Phase 1 Questions Flashcards
(121 cards)
1
Q
What are the three main financial statements?
A
Income Statement, Balance Sheet, Cash Flow Statement.
2
Q
How are the three financial statements linked?
A
Net income flows into retained earnings and operating cash flow; changes in working capital, capex, and financing flow through cash.
3
Q
What is working capital?
A
Current assets minus current liabilities; a measure of short-term liquidity.
4
Q
How does depreciation impact all three statements?
A
Reduces net income (IS), increases accumulated depreciation (BS), added back in operating cash flow (CF).
5
Q
What’s the formula for enterprise value?
A
EV = Equity Value + Debt + Minority Interest + Preferred Equity – Cash.
6
Q
Walk me through a DCF.
A
Project FCFs, calculate terminal value, discount both to present using WACC, sum for enterprise value.
7
Q
What are common DCF terminal value methods?
A
Gordon Growth (Perpetuity) and Exit Multiple methods.
8
Q
What is WACC and why is it used?
A
Weighted Average Cost of Capital; discount rate reflecting opportunity cost of capital for all investors.
9
Q
Name 3 key valuation multiples.
A
EV/EBITDA, EV/Revenue, P/E.
10
Q
What is precedent transaction analysis?
A
Compares valuation multiples from recent similar M&A deals.
11
Q
What is comparable company analysis (Comps)?
A
Values a company using multiples of similar public peers.
12
Q
What is sensitivity analysis?
A
Adjusts key assumptions (e.g., revenue growth, margins) to see effect on valuation or output.
13
Q
What is a scenario analysis?
A
Evaluates outcomes across base, upside, and downside cases.
14
Q
How do you calculate FCF?
A
FCF = EBIT (1–Tax) + D&A – CapEx – Change in NWC.
15
Q
What is the purpose of an LBO model?
A
To assess returns from buying a company using significant debt.
16
Q
What are the key drivers of IRR in an LBO?
A
Entry/exit multiples, EBITDA growth, debt paydown.
17
Q
What’s a good target IRR in PE?
A
Typically 20%+ depending on risk.
18
Q
What is the debt service coverage ratio?
A
EBITDA ÷ (Interest + Principal Payments); shows ability to cover debt.
19
Q
How does equity value differ from enterprise value?
A
Equity value is value to shareholders; EV includes debt and cash neutrality.
20
Q
What is circular referencing in Excel models?
A
When a formula indirectly refers to its own result; often seen in interest or revolver calculations.
21
Q
How do you resolve circular references in Excel?
A
Use iteration settings, or calculate interest with prior-period values.
22
Q
What are common Excel shortcuts for modeling?
A
Ctrl + Arrows (navigation), Alt + E S V (paste values), F4 (anchor cell), Ctrl + 1 (format).
23
Q
What is model audit best practice?
A
Color coding inputs/outputs, avoiding hardcoding, separating assumptions, using clear labeling.
24
Q
What is the purpose of a balance check?
A
Ensures assets = liabilities + equity in every period.
25
What is a toggle or flag in modeling?
Binary input (0/1) used to activate/deactivate assumptions (e.g., capex stops in final year).
26
Why do we separate operating and financing sections in the CF statement?
To distinguish core operations from capital structure impacts.
27
What is a revolver in an LBO model?
A line of credit that fills short-term cash shortfalls.
28
What is PIK interest and how is it modeled?
Payment-in-kind; interest accrues as debt rather than cash payment, added to principal.
29
What’s the difference between EV/EBITDA and P/E?
EV/EBITDA includes debt and applies to all capital providers; P/E is equity-specific.
30
What is a sanity check in valuation?
Cross-verifying outputs with alternative methods or ranges (e.g., implied multiples).
31
What is a bridge from net income to cash flow from operations?
Adjust NI for non-cash items and working capital changes.
32
What makes a model “scalable”?
Easy to update, reuse, or adjust for new deals or inputs with minimal changes.
