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BREAKING INTO WALL STREET – LBO EXAM QUESTIONS WITH CORRECT ANSWERS
"Depreciation Expense found in the SG&A line of the income statement for a manufacturing firm
would most likely be attributable to which of the following - CORRECT ANSWER computers
used by the accounting department" "If a company has projected revenues of $10 billion, a gross profit margin of 65%, and projected
SG&A expenses of $2billion, what is the company's operating (EBIT) margin? - CORRECT
ANSWER 45%"
"A company has the following information, 1. 2014 revenues of $5 billion,2013 Accounts receivable of $400 million, 2014 accounts receivable of $600 million, what are the days sales
outstanding - CORRECT ANSWER 36.5"
"Which of the following is true - CORRECT ANSWER Coca Cola's brand name is not reflected
as an intangible asset on its balance sheet" "A company has the following information:
- 2014 share repurchase plan of $4 billion
- Average share price of $60 for the year 2013
- Expected EPS growth for 2014 of 10%
What should the number of shares repurchased by the company be in your financial model? -
CORRECT ANSWER 60.6 million"
"A debt holder would be primarily concerned with which of the following multiples? I. Enterprise (Transaction) Value / EBITDA II. Price/Earnings
III. Enterprise (Transaction) Value / Sales - CORRECT ANSWER 1 and 3 only"
"On January 1, 2014, shares of Company X trade at $6.50 per share, with 400 million shares outstanding. The company has net debt of $300 million. After building an earnings model for Company X, you have projected free cash flow for each year through 2014 as follows: Year 2014 2015 2016 2017 2018 2019 2020 Free Cash Flow 110 120 150 170 200 250 280
You estimate that the weighted average cost of capital (WACC) for Company X is 10% and assume that free cash flows grow in perpetuity at 3.0% annually beyond 2020, the final projected year.
According to the discounted cash flow valuation method, Company X shares are: - CORRECT
ANSWER .13 per share overvalued"
"An acquisition creates shareholder value: - CORRECT ANSWER when a company acquires a
business whose fundamental value is higher than the purchase price" "• Acquirer purchases 100% of target by issuing additional stock to purchase target shares
- No premium is offered to the current target share price
- Acquirer share price at announcement is $
- Target share price at announcement is $
- Acquirer EPS next year is $3.
- Target EPS next year is $2.
- Acquirer has 4 thousand shares outstanding
- Target has 2 thousand shares outstanding
What is the exchange ratio for the deal? - CORRECT ANSWER 1.7x"
"• Acquirer purchases 100% of target by issuing additional stock to purchase target shares
- No premium is offered to the current target share price
- Acquirer share price at announcement is $
- Target share price at announcement is $
- Acquirer EPS next year is $3.
- Target EPS next year is $2.
- Acquirer has 4 thousand shares outstanding
- Target has 2 thousand shares outstanding
Assuming a 40% tax rate, what are the necessary pre-tax synergies needed to break-even? -
CORRECT ANSWER "
"Use the following information to answer the question below:
- Acquisition takes place on July 1, 2013
- Acquirer FYE - June 30
- Target FYE - December 31
- Acquirer expected EPS for FYE June 2014 is $2.
- Target consensus EPS for FYE Dec 2013 is $1.
- Target consensus EPS for FYE Dec 2014 is $1. Assuming 360 days in a year for simplicity, calculate target EPS adjusted to acquirer FYE in the transaction year
(FYE June 2014) - CORRECT ANSWER $1.45"
- The company's new leverage ratio becomes 5.0x
- Financial sponsor exit is planned for Year 5. Assume that the EV/ EBITDA multiple at exit year is the same as the current multiple.
- Required rate of return is 25%
- Exit year EBITDA projected to be $3.0 billion
- The company's year-end leverage ratio is 1.6x
How much debt is paid down by the exit year (since the LBO announcement)? - CORRECT
ANSWER 5.2 billion"
"On December 30, 2013:
- Company Y trades at $10 per share
- Enterprise Value / EBITDA multiple of 5.0x
- Leverage ratio of 0.6x (Net debt/EBITDA)
- 2013 EBITDA = $2.0 billion
- Assume no cash on company Y's balance sheet On December 31, 2013:
- Company Y undergoes an LBO and is recapitalized
- The company's new leverage ratio becomes 5.0x
- Financial sponsor exit is planned for Year 5. Assume that the EV/ EBITDA multiple at exit year is the same as the current multiple.
- Required rate of return is 25%
- Exit year EBITDA projected to be $3.0 billion
- The company's year-end leverage ratio is 1.6x What is the initial equity necessary to achieve the rate of return required by the financial
sponsors? - CORRECT ANSWER 3.34 billion"
"A debt holder would be primarily concerned with which of the following multiples? I. Enterprise (Transaction) Value / EBITDA II. Price/Earnings
III. Enterprise (Transaction) Value / Sales - CORRECT ANSWER one and three only"
"Company A shares are currently trading at $20 per share. A survey of Wall Street analysts reveals that EPS expectations for Company A for the full year 2014 are $1.50 per share. Company A has 200 million diluted shares outstanding. Company A's major competitors are trading at an average share price / 2014 Expected EPS of 15.0x.
