Interview Questions: The Finance Classics

by Derek Loosvelt | March 10, 2009

Everyone needs practice--especially for those tricky finance interviews. And the best way to practice is to study the classic questions every finance interviewer will ask. Here are a few chestnuts; expect to see at least one of these at your next interview.

1. How would you value a company you're considering buying?

One of the most common questions Wall Street interviewers ask. (Other variations of this question are: "how would you value a stock you were considering buying, taking public, etc.) Wall Streeters use this question to separate the finance jocks from the neophytes. Here's a basic answer that should impress your interviewer:

One answer to this question is to discount the company's projected cash flows by a "risk-adjusted discount rate." After projecting the first five or 10 years, you add in a "Terminal Value," which represents the present value of all the future cash flows that are too far into the future to project. You can calculate the Terminal Value in one of two ways: (1) you take the earnings of the last year you projected, say year 10, and multiply it by some market multiple like 20 times earnings, and that's the terminal value; or (2) you take the last year, say year 10, and assume some constant growth rate after that, perhaps 10 perhaps. The present value of this growing stream of payments after year 10 is the Terminal Value.

Note: To figure out what "discount rate" you would use to discount the company's cash flows, tell your interviewer you would use the "Capital Asset Pricing Model" (or "CAP-M"). (In a nutshell, CAPM says that the proper discount rate to use is the risk-free interest rate adjusted upwards to reflect this particular company's market risk or "beta.")

Finally, you should also mention other methods of valuing a company, including looking at "comparables"--that is, how other similar companies were valued recently as a multiple of their sales, net income, or some other measure.

2. Walk me through the major line items on a cash flow statement.

A question to test your accounting skills. The answer: First the beginning cash balance, then cash from operations, then cash from investing activities, then cash from financing activities, and finally the ending cash balance.

3. What is EBITDA?

Also known as "cash flow," EBITDA is Earnings Before Interest, Taxes, Depreciation, and Amortization.

4. Say you knew a company's net income. How would you figure out its "cash flow?"

A basic answer: You start with the company's net income. Then you add back depreciation and amortization. Then you subtract the company's capital expenditures (called "CapEx" for short, this is how much money the company must invest each year on plants and equipment). The number you get is the company's cash flow. Cash flow basic formula:

(Net Income + Depreciation and Amortization) - Capital Expenditures = Cash Flow

5. Company A is considering acquiring Company B. Company A's P/E ratio is 55 times earnings, whereas Company B's P/E ratio is 30 times earnings. After Company A acquires Company B, will Company A's earnings per share rise, fall, or stay the same?

Company A's earnings-per-share will rise, because of the following rule: when a higher P/E company buys a lower P/E company, the acquirer's earnings-per-share will rise. The deal is said to be "accretive," as opposed to "dilutive," to the acquirer's earnings.

Filed Under: Finance


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