WCM Educational Recap #13: Technical Interviews

Recapped by Morgan Tannis

Welcome back to the Western Capital Markets blog! This week, we dive into technical interviews and cover the techniques and preparation strategies required to ace them.

Introduction to Technical Interview Questions

Categories of Technical Questions

1. Accounting
2. Discounted Cash Flow
3. Leveraged Buyout
4. Merger Model
5. Enterprise & Equity Value (not covered in the post)
6. Valuation (not covered in the post)

Example Technical Questions

• Market-Based: “Where is the stock market going?”
• Technical: “Walk me through a DCF.”
• Brain Teasers/Other: “What is 17 x 22?”

Prep Strategies

• Learn the concepts from BIWS Overview Portion and YouTube
• Practice the BIWS and WSO guides
• Mock interview and make note of all questions asked
• Execute in interviews and ask for feedback afterwards

Technical vs. Behavioral Questions

• While technical questions can lose you job opportunities, they can’t get you the job; behavioral questions are the differentiating factor

Accounting Questions

Response Framework

Walk-through changes in the financial statements in the following order; make sure everything balances!

• Income Statement → Cash Flow Statement → Balance Sheet

Flow-Through Question

Example 1: How do the income statement, cash flow statement, and balance sheet link?

Answer:

• Net income from the income statement flows into net income on the cash flow statement under cash flows from operations and shareholders’ equity on the balance sheet
• The net change in cash from the cash flow statement flows into cash on the balance sheet
• Reflect balance sheet changes in working capital on the cash flow statement

Operating Leverage Questions

Operating Leverage: Degree to which a firm can increase operating income by increasing revenue

High Operating Leverage: The majority of expenses are fixed

$100 Revenue

• $40 Fixed Costs (rent)
• $10 Variable Costs (10% of revenue)
• $50 Net Income

Low Operating Leverage: The majority of expenses are variable

$100 Revenue

• $40 Variable Costs (40% of revenue)
• $10 Fixed Costs (rent)
• $50 Net Income

Example 1: If a company’s revenue is expected to increase by $10, would you rather buy a company with higher operating leverage or lower?

High Operating Leverage:

$100 Revenue → $110 Revenue

• $40 Fixed Costs (rent)
• $11 Variable Costs (COGS)
• $59 Net Income

Low Operating Leverage:

$100 Revenue → $110 Revenue

• $44 Variable Costs (COGS)
• $10 Fixed Costs (rent)
• $56 Net Income

Answer: Buy the company with higher operating leverage; it generates greater net income.

DCF Questions

Components of a DCF

Projection Period

• Project operational performance based on industry growth, management expectations, etc.
• Begin projections with revenue and use to derive unlevered free cash flows
• Sum present value of cash flows from this period

Terminal Value

• The present value of a company’s cash flows beyond the projection period
• Key Methods: Gordon Growth, Exit Multiple

Valuation and Implied Share Price

• Sum of projection period and terminal value is enterprise value
• Derive equity value from enterprise value to get implied share price
• Assess implied upside/downside and market over/undervaluation

DCF Technicals: Impacts of Tax

Example 1: How do tax rate increases impact valuation?

• Free Cash Flows: Higher tax rate means lower NOPAT, lower cash flows ↓
• Cost of Debt: Cost of debt decreases, protected by tax shield ↑
• Beta: Lower cost of equity from un-levering and relevering, includes tax ↑

LBO Questions

Components of an LBO

Example 1: Purchase and sale of Company A

Purchase Price of $500M

• Equity: $100M
• Debt: $400M

Exit Price of $650M

• Equity: 450M
• Debt: 200M

Other Information

• Holding Period: 5 years
• Debt to Equity Split: 1:4
• Levered FCF: Pay $200M of debt

Returns

• Total Return: 350%
• Annual Return: 35%

Evaluate LBOs with Money-on-Money (MoM) multiple and Internal Rate of Return (IRR)

LBO Technicals: EBITDA vs. FCF

Example 1: Would you rather have a $5 increase in final year EBITDA or Free Cash Flows?

• Normally, opt for FCF; EBITDA still has expenses and tax that need to be deducted. This case is different; changes occur in the final year
• Cash Flow Component: $5 increase in EBITDA impacts FCF less than $5 due to deductible tax and interest expenses
• Exit Component: If the company was going to be sold at a 10x multiple (for example), the $5 increase in EBITDA also results in $50 extra proceeds from sale

Merger Model Questions

M&A Technical Questions

Merger Model & Accretion/Dilution

• Objectives: Test your understanding of merger models and key accretion/dilution concepts and calculations
• Merger Model: Walkthrough model stepwise
• Merger Math: Is the deal accretive or dilutive? By what %?

Theoretical & Accounting

• Objectives: Test your understanding of reasons for acquisitions and key M&A accounting terms
• Theoretical: Types of synergies and effects of acquisition

Accounting: Creation of DTA/DTL and balance sheet effects

Understanding Acquisitions

Financial Reasons for Acquisitions

• Consolidation and economies of scale
• Market share capture
• Seller undervaluation
• Customer acquisition
• Product expansion/diversification

Fuzzy Reasons

• Acquisition of intellectual property
• Competition elimination
• Talent acquisition
• Management ego
• Publicity

Merger Model

Walkthrough

1. Project purchase price of the target
2. Determine funds used (debt, equity, cash)
3. Project pro-forma statements
4. Determine acquisition effects
5. Conduct accretion/dilution analysis

Important Definitions

• Accretive: Increase in EPS following a merger or acquisition
• Dilutive: Decrease in EPS following a merger or acquisition

Accretion and Dilution

Example Question: Company A has 10x P/E multiple and Company B has 20x P/E multiple. Company A acquires B. Is the deal accretive or dilutive?

Answer:

Determine WACC and target’s yield

• Cost of Cash = Foregone Interest on Cash * (1 — tax rate)
• Cost of Debt = Interest Rate * (1 — tax rate)
• Cost of Equity = Inverse of Buyer’s P/E multiple
• Seller’s Yield = Inverse of Seller’s Yield (P/E multiple)

Compare WACC and target’s yield

• WACC > yield is dilutive
• WACC = yield is break-even (neither accretive or dilutive)
• WACC < yield is accretive

Market Questions

Market-Based Questions

Sample Questions:

• Thoughts on the economy?
• Tell me about an industry trend
• Pitch me a stock/What’s a company you admire?
• Short me a stock
• What’s an M&A transaction you are following?
• Which two companies should merge?

Answer Format:

• 60-seconds
• Event/company summary (business models, market characteristics)
• Primary thesis point (Why this stock? Why this outcome?)
• 1–2 catalysts

Helpful Resources:

• Morning Brew: https://www.morningbrew.com/
• FT Due Diligence: https://www.ft.com/due-diligence
• Axios: https://www.axios.com/
• RBC Investment Outlook: https://www.rbcgam.com/en/ca/insights/global-investment-outlook
• More: https://www.westerncapitalmarkets.com/resources

Preparation and Delivery

Preparation

• The value is in the explanation, not the answer. Work through the steps out loud
• If stuck, draw on existing understanding of concepts and work your way to a potential answer
• Structure is your friend; identify if you’re giving too much or not enough info

Delivery

• Keep composed, clarify questions if needed, and write down valuable information
• Enunciate! Speak slower than you think you need to!
• Talk through every step even if you’re stuck
• Be conversational and fake it ’til you make it!

Key Takeaways

1. Make the most of your available time to familiarize yourself with the basics
2. Structure and practice are your friends
3. Keep up to date with market news
4. Stay confident and keep calm! Show your work!