Using the comparable company analysis valuation method, Company A shares are: - CORRECT
ANSWER 2.5 per share undervalued"
"When looking to do a transaction comp analysis, some of the merger-related filings that should
be looked at include each of the following except: - CORRECT ANSWER Form s-1"
"when determining value for a company based on transaction rather than trading comps, one of
the key differences that will affect the value is - CORRECT ANSWER premium paid for control
of the business"
What's an LBO? - CORRECT ANSWER "
"Typical capital structure of an LBO? - CORRECT ANSWER Is a range; could see 40% debt and
60% equity, up to around 70% debt and 30% equity depending on the deal"
"Why does leverage boost returns? - CORRECT ANSWER - Allows a pe firm to buy a bigger
business with less capital upfront
- interest expense is tax deductible -"
"Things that boost returns in an LBO? - CORRECT ANSWER - multiple expansion
- amount of leverage used
- deleveraging: as this happens, it increases the pe firm's amount of equity in the firm
- EBITDA growth"
"Is B2B or B2C better for LBO? - CORRECT ANSWER B2B > demand in B2B markets tends to
less volatile and more sticky than in B2C markets"
"What subsections in tech offer good candidates for an LBO? - CORRECT ANSWER -
enterprise software (SaaS, recurring rev, contracts, software businesses can't easily stop using)
"Two types of synergies in an acqusition - CORRECT ANSWER - Revenue: when you combine
two businesses and the whole has more revenue than the parts (occurs cuz cross selling, upselling)
- Cost: when combining two businesses reduces cost (vertical integration)"
"Cross selling - CORRECT ANSWER "
"Management buyout (aka Equity Roll Over) - CORRECT ANSWER special type of LBO where
the firm's top management continues to run the firm and has substantial equity position in the reorganized firm"
Step 5: after several years, make assumptions ab the exit - usually assuming an EBITDA exit multiple using a 'Sensitivity Analysis' table"
"Why use leverage when buying a company? - CORRECT ANSWER To boost returns and also
gives the firm access to more capital to purchase other or larger companies"
"What variables impact an LBO model the most? - CORRECT ANSWER - Purchase and exit
multiples have the biggest impact on the returns of a model.
- the amount of leverage (debt) used also has a significant impact
- operational characteristics such as revenue growth and EBITDA margins."
"How would a dividend recap impact the 3 financial statements in an LBO? - CORRECT
ANSWER - IS: no changes
- CFS: under CFF, addititional cash from debt raise would cancel with cash paid out to investors > no change to cash
- BS: Debt would go up, shareholder's equity goes down (cus retained earnings), cancelling out"
"Why would a PE firm choose to do a dividend recap of one of its portfolio companies? -
CORRECT ANSWER Primarily to boost returns"
"What's meant by the tax shield in an LBO? - CORRECT ANSWER - refers to that the interest
paid by a firm is tax deductible"
"How could a PE firm boost its return in an LBO? - CORRECT ANSWER 1) Reduce purchase
price in the model
- Increase exit multiple and exit price
- Increase leverage used
- Increase company's growth rate
- Increase margins by reducing expenses"
"What's bank debt? - CORRECT ANSWER - Revolvers and term loans
- floating rate
- typically will have a minimum yield that comes into play if rates fall below that
- secured by collateral"
"Difference between bank debt and high yield debt? - CORRECT ANSWER Simplification, but
broadly 2 types of debt.
- high yield has higher interest rates
- high yield debt interest rates usually fixed, bank debt interest rates floating (change on LIBOR or Fed)
- high yield debt more incurrence covenants, bank debt more maintenance covenants.
- Bank debt usually amortized (principal paid off over time) whereas high yield has entire principal due at end (bullet maturity)." "Let's say we're analyzing how much debt a company can take on, and what the terms of the debt
should be. What are reasonable leverage and coverage ratios? - CORRECT ANSWER - mostly
dependent on the company, industry and leverage and coverage ratios of comparable LBO transactions
- look at the types and terms of debt similar sized companies in the industry have recently used
- Some general rules: i.e., wouldn't lever a company to 50x EBITDA, rare to see leveraged above 5- 10x EBITDA"
"How is the BS adjusted in an LBO model? - CORRECT ANSWER - new debt is added to
liabilities, shareholder's equity is typically wiped out and replaced by however much equity the pe firm contributes
- cash is adjusted for any cash used to finance the transactions and goodwill is used as a plug to make the BS balance
- other changes: capitalized financing fees added to assets side"
"Capitalized Financing Fees definition - CORRECT ANSWER "
“What is generally not considered to be a pre-tax non-recurring (unusual or infrequent) item? -
CORRECT ANSWER Extraordinary gains/losses"
"what is false about depreciation and amortization - CORRECT ANSWER D&A may be
classified within interest expense" "Company X's current assets increased by $40 million from 2007-2008 while the companies current liabilities increased by $25 million over the same period. the cash impact of the change in
working capital was - CORRECT ANSWER a decrease of 15 million"
"the final component of an earnings projection model is calculating interest expense. the
calculation may create a circular reference because - CORRECT ANSWER interest expense
affects net income, which affects FCF, which affects the amount of debt a company pays down, which, in turn affects the interest expense, hence the circular reference"
"a 10-q financial filing has all of the following characteristics except - CORRECT ANSWER
issued four times a year." "A company has the following information:
WACC. Assume all cash flows are generated at the end of the year (i.e., no mid-year adjustment):
CORRECT ANSWER 837 million"
"On January 1, 2014, shares of Company X trade at $6.50 per share, with 400 million shares outstanding. The company has net debt of $300 million. After building an earnings model for Company X, you have projected free cash flow for each year through 2014 as follows: Year 2014 2015 2016 2017 2018 2019 2020 Free Cash Flow 110 120 150 170 200 250 280 You estimate that the weighted average cost of capital (WACC) for Company X is 10% and assume that free cash flows grow in perpetuity at 3.0% annually beyond 2020, the final projected year.
