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How to Answer the Top Five Technical Investment Banking Interview Questions

Whether you are in college looking for an internship or have recently graduated and are looking for a full-time position, interviews for investment banking positions can be daunting. And if a single interview isn’t enough to stress over, many financial firms find it efficient to hire through a Super Day event. Candidates are run through a series of as many as four to six interviews back to back. Each interviewer spends about thirty minutes with a candidate, and each interview evaluates the candidate from a different perspective. Under consideration are the candidate’s technical knowledge, behavior, cultural fit, and overall skill level (we’ve also written a post with general interview tips). And often most importantly, the interviewers want to know whether you are someone they would like to sit next to for sometimes 80+ hours per week!

As you are thinking about interviewing, you’re probably wondering if your skills and technical knowledge are enough for the position—if you’re nervous about just what questions you’ll be asked by interviewers who are making that determination, read on. While you never know exactly where an interviewer is going to go, you should be rock solid with answers to the questions below.

Questions & Answer Guide

  1. How do you value a company?
    • Purpose of the Question: This is one of the basic questions for gauging your understanding of mergers and acquisitions. Whether you’re performing a valuation analysis or analyzing a potential acquisition target—you need to know not only how to do this but also how to articulate the process.
    • Potential Answer: A good answer includes mention of the different valuation methodologies that could be used—such as trading comps analysis, transaction comps analysis, and discounted cash flow (DCF). The best choice depends on the situation:
      • For valuing an IPO, trading comps analysis is the standard.
      • For determining how much to pay for a target company, a transaction comps analysis is the norm.
      • For valuation of a company with stable cash flows, a DCF analysis should be used. This analysis will determine the intrinsic value of a stable company based on the present value of its future free cash flows.
  1. What are the three financial statements and how are they linked?
    • Purpose of the Question: This is another bottom-line requirement for an investment banker. This type of role is often just as much about accounting as it is about finance. In addition to ensuring you know the fundamentals about the function of each key financial statement, the interviewer is interested in whether you can make connections between the three.
    • Potential Answer: The three financial statements are the balance sheet, income statement, and statement of cash flows.
      1. The balance sheet is a snapshot of a company’s assets, liabilities, and shareholders’ equity at a point in time. It’s prepared for its quarterly and annual financial statements filed with the SEC. The master equation of the balance sheet is Assets = Liabilities + Shareholders’ Equity.
      2. The income statement shows the company’s revenues and expenses earned and incurred over a period of time. Also called a profit and loss statement, the income statement shows how the fixed and variable operating and non-operating expenses impact the bottom line and are transformed into net income or net profit. Earnings per share can be determined by dividing the net income by the weighted average number of shares outstanding. The amount of net income flows to the retained earnings portion of the shareholders’ equity section of the balance sheet.
      3. The statement of cash flows shows all cash that flows into a company from ongoing operations and external investing, and cash that flows out from the company to pay for business costs and investments during a defined period. It functions as a bridge between the balance sheet and income statement by showing how money moved in and out of the business.
  1. If you could pick only one financial statement to evaluate a company, what would it be and why?
    • Purpose of the Question: This question is also confirmation of your knowledge of the financial statements and their purpose.
    • Potential Answer: A strong answer to this question would justify the cash flow statement as the one statement to choose. Why? Cash is king! The cost of goods sold (COGs) and the company’s fixed costs can determine whether the company is well positioned for success. If the cost to produce goods is high compared to the rest of the industry or for where the company is in its lifecycle, the outlook for the company may not be as good as it could be. Its business isn’t sustainable. Companies could look like they are booming based on their top line, but if they are bleeding cash, they aren’t viable for the long term.
  1. How would a $10 million decrease in depreciation affect the financial statements, assuming a 40% tax rate?
    • Purpose of the Question: This question dives deeper into your technical understanding and whether you can explain how changes in one financial statement affect another.
    • Potential Answers: Depreciation is a tax shield, as it reduces a company’s taxable income. With a decrease in depreciation, the tax shield is lost and expenses are lower, so “income” on the income statement effectively increases. However, if you earn more, you pay more taxes. If the tax rate is 40%, net income would only increase by $6 million because $4 million would go to taxes. This $6 million of net income is reported to the cash flow statement. With the decrease in depreciation of $10 million, the net effect on operating cash flow is a decrease of $4 million. ($6 million − $10 million = −$4 million).
  1. Walk me through a DCF.
    • Purpose: The interviewer wants to see if you understand one of the more common valuation methodologies.
    • Potential Answer: To score here, you should explain that a discounted cash flow consists of two components:
      1. the computation of the company’s free cash flows for a given period, called the projection period, and
      2. the determination of the company’s terminal value, which is the value of all of the company’s cash flows beyond the projection period into the future.

When these are determined, you’ll discount the free cash flows and terminal value back to today’s value using WACC as the discount rate. WACC is the weighted average cost of capital, or the weighted cost of the company’s debt and equity. The result of this computation is the company’s enterprise value.

Make It a Great Interview

Although a standout interview will rely on more than your technical skills, with these concepts firmly in mind you should be on your way to making a great impression on the technical portion. Check back for more interview tips from Knopman Marks so you can land your dream internship or full-time position.