33
How do you explain model assumptions to a senior analyst? (3)
Clearly state logic, source of data, and implications on outputs.
34
What are the biggest red flags in a bad model? (4)
Broken links, hardcoded outputs, unbalanced BS, no documentation.
35
How do you make a model efficient and readable?
Consistent formatting, labels, clear separation of inputs/outputs, no excessive formulas per cell.
36
How do changes in working capital impact cash flow?
An increase in working capital is a use of cash; a decrease is a source of cash.
37
What is the mid-year convention in DCF analysis?
It assumes cash flows are received evenly throughout the year, so it discounts them by half a year less.
38
Why might you use unlevered FCF in a DCF?
To evaluate the business independent of capital structure; it's useful for enterprise value.
39
What is the impact of operating leases on EV?
Operating leases are capitalized and added to debt when calculating EV.
Because operating leases (like long-term office or equipment rentals) are fixed, recurring obligations, just like debt. They represent future payments the company must make, so investors treat them as a form of debt-like liability when valuing the business
40
How is equity value derived from enterprise value?
Equity Value = EV – Net Debt – Preferred Equity – Minority Interest + Cash.
41
What is a deferred tax liability?
A future tax payment due to temporary differences between accounting and tax treatment.
42
How do you model interest expense in an LBO?
Base it on the average debt balance each year, adjusting for amortization or revolver draw.
43
What are common sources of debt in an LBO?
Bank debt (revolver, term loan), mezzanine debt, high-yield bonds.
44
Why is EBITDA often used in valuation?
It approximates cash flow from operations and excludes capital structure and non-cash items.
45
What’s a platform vs. add-on acquisition?
Platform is the initial entry; add-ons are subsequent, smaller acquisitions to build scale.
46
How do you calculate net debt?
Net Debt = Total Debt – Cash and Cash Equivalents.
47
Why use EV/EBITDA instead of P/E?
EV/EBITDA is capital structure-neutral and reflects the whole firm’s performance.
48
What are the limitations of using comps?
Market inefficiencies, different accounting policies, and lack of truly comparable companies.
49
What is a stub period?
A short financial period used when aligning acquisition or model timelines.
Example: If a company is acquired on May 10, but your model uses calendar years, you need to model a stub from May 10 to Dec 31.
50
What’s the formula for IRR?
IRR is the discount rate that makes NPV = 0 for a series of cash flows.
51
How does an earn-out affect valuation?
It adds a contingent liability that may impact future consideration paid.
52
What are driver-based assumptions?
Model inputs tied to key metrics like volume, price, and margin, increasing transparency.
53
How do you audit a model for errors?
Check for balance, trace precedent cells, stress test with assumptions, and use Excel auditing tools.
54
What’s the difference between book value and market value of equity?
Book value is based on accounting; market value reflects current stock price x shares.
55
How do you normalize earnings?
Adjust for non-recurring items, seasonality, or extraordinary expenses.
56
What is a waterfall return structure?
Shows how investment proceeds are distributed among investors and sponsors based on hurdles.
57
What is mezzanine debt?
Subordinated debt with equity-like features; higher risk and return than senior debt.
58
What’s the difference between IRR and MOIC?
IRR measures rate of return over time; MOIC (multiple of invested capital) measures total return.
59
Why would you run a sensitivity on exit multiple?
Exit multiple heavily affects value in both DCF and LBO; assumptions vary widely.
60
What is the impact of NOLs on valuation?
NOLs (net operating losses) reduce taxable income, increasing FCF and valuation.
61
How does purchase price allocation work?
Assigns acquisition price to assets/liabilities and creates goodwill for the excess.
62
How do you model goodwill in an acquisition?
Set goodwill as the difference between purchase price and fair value of net assets acquired.
63
What are integration costs in M&A?
Non-recurring expenses incurred to combine operations post-acquisition.
64
What is accretion/dilution analysis?
Measures the impact of a deal on acquirer’s EPS – accretive if EPS goes up, dilutive if down.