Calculate Company X's implied Enterprise Value by using the discounted cash flow method: -
CORRECT ANSWER 2951.2 million"
"the formula for discounting any specific period cash flow in period "t"is: - CORRECT
ANSWER cash flow from period "t" divided by (1+discount rate raised exponentially to "t""
"the terminal value of a business that grows indefinitely is calculated as follows - CORRECT
ANSWER cash flow from period "t+1" divided by (discount rate-growth rate)"
"the two-stage DCF model is: - CORRECT ANSWER where stage 1 is an explicit projection of
free cash flows (generally for 5-10 years), and stage 2 is a lump-sum estimate of the cash flows beyond the explicit forecast period"
"disadvantages of a DCF do not include - CORRECT ANSWER free cash flows over the first 5-
10 year period represent a significant portion of value and are highly sensitive to valuation assumptions"
"the typical sell-side process - CORRECT ANSWER shorter than the buy side, buyer secures
financing, and doesn't involve id'ing potential issues to address such as ownership and unusual equity structures, liabilities, etc." "the following happened in a recent M&A transaction: 1. PP&E of the target company was increased from its original book basis of $600 million to $800 million to reflect fair market value for book purposes in accordance with the purchase method of accounting. 2. no "step-up" for tax purposes. 3. original tax basis of $650 million. assuming a corporate tax rate of 35% for book
purposes, the company should record the following - CORRECT ANSWER A deferred tax
liability equal to $52.5 million"
"Pushdown accounting: - CORRECT ANSWER Refers to the establishment of a new
accounting and reporting basis in an acquired company's separate financial statements" "Use the following information to answer the question below:• Acquirer purchases 100% of target by issuing $100 million in new debt to purchase target shares, carrying an interest rate of 10%
- Excess cash is used to help pay for the acquisition
- Acquirer expects to be able to close down several of the target company's old manufacturing facilities and save an estimated $2 million in the first year
- Target PP&E is written up by $25 million to fair market value
- Investment bankers, accountants, and consultants on the deal earned $30 million in fees
Which of the following adjustments would be made to the pro forma income statement? -
CORRECT ANSWER Advisory fee expense of $30 million
Depreciation expense increase due to PP&E write-up Pre-tax synergies of $2 million"
A 338(h)(10) election: - CORRECT ANSWER Requires that both buyer and seller must jointly
elect to have the IRS deem the acquisition an asset sale for tax purposes"
"A good LBO candidate has which of the following characteristics? - CORRECT ANSWER
Little to no existing leverage, steady cash flows and little investment in business through capex and working capital"
"Which of the following is NOT a disadvantage of performing an LBO analysis? - CORRECT
ANSWER Stand-alone LBO may overestimate strategic sale value by ignoring synergies with
acquirer" "While equity contribution went as low as the single digits in the 1980's, the current split between
equity and debt in an LBO deal is best characterized as: - CORRECT ANSWER Equity - 35%;
Debt 65%" "Non-equity claims that should be deducted from Enterprise Value to find Equity Value include
all of the following EXCEPT: - CORRECT ANSWER Minority interest, preferred stock,
capitalized leases"
"LTM (Last Twelve Months) is calculated as follows - CORRECT ANSWER Latest completed
fiscal year results + Latest reported stub period results - Same stub period results from one year ago" "Company A shares are currently trading at $50 per share. A survey of Wall Street analysts reveals that EPS expectations for Company A for the full year 2014 are $2.50 per share. Company A
payments, they may use high yield debt. (Further, if they don't have plans for major expansion or selling off the company's assets, they may choose to use high yield debt)"
"Why might you use bank debt rather than high-yield debt in an LBO? - CORRECT ANSWER
If the pe firm is concerned about meeting interest payments and wants a lower-cost option, they'll typically use banks debt; (also, if they're planning a major expansion or high capex and don't want to be restricted by incurrence covenants, they'll use bank debt)"
