12/31/15

Mod Note (Andy) - as the year comes to an end we're reposting the top discussions from 2015, this one ranks #23 and was originally posted 8/28/2015.

Inspired by the "Why YOU Aren't Getting Offers" repost for #TBT.

I just participated in a series of interviews and I was sincerely disappointed. I was asked to cover the technical portion and no one could walk me through a DCF well. While I am going to talk to the people who referred these candidates (and also make note of the quality of their referrals), it occurred to me that often candidates don't realize or get clear feedback on why they didn't move on in the process (interviewer has no upside, potential legal nightmare, against policy etc.). Yes, there are always "better candidates", but there are some very common (and highly fixable) problems I see way too frequently. Perhaps that's the frustrating part, because I feel like these are things that are very easy to prepare for.

It's not just about getting it right, but presenting it well.

Let's use an example of DCF because it is standard / plain vanilla / middle of the fairway. You will get this question for sure at some point. You should know this cold. It should be polished. There is no "but what if I sound too canned" debate. I have never heard anyone sound "too canned" on something like this (or anything for that matter). I HAVE dinged people for just regurgitating when it is clear they don't really understand what's happening.

I think the worst part is that people think they know it really well and when you ask them to walk through it, they fall apart completely. And often it's not necessarily because they don't understand the concept, but they are weak at presenting it.

General Guidelines for Interviewing


1. IBD is very much about having the right answer. You have to be crisp in your terminology. You can't "get the idea" you need to tell me exactly.
2. If you are doing a memory dump to prove you know the material, stop. The whole interview should be a back-and-forth conversation. I may or may not want to probe deeper. Let the interviewer lead. I don't want to hear CAPM in your first go (more on this and pacing later). If you just keep going, I'll let you dig your own grave. I'm not incentivized to save you. I'm looking for reasons to disqualify you and reduce the list of names I need to weed through. We will always have more candidates / interviewees than spaces.
3. If you throw a number out there (terminal growth should be between 2 to 4%, "I would forecast out seven years") you better be ready to defend why you do it.

DCF Example


Q: "Walk me through a DCF"
A: There are three steps to a DCF
1. Forecast free cash flows in the near-term, until the business becomes "stable" / predictable
2. Determine terminal value to capture value of the business as an ongoing concern beyond forecast period
3. Discount these cash flows to present value

That's it. 15 to 20 seconds. Let the interviewer probe for more.

In the first pass, I don't want to hear:
- The formula for FCF
- Multiples / perpetuity growth method for terminal value
- WACC
- CAPM

These are things that the interviewer can take the lead and dig deeper if they ask. I want to see some professional maturity in that you can structure your thoughts and answer my question succinctly in a manner that shows me you are confident and have a strong command for the materials.

The worst is when the candidate takes the lead and gets something wrong. Then I have to interrupt and get them to clarify. It's usually downhill from there.

I want you to make my job as an interviewer harder. I want to have an energetic debate about the top 10 candidates we interviewed rather than immediately disqualify 5 because they were terrible at the outset.

Comments (72)

8/20/15

This is great. Thanks!

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8/20/15

you're on a roll! thanks again for posting, just added to the frontpage

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8/20/15

... I only do these posts to see what pics you will pair with them. Lol.

8/21/15

haha, funnest part of my day. google image search is more fun than reddit.

re the 2 monkey shits, nothing worse than a lurker contrarian

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8/20/15

Nice post. I wish I had thought of this while I was interviewing. From an applicants standpoint, though, this is pretty tough. If an applicant answers the question exactly like you wanted, they run the risk (at least in their mind) that you may think that they are not too familiar with the DCF. This is why most applicants give these lengthy answers.

8/20/15

That's fair. It's not an easy thing to do, but I'm trying to provide the rationale to why this way is better. It's not obvious which is why "memory dump" is so frustratingly common.

Some things people might not realize when "memory dumping": The interviewer needs to standardize questions across candidates (I want to ask everyone the same question so I can level set as time is limited) so that when we have round tables about candidates I can give apples to apples comparisons of candidates. Rambling dominates the conversation and doesn't let them do that. It also opens yourself up to messing up because you are nervous and say the wrong thing for something the interviewer wasn't even looking for.

