Top Investment Banking Interview Questions
The Holy Grail of Behavioral Interviews: Why Investment Banking?
The question that sets the tone of the entire interview. Recruiters are not interested in what learning opportunities brought you to the firm. They want to know your field experience and how that fits into the role. If you are from a technical background with minimal exposure to the industry, or maybe with a couple of internship experiences, talk about how well you have done in the practical fields in academia or internship. How the faculties, or friends in the business started you into following Mergers and Acquisitions, news about upcoming startups and important deals.
Combine any experience from your background to the banking world that will enable you to become an investor one day. Modify the answer based on your experience, but always remember the basics: exposure to finance and background experience speaks for your long-term goals.
Drilling Down into Technical Questions: What Are Recruiters looking for?
1. What are the three financial statements?
The most common question to come up in a technical interview. There are three important financial statements.
i. Income statement: It shows the revenue and expenses of an organization and the net income made during a financial period.
ii. Balance Sheet: It documents the assets and liabilities of a company at a point in time. Assets are any resources starting from the office furniture, machinery, equipment, liquid cash, etc. whereas liabilities are comprised of accounts payable and debt and then shareholder's equity. The assets should always be of equal value to liabilities and equity in the balance sheet.
iii. Cash Flow Statement: Reports the net change in cash during a financial period. It gives the cash flow from the operating, investing and financing activities of the company.
2. How do you value a company?
There are two primary methods of computing valuation of a company: relative valuation and intrinsic value.
In this method, the valuation is derived from a comparable peer group. Decidedly there are no two companies that are completely identical, but you should try to find our companies that have a similar growth pattern, risk involved, capital return and operational structures. Appropriate industry multiples such as EV/Rev, P/E, EV/EBITDA should be calculated, a median applied on these multiples should give you the data.
It’s always a good idea to do a couple of industry research to tackle any follow-up question on which industries you are interested in, and the common valuation multiples related to that before going into an interview.
According to DCF method, the present cash flow value should be equal to the value of a productive asset. The enterprise value is determined by discounting the terminal and free cash flow values by the cost of capital. Once you deduct the net debt from enterprise value, what remains is the equity value, dividing this by the outstanding diluted shared gives the equity value per share.
3. What factors drive mergers and acquisitions?
i. The merger will acquire new projects or techs
ii. Cornering a larger percentage of market share by acquiring a rival company
iii. Saving cost by creating synergies
iv. Financial numbers and metric improvement
v. Acquiring new distributors or suppliers to strengthen the pricing capabilities of supply chain
4. Is cost of equity higher than cost of debt?
Yes. Cost of debt is covered by a tax shield as a deductible expense and hence is always lower than that of cost of equity which does not have any deductible component for tax evaluation. Also, equity investors do not have any fixed payout and in the event of a liquidation, prioritized at the lowest.
5. How would you calculate beta for a company?
Beta is the indicator of systemic risk associated with an asset. A company with 1.0 beta is comparable in terms of risk with the stock market, and hence can rise and fall at the same rate. Standard errors of estimation are known to cause a potentially large range in error calculating betas which are prevalent when projected or historical data is used to calculate raw beta. So, the recommended method is the industry beta.
For comparable companies, betas can become distorted due to variations in the leverage rate. So, for these companies, calculating beta should be done in two steps. First, the beta should be unlevered using the following formula:
Unlevered β = β ( Levered ) / [1 + ( Debt / Equity ) ( 1 – T ) ]
then with the value of the unlevered average beta, the capital structure of the main company should be calculated by re-levering using the following formula:
Levered β = β ( Unlevered ) x [ 1 + ( Debt / Equity ) ( 1 – T ) ]
6. How can the valuation of a company with a history of negative cash flow be calculated?
Since multiple analysis does not work in the event of negative cash flow, the DCF or Intrinsic Value approach is the right method to calculate a valuation for such companies.