the P/E ratio and also accounts for the growth rate of a company’s EPS. Rapidly growing stocks have higher PEG ratios while stocks that are priced conservatively have the same P/E and PEG ratios. If a company boasts of the same P/E and PEG ratio, one can argue that stocks are too expensive as compared to companies with the same EPS but a lower P/E ratio.
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16. What are the different types of synergies?
The different types of synergies are revenue synergy and cost synergy. Revenue synergy allows more room to grow geographically while cost synergy represents a situation where companies need to close down stores, offices and branches.
17. What are the benefits of a company getting listed on an exchange?
The main benefit for the company is being able to pursue liquidity and there are investors who wish to only invest in exchange-listed issuers. Getting listed also helps companies establish recognised values for their stocks. This also helps in using stocks for acquisitions instead of cash.
The key to successfully acing your investment banking interview questions is by practising questions from banking, valuation and acquisitions extensively. One can also check out expansive courses such as upGrad’s MBA in Digital Finance and Banking program. Professional courses deliver 360-degree career guidance and expert training to students to help them get job-ready.
We hope this article gives you clarity on investment banking interview questions!
What does an investment banker do?
An investment banker acts as a broker or an intermediary between investors and corporations raising funds. This includes corporations issuing securities for a privately placed offer as well as corporations raising funds from public i.e. Initial Public Offering (IPO). A buy side investment banker will help the investor to identify opportunities and evaluate the investment opportunity.
A sell side investment advisor helps the corporation to raise funds by identifying potential investors to invest in the company at a reasonable valuation for the corporation.
Does investment banking pay well vis-à-vis the working hours demanded in the job?
Investment banking is one of the very few careers rewarding fresher college candidates with a six-digit figure compensation opportunities. The stakes of people involved in the transaction are huge and hence, it is highly demanding as well as one of the most rewarding careers. The demand for investment bankers has risen considerably lately because of the high number of mergers and acquisition transactions and increase in private equity activity in India.
How important are financial ratios in an investment banking interview?
Investment banking is all about helping the investor and the corporation to help with their financial needs. It is of utmost importance for the banker to draw financial conclusions to facilitate the transaction with ease. Here are some of the most important financial concepts to be known by every interview candidate for an investment banking profile. Terms related to the financial statements like working capital, depreciation, enterprise value, financial ratios like liquidity ratio, solvency ratio, valuation ratio and profitability ratios, methods of valuations like DCF, FCFF etc, cost of capital, capital budgeting, recent M&A transactions and most recent funded startups, accounting post M&A transaction etc.