Also, I would say that this whole "philosophy" is portable to any level. Example: MD who asks for you to put together a carpet bomb deck for a client. The clients aren't stupid. This is the candidate equivalent of rambling in an interview. It shows a lack of confidence. They know it. The MD knows it.

8/20/15
TorontoMonkey1328:

The interviewer needs to standardize questions across candidates (I want to ask everyone the same question so I can level set as time is limited) so that when we have round tables about candidates I can give apples to apples comparisons of candidates.

I'm sure your approach to interviewing works for you and your group but it just feels lazy to me.
It seems more effective to gear technical questions towards someone's background and evaluate what they were able to get out of prior internships, than to see how well they can memorize an interview guide.

They'll learn how to build a dcf on the job.

8/21/15

No offense, I don't buy the "they will learn the DCF on the job" argument. I want my hires to know the basics so we can move on to more sophisticated topics because everyone knows there is more to IBD than cranking DCFs. But it's table stakes, a platform skill to build on. In a competitive job environment, all things equal, I will take the candidate that has stand out technicals.

I agree with the no value to memorizing interview guides, but that's not my point. I feel like memorizing is a "base minimum". Like jesus, at the very least you could memorize the answers. Any interviewer can spot pure memorization from a mile away. I'm saying structure your answers to pace your interview.

Also, this structure is not the end of the interview. It's the start (the FIRST 15 to 20 seconds, not the last). I will ask the majority of the other questions and I want to know that candidates have the capacity to understand this at the start. I've seen too many people set up for failure because they were hired because people thought they "had the capacity to learn" but never really pushed them to see if that was true early on.

Why should I invest (and potentially waste) my time teaching an analyst if they haven't spent the basic requisite time to at least try to do it themselves first? This stuff is not hard. If you've ever had to do it for a class, you should have a basic understanding. If you've ever had to do it for a case comp, you should have a basic understanding. If you haven't had the opportunity, but you want this job, then go find the time to try it so you can get your own understanding.

8/21/15
TorontoMonkey1328:

No offense, I don't buy the "they will learn the DCF on the job" argument. I want my hires to know the basics so we can move on to more sophisticated topics because everyone knows there is more to IBD than cranking DCFs. But it's table stakes, a platform skill to build on. In a competitive job environment, all things equal, I will take the candidate that has stand out technicals.

I agree with the no value to memorizing interview guides, but that's not my point. I feel like memorizing is a "base minimum". Like jesus, at the very least you could memorize the answers. Any interviewer can spot pure memorization from a mile away. I'm saying structure your answers to pace your interview.

Also, this structure is not the end of the interview. It's the start (the FIRST 15 to 20 seconds, not the last). I will ask the majority of the other questions and I want to know that candidates have the capacity to understand this at the start. I've seen too many people set up for failure because they were hired because people thought they "had the capacity to learn" but never really pushed them to see if that was true early on.

Why should I invest (and potentially waste) my time teaching an analyst if they haven't spent the basic requisite time to at least try to do it themselves first? This stuff is not hard. If you've ever had to do it for a class, you should have a basic understanding. If you've ever had to do it for a case comp, you should have a basic understanding. If you haven't had the opportunity, but you want this job, then go find the time to try it so you can get your own understanding.

You're rambling...

8/21/15

I am. I'm straight up ranting. Take it for what it's worth.

8/21/15

Good points. Thanks for sharing. This is insightful, even for someone like me who is already working in the industry.

8/20/15

... Also... Two Monkey Shits? Guys, at least have the courtesy to leave some feedback as to why you disagree.

Best Response
8/21/15
TorontoMonkey1328:

... Also... Two Monkey Shits? Guys, at least have the courtesy to leave some feedback as to why you disagree.

You get a monkey shit from me because you assume that what's right for you is objectively right for everyone.

I've had interviews where I've given the sort of responses you're looking for to general "walk me through a DCF" or "walk me through CAPM" type of questions and got hammered for doing so.

One interviewer asked me,

"if you had to explain CAPM to an economic illiterate. A 70 year old grandmother that never went to high school, and if you only had 15 seconds, how would you do it?"

My response,

"CAPM is an economic model which says that investors are paid for accepting risk, but not for all forms of risk. Specifically, they are rewarded for bearing risks of the general economy and the model attempts to price that risk."