65
How do taxes impact LBO modeling?
Tax shields from interest expense lower effective taxes, boosting cash flow.
66
What is a management rollover?
When management reinvests equity into a new deal; common in PE-backed deals.
67
What’s the purpose of a returns bridge?
Breaks IRR or MOIC into components like EBITDA growth, debt paydown, and multiple expansion.
68
What is a “cash-free, debt-free” transaction?
In a “cash-free, debt-free” transaction, the buyer does not acquire the seller’s cash or debt. The purchase price reflects the core enterprise value of the business, not its equity value. Any existing debt is paid off, and excess cash is typically distributed to the seller before close.
69
What are common pitfalls in a DCF?
Over-optimistic projections, wrong WACC, incorrect terminal value calculation.
70
Why are precedent transactions often higher than comps?
They include a control premium for acquiring the company outright.
71
How do you derive a company’s implied share price from a DCF?
Take the DCF-derived enterprise value, subtract net debt, and divide by diluted shares outstanding.
72
What is the impact of capitalizing vs. expensing on EBITDA and FCF?
Capitalizing increases EBITDA but reduces FCF via CapEx; expensing reduces EBITDA but doesn't impact CapEx.
73
What is a dividend recapitalization?
A PE firm takes on new debt to pay itself a dividend, reducing equity value but not operations.
74
What is the impact of changing leverage on WACC?
Increasing leverage reduces WACC up to a point, then increases due to higher equity and debt risk.
75
What are common DCF red flags in investor presentations?
Terminal value > 75% of EV, unreasonable growth/margin assumptions, inconsistent capex vs. revenue growth.
76
What is the treasury stock method?
Estimates the number of diluted shares from options by assuming proceeds are used to buy back shares.
77
Why is EV/EBITDA preferred over EV/EBIT in capital-intensive industries?
EBITDA excludes depreciation, which can distort comparisons if capex policies vary.
78
How would you model a step acquisition?
Revalue previously held equity at fair value and recognize a gain/loss before combining entities.
79
What is a deferred tax asset?
Future tax reduction due to temporary differences or net operating losses.
80
How does purchase accounting impact goodwill and depreciation?
Assets are revalued, increasing depreciation/amortization; goodwill is created for excess purchase price.
81
What’s the impact of negative working capital?
The business collects cash before paying liabilities; a cash flow benefit in growing businesses.
82
Why use a minimum cash balance in models?
To reflect operational cash needs; prevents models from showing unrealistic cash distributions.
83
How do you handle circular logic in revolver modeling?
Use iterative calculation or set up a debt sweep after calculating cash flow.
84
What’s the impact of capital structure on equity value but not EV?
Changes in debt or equity affect equity value but EV remains neutral unless operations change.
85
What is the role of maintenance vs. growth capex in valuation?
Only growth capex is needed to support expansion; maintenance is part of sustaining operations.
86
Why do PE firms use management fees and carried interest?
Fees cover fund operations; carry incentivizes GPs based on performance.
87
How is equity value affected by off-balance sheet liabilities?
It should be adjusted downward if such liabilities (e.g., operating leases, pensions) are material.
88
What is the significance of a quality of earnings (QoE) report?
It normalizes and verifies earnings, removing non-recurring items and accounting distortions.
89
What is the IRR rule of 72?
Estimates time to double money at a given IRR: 72 ÷ IRR = years to double.
90
What are holdback provisions in M&A?
Purchase price held in escrow to cover potential post-close claims.
91
What is a clawback in private equity?
Ensures LPs don’t overpay carry to GPs if future losses occur.
92
Why might an LBO model assume asset sales?
To simulate value realization or debt paydown strategies post-acquisition.
93
What is a dividend recap’s effect on IRR and MOIC?
It boosts IRR by accelerating cash return, but MOIC remains unchanged.
94
How would you model a PPA write-up in Excel?
Increase asset values, create deferred tax liability, and calculate amortization impact.
95
What is a “roll-up” strategy?