The interviewer then slammed me for not going into more detail. Not explaining how risk is defined (systematic volatility), not explaining that there's a risk-free component and a risk premium component, not introducing the concept of beta and its relationship to the general market, etc. He even said, "don't you have a masters in finance?!"

So to get back to the point, there is no "right" way to answer an interview question, though there are definitely plenty of wrong ways (wouldn't be appropriate to get into risk-neutral pricing when trying to explain CAPM). It all depends on the interviewer. Interviews are generally crap-shoots. The person interviewing you most likely has an inflated image of his/her self and are biased.

"Elections are a futures market for stolen property"

8/21/15

double

"Elections are a futures market for stolen property"

8/22/15

I appreciate the honesty. As for the interviewer that's shitty. If I'm looking for you to explain a specific concept I'll normally guide to it. While I'm not motivated to save shitty candidates I am actively not trying to shit can good ones either.

One thing to consider: if your interviewer is an asshole, do you want to work with this guy? Will he mentor you to be a good banker? I understand we can't always choose where we get offers, but I think beating up candidates is poor form. Of course the interviewer will have a stronger command of the material.

I'll give you a +1 for sticking your neck out.

8/21/15

Also, it takes two seconds for the interviewer to ask: "are you familiar with the math?"

Especially after asking to keep it to the 70 old financially illiterate grandma level.

Fuck that guy.

8/23/15

Same here, as an interviewer, it annoys me when I have to scratch for minutes what the candidate knows and what he does not. If you have been interviewing for some time, you have the tools to make sure that you are not hearing a memory dump, instead of punishing people for not giving only pieces of the answer you want to hear (e.g: the moment they bring up the WACC you have enough material for 15 more minutes of conversation)

8/23/15

Fair enough. My only comment to that is that I don't want to talk about WACC for 15 minutes. I'd probably like to do my M&A questions (shameless plug) and some other questions too.

But I appreciate the feedback. As candidates can see, there are a variety of different style preferences.

Chacun son gout.

  • Anonymous Monkey
  • 1/1/16

Actually CAPM is equivalent to a model of the stochastic discount factor that is linear in the market return. Since risk neutral probabilities are simply the P-measure probabilities weighted by the stochastic discount factor, you can easily get to CAPM from a risk neutral pricing model and vice versa.

8/21/15

The mathematical concept of a discount rate is integral to an absolute model though. I understand that you want a simple answer, but some kid who is interviewing and also about to shit his pants is not going to give a 15 second answer. If I'm qualified and I'm confident in my technical knowledge; I'm going to showcase my foundation by going through the model.

8/21/15

My flip on this question was to ask them what they would check if their analyst showed them a DCF, and they had 5 minutes before showing their MD.

It's not an overly technical question, but it very quickly gave me the view of did you know what a DCF was, and more importantly for me did you UNDERSTAND what the real key drivers were. Had you actually sat down with one before and fiddled with the drivers or learnt the answer from here

And like TorontoMonkey said - you need similar questions to compare 15-20 candidates across. And I wasn't going to gear my questions to the individuals background

8/21/15

That's a clever idea. I might use that in my next interview. +1.

1/1/16

Would I be correct in assuming that this is another way of asking "what input is the DCF is most sensitive to?" If so, would the answer be the terminal growth rate? From my experience, varying this value can significantly change the terminal value, and thus the overall valuation of the company. I suppose that this would make sense, since the growth rate is applicable for an infinite number of years. Of course, so is the WACC, but the WACC seems to be more empirically calculated than the growth rate, so if I am not mistaken, we should expect less certainty in our growth rate than our WACC.

1/1/16

terminal growth Rate / Exit Multiple will be the drivers to which EV is most sensitive, yes. This is because, as you correctly point out, the Discounted Horizon Value can often make up 70%-90% of the total discounted NPV. WACC is an important driver too, but with all DCF models I have ever done, it is far less sensitive than Terminal value in contribution to final NPV.

1/1/16

Awesome - thanks for the clarification! Also, happy New Year!

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8/21/15

My father spent some of his career in the police and eventually ended up at the police training school. He once told me that he was very forgiving with candidates in interviews as they can never really be sure of what would questions would be asked or what format the interview would take. He would be willing to make a judgement based on perceived potential.