Acquiring smaller companies in a fragmented industry to build scale and synergies.
96
What is an internal rate of return hurdle?
The minimum IRR a GP must achieve before receiving carried interest.
97
What is a debt sweep?
Allocates excess cash to repay debt automatically in models.
98
How does leverage affect equity sensitivity in an LBO?
Higher leverage increases equity return volatility for small changes in performance.
99
Why might you unlever beta and then relever it?
To remove capital structure effects for comparison and then apply target leverage for valuation.
100
What is a control premium?
A control premium is the amount a buyer pays above a company’s current market price to gain a controlling interest. It reflects the value of having decision-making power and operational control. This premium compensates shareholders for giving up that control.
101
What is the downside of high exit multiple reliance in LBOs?
Returns become more sensitive to market timing than operational improvement.
102
What is a contingent consideration?
Future payment dependent on performance milestones, commonly used in M&A.
103
What are the key risks in LBOs beyond financial leverage? (4)
Execution risk: The company fails to hit growth targets because the new management strategy wasn’t implemented effectively.
Industry cyclicality: A consumer goods company sees earnings drop sharply during a recession due to lower spending.
Interest rate sensitivity: Rising rates increase debt service costs, cutting into cash flow and reducing returns.
Integration issues: A PE firm acquires two logistics companies, but merging systems and cultures causes delays and cost overruns.
104
What is a bridge to sources and uses in a transaction model?
Outlines how the deal is funded and where funds are allocated.
105
What is a stub equity value and when is it used?
Equity remaining post-partial sale or recap; used in complex transactions or dual-track exits.
106
What is a revolver and how is it used in an LBO?
A revolving credit facility acts like a corporate credit card, used to cover short-term cash shortfalls and paid down as cash becomes available.
107
What is Term Loan A and how does it differ from Term Loan B?
Term Loan A typically has shorter maturity (5-7 years), amortizes evenly, and is held by banks; Term Loan B has longer maturity, minimal amortization, and is held by institutional investors.
108
Why is Term Loan B popular in LBOs?
Because of its low amortization and flexibility, it preserves cash flow for other uses like reinvestment or dividends.
109
What is mezzanine debt?
A hybrid of debt and equity, mezzanine debt sits between senior debt and equity in the capital structure and often includes warrants or PIK interest.
110
How does mezzanine debt impact returns in an LBO?
It increases leverage and potential equity returns but comes with higher interest costs and risk.
111
What is high-yield debt?
Also called junk bonds, these are non-investment grade bonds with higher interest rates and fewer covenants, often used to finance LBOs.
112
What are the key differences between bank debt and bond debt?
Bank debt usually has stricter covenants and amortization schedules, while bond debt has higher interest rates but is covenant-light.
113
What is unitranche debt?
A single debt facility combining senior and subordinated debt, simplifying the capital structure and offering blended interest rates.
114
What are maintenance covenants in debt agreements?
Ongoing financial metrics the borrower must meet, such as minimum DSCR or maximum leverage ratio.
115
What are incurrence covenants?
Restrictions that only apply when the borrower takes certain actions like issuing new debt or paying dividends.
116
What is an accordion feature in a credit facility?
Allows a borrower to increase the size of an existing credit facility, typically with lender consent.
117
How is PIK toggle debt structured?
Allows the issuer to choose between paying interest in cash or PIK, often at different interest rates.
118
What is second lien debt?
Debt that ranks behind first lien senior debt but ahead of unsecured or subordinated debt in bankruptcy.
119
Why might a company use a revolver instead of cash?
To maintain liquidity flexibility and avoid draining cash reserves, especially for seasonal or timing mismatches.
120
What is an asset-based loan (ABL)?
A line of credit secured by assets like inventory or receivables, commonly used by companies with strong collateral but weak cash flow.
121
What is an earn-out?
An earn-out is a type of deal structure in M&A where part of the purchase price is contingent on the target company hitting future performance goals — like revenue or EBITDA targets.