What he had absolutely no time for were candidates that failed the fitness test. They knew in advance what would be required of them as part of the fitness test, they had ample opportunity to prepare for it, so failure to pass indicates a serious lack of commitment.

I wholeheartedly agree with the original poster. Everyone who goes to an ib interview should expect that they will get asked technical questions, so there is absolutely no excuse for not being able to answer such questions in a confident and succinct manner.

Knowing how to discount cash flows etc. is the absolute minimum the interview expects from a candidate, and the question is being asked to allow the candidate to demonstrate that they are familiar with very basic financial concepts. Elaborating on the answer and talking about CAPM, country risk premium or whatever isn't going to impress anyone.

I also agree that canned answers are obvious to a seasoned interviewer, and potentially disastrous to the candidate that uses them. Canned answers indicate a lack of understanding. Technical questions at the analyst level are not hard at most firms. If you really want to work in the industry, you would have learnt these very basic concepts to a point where you genuinely understand them, so communicating them should not be a problem.

TL;DR: Agree with the OP. Most analyst level technical questions aren't hard so no excuses for not being able to answer them. Understand the concept, don't just learn the answer.

8/21/15

Thanks for the post. I think that being able to show an interviewer that you understand the "why" and the "how" and also being able to articulate that is very important. This shows that you understand the concept behind the calculations. Obviously the more technical calculations are expected at some point but this is a great way to show an interviewer that you know what you are talking about.

8/21/15

When I interview candidates who will be working for me I am most concerned with personality fit and a demonstrated interest in finance. Someone who is interested in finance would have taken the initiative to learn the basics. With that said, given that we are pulling from pools of qualified applicants with some baseline level of intelligence there isn't anything that cannot be taught and learned relatively quickly. Let's be honest, IB type finance is not that hard. It's why top liberal arts grads can still make great analysts.

8/21/15

@TorontoMonkey1328 I have to agree with what you're saying and, you did address this as someone brought this up but interviewers can be vague at times. Also all the information that is available out there can be a double edged sword as an applicant could have prepared to death and gotten into a habit of just regurgitating info.

Why not broaden the question and say, "Walk me through a DCF in a general sense...not looking for formula or how to calculate just a broad overview"?

This sets the expectations and avoids the puzzlement of how specific you should go. This also signals to me that questions further down will be focused on concepts and or start off broad and then drill down to details so it keeps the pace of Q and A nice and smooth.

Don't know if that made any sense but just my two cents...

8/21/15

Similar topic covered in this guy's internship blog.

http://lifeofasummerintern.blogspot.com/2008/09/wh...
Very good read. I also think this is a great way to answer the "run me through a DCF" question especially if you are having a phone interview.

8/22/15

Thanks for this TorontoMonkey, SB'd. Wondering if you could make something like this in the future about your personal pet peeves when it comes to behavioural questions. This thread made me curious as to whether industry professionals agree with the cookie-cutter answers the prep guides provide on common questions such as "Why investment banking" and key things you look for during "Walk me through your resume".
What you mentioned in the OP was actually quite contrary to some of the answers I've received from investment banking prep guides, nonetheless a refreshing take on how to approach the question.

8/23/15

Happy to write one. Maybe next time I find myself waiting for my analyst to grind through some changes. Just had the incoming first years join so they're still a bit slow. ;)

8/28/15

I don't care if an analyst can run a DCF, or even do math...as long as all the fonts match and the formatting is good -- I am happy...your DCF is going in the back of the book anyway and mgmt. already knows what their company is worth...if not, get new clients.

8/28/15

great post. every interviewer has their own style as well as substance approach. and that's how it should be. it's up to the candidate to be FULLY prepared for all questions. pretend that that you are talking to an investor and selling them on why they should buy the company. you should know the numbers, the terminology, polish your presentation and be ready to defend your proposal from even the most obscure questions. an IB job is tough enough as it is without an associate/VP spending an extra 3+ hours a day for 6-12 months getting an analyst up to speed plus all the fuck-ups in-between. if you know the concepts then you can thrive, if not u'll drown and drag the team with you. the interviewer is not a dick for putting you over a barrel, you are a tool for not being ready to take it. tough love, but such is life.

"I'm talking about liquid. Rich enough to have your own jet. Rich enough not to waste time. Fifty, a hundred million dollars, buddy. A player. Or nothing. "
-GG

8/28/15

Bravo to you. I spent 25 years in IB and interviewed scores of people. Feedback was always sanitized. Now as a career counselor I work with IB and PE candidates and I understand how valuable feedback can be. I'm asking all my clients to read this.

1/1/16

I think i will ask the interviewer upfront whether they prefer short succinct answers or longer ones which can provide additional stuff to talk about.
Last time i did not lead the guy gave me 0 questions on valuation and kept asking me about DCM stuff.
Plus at this point i covered so much stuff that i doubt the itwer will ask me about all of it while i want to display that my interest and drive led me to go beyond the little pdf guides and that i studied merger models, m&a related accounting topics : Non-controlling interests, Deferred taxes, Stock vs Asset Sales (and Section 338(h) Elections) Employee stock options, Purchase Accounting and Goodwill Allocation... LBO stuff and i went through the whole leveraged loans primer just in case some turd decides to ask me loan questions for an IBD position again.

Btw i'm kinda desperate to get an off-cycle gig by now. do you think making a full merger model from scratch and showing my work to associates around could help me land interviews ?

8/4/16

I have a question- Do you expect this from a summer internship applicant from undergraduate?

8/4/16

Depends on what school but usually yes.

8/4/16

It's clean and simple.

A DCF is represented by two key pieces - a projection of free cash flows say 5-10 years into the future, discounted by the weighted average cost of capital, plus a terminal value.

That's how you should answer the question. They will likely probe you further if they want to, and you should respond concisely and clearly if they do.

8/4/16

Sav:

It's clean and simple.

A DCF is represented by two key pieces - a projection of free cash flows say 5-10 years into the future, discounted by the weighted average cost of capital, plus a terminal value.

That's how you should answer the question. They will likely probe you further if they want to, and you should respond concisely and clearly if they do.


I have heard this from most people. Why is it that such a basic answer like this is better than giving my full walk-thru, which would show a greater understanding than the answer you have posted, which can easily be a memorized answer... I understand they will further grill you if you answer more detailed at first, but cant it go both ways in that it shows that you actually know what you are talking about, instead of memorizing something? I bet the answer you just posted is given by 99% of applicants. Shouldnt you differentiate and answer more thoroughly than that (since that is missing a ton of detail)
8/4/16

Hedgehog68:

Sav:

It's clean and simple.

A DCF is represented by two key pieces - a projection of free cash flows say 5-10 years into the future, discounted by the weighted average cost of capital, plus a terminal value.

That's how you should answer the question. They will likely probe you further if they want to, and you should respond concisely and clearly if they do.

I have heard this from most people. Why is it that such a basic answer like this is better than giving my full walk-thru, which would show a greater understanding than the answer you have posted, which can easily be a memorized answer... I understand they will further grill you if you answer more detailed at first, but cant it go both ways in that it shows that you actually know what you are talking about, instead of memorizing something? I bet the answer you just posted is given by 99% of applicants. Shouldnt you differentiate and answer more thoroughly than that (since that is missing a ton of detail)

I want the simple answer first when asking a candidate to walk me through a DCF. If they nail the answer I will dig down into specific concepts to measure understanding. I don't want to sit there for 5 min hearing you recite formulas. I would prefer to guide the conversation.

"For I am a sinner in the hands of an angry God. Bloody Mary full of vodka, blessed are you among cocktails. Pray for me now and at the hour of my death, which I hope is soon. Amen."

8/4/16

My answer is rehearsed, clean, and under 1 minute. People tend to really like my answer. Then if they want, they can drill into EV, TSM, TV, WACC, etc.

I wouldn't go much more bare bones than what I posted, but to each their own.

"Success means having the courage, the determination, and the will to become the person you believe you were meant to be"

8/4/16

Keep it simple. If they want the formula, they'll probably ask for it.

8/4/16

lol. understanding > memorizing forumlas.
also know midyear discounting and its respective adjustments on growth and multiples calculations

8/4/16

Talk about WACC but know the formula by heart.

8/4/16

Steps to a DCF (free cash flow to the firm)

1. Project 3-10 yrs of Free Cash Flows (standard is 5)
2. Arrive at Terminal Value (use either gordon growth or exit multiple method)
3. Discount FCF and TV back to present at WACC --> gives you your Enterprise Value
4. Move from Enterprise Value to equity value using the equation:
Enterprise Value = Equity Value + Net Debt (debt-cash) + Minority Int + Pref Stock + other unfunded liabilities
5. Divide equity value by diluted shares outstanding

"Success means having the courage, the determination, and the will to become the person you believe you were meant to be"

8/4/16

nontargetPSD92:

Steps to a DCF (free cash flow to the firm)

1. Project 3-10 yrs of Free Cash Flows (standard is 5)

2. Arrive at Terminal Value (use either gordon growth or exit multiple method)

3. Discount FCF and TV back to present at WACC --> gives you your Enterprise Value

4. Move from Enterprise Value to equity value using the equation:

Enterprise Value = Equity Value + Net Debt (debt-cash) + Minority Int + Pref Stock + other unfunded liabilities

5. Divide equity value by diluted shares outstanding


This would be my exact answer. But other posters say to answer in such a basic manner. I agree with you, and I think the first poster's answer above would make you sound stupid and make it look like you read what a DCF is on wikipedia before the interview..
8/4/16

Memorizing more doesn't mean understanding more. If you think you're going to impress your interviewer by saying more you've got the wrong idea of what this question is trying to probe at. The interviewer is just trying to check a few boxes off. I always recommend a concise answer for the following reasons -

1. The more you talk the more likely you'll say something that might not be exactly what I'm looking for - even when you say "standard is 5" - the back of my head is thinking: the correct number of years should be the longest amount of time you can accurately project or the number of years you expect until you reach stable cash flows.

2. A concise answer tells the interviewer that you have the big picture and you're ready for the conceptual questions - the interviewer will probably ask 3-4 more. Start big picture and these 3-4 followups are questions you'll probably be able to own. In the answer above, you mentioned things like minority interest, preferred stock, etc... those sorts of terms might just trigger the interviewer to pick a tough question for you just to make you look bad.

3. You say you can get this question in under a minute - I just answered it in like 15 seconds. Believe it or not, I'd rather take that extra 45 seconds and talk about things more interesting that won't bore the interviewer to death.

8/4/16

FCFF/FCFE is extremely basic stuff that you should know cold. You have the guide, so I won't bother running through what differentiates them. As for "how many formulas you should learn", you should learn this material conceptually, not memorize it. Actually take the time to understand how the three F/S tie together. If you understand what EBIT/EBITDA/NI/OCF/Revenue actually means, you can back out a FCFF/FCFE from any starting point. Again, this stuff is VERY basic stuff and 100% fair game. Basic and advanced sections, especially if you're a finance/econ/accounting major. Since we're talking about BWIS guides, I'd say everything in there (DCF to LBO individual guides) is fair game. This is especially true if you don't come from a target school. They will expect you to know this stuff ice cold.

Good luck!

You speak in in varying levels of verbosity.You often adopt the typing quirks of others as you find it boring to settle on styles.

8/4/16

Great answer. Banana this man.

"If you have a difficult task, give it to a lazy person; they will find an easier way to do it." - Hlade's Law

8/4/16

oh you know i did ;)

Make Idaho a Semi-Target Again 2016
Not an alumnus of Idaho

8/4/16

Dude don't treat it like you're studying for a chemistry final. Like above poster said, that's a very very basic concept that you need to know. You might be able to squeak by knowing a few "alternate formulas," but you're going to need to know this anyway, so just figure it out conceptually now.

But to answer your question, it's only really ever come up in one interview where I had a ~7 minute discussion on what exactly a DCF is telling you (which primarily revolved around why you strip out interest payments and tax shields).

8/4/16

Thanks - conceptually I'd say I understand most of it, but the study guide's just packed with formulas - wasn't sure whether I'd get grilled on rote memorization or not.

Make Idaho a Semi-Target Again 2016
Not an alumnus of Idaho

8/4/16

scoopbooks.com; best books for banking

8/4/16

DCF - intrinsic way of valuing a firm.
Step 1: Calc Free Cash Flow Attn: FCFF - to the firm (all cap providers), FCFE - to equity investors (Owners of the company)

Most of the cases, use FCFF, since most of the firms have debt to max equity return
FCFF Calc:

EBIT
- tax
+ D&A
- CapEx
- Inc. in Working Cap
+ Any non-cash charges (Ex: Deferred Tax)

Step 2: Usually bankers use a 2 stage model
Stage 1: Usually 10 years forward projections (explicit period or growth period)-- Calc. FCFF
Stage 2: TV - Terminal Value - Assume the cash value of business beyond the last projected year (Yr. 10)

Two ways of Calc. TV
- Perpetuity formula
- Exit Multiple (X Ebitda)

NPV all of the future cash flows.

The sum of all NPV FCFF will be your EV - Enterprise Value

EV - net debt = equity value

net debt = total long term debt - excess cash

equity value / dilutive shares outstanding = share price

Sweeeettt!!!

8/4/16

Tian,

I think that is a great summary 2 points:
1. Not everyone removes excess cash from net debt (although it should be done).
2. For net debt, I typically include short term interest bearing debt as well (short term portion of LT debt, maybe line of credit or note payable). Isn't this the standard way of calculating debt?

8/4/16

Just want to add discount rate for NPV is WACC - weighted average cost of capital.

Make sure you know how to calc that.

8/4/16

What is the RFR for WACC? the 10 year note or the 30 year long bond?

8/4/16

Another thing to note is the half-year convention for DCF - I was asked this in a interview. When you are calculating NPV above, you are assuming that all your UFCF (unlevered free cash flow) is coming in at the end of the year when this most likely is not the case. Instead of taking the NPV at the end of the year, you take the NPV as if your UFCF came all in the middle of the year (you let your (Year# = oldYear# - .5) in your NPV eqn, so for ex: 1 becomes .5, 2 becomes 1.5, etc..). Note that this is not exact (as many companies are seasonal), but just what some would consider a 'better' approximation. If your business tends to earn all of its revenue at the end of Q4 (a Christmas tree farm, etc.) then the regular NPV at the end of the year would be fine - this probably won't be the case, but it's still something to think about and will aid your understanding.

Anyways, there is one last thing to consider: if we have done 5 years of UFCF, we have only discounted cash flows from years .5, 1.5, 2.5, 3.5 and 4.5. Now if we calculate the terminal value with the perpetuity (using WACC and a growth rate) or an EBITDA multiple, we will effectively be calculating from year 5 onto infinity. This is bad because we are then forgetting about the cash flow between years 4.5 and 5. Hence, we need to project one more year (year 6) or just use the growth rate from our perpetuity to predict what the next years cash flow would be. However, this time when we take the NPV, we take the UFCF/2 (divided by 2) from year 6 and take the NPV 5 years back (Why? - b/c this is consistent with our formulation - think about this).

So calculate your Terminal Value as usual, take the NPV 5 years back, add all everything up and you're done!

Notice that the half-year convention will give you a higher valuation (compared to a full-year convention) given that WACC is greater than 0 and all cash flows are greater than 0. You might want to think about why this is.

8/4/16

bmwhype - I believe the standard is the 10 year note.

8/4/16

I don't think it's expected for SA or FT analysts - I never got asked about it during any of my interviews. I've only seen it in the Vault Guide and briefly (maybe a 5-minute aside) in a Corp. Fin class, so I'm curious. Does it comes up in the post-MBA associate interviews?

8/4/16
tmtbanker:

I don't think it's expected for SA or FT analysts - I never got asked about it during any of my interviews. I've only seen it in the Vault Guide and briefly (maybe a 5-minute aside) in a Corp. Fin class, so I'm curious. Does it comes up in the post-MBA associate interviews?

Yeah I just read about it in the vault guide also, but never learned about it in my corporate finance class, just wacc. And even if the interviewer does ask about it, I can't get dinged too bad for not knowing APV, right?

8/4/16

APV isn't that hard, you shouldn't go out of your way to mention it, but just be able to say briefly what it is if asked. I doubt anyone would mention it or delve deeply into it (the person interviewing you will probably not even know what it is, lol).

8/4/16

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8/4/16

Capitalist

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