Investment Banking Basics
1. What is investment banking?
Investment banking is a division of financial services that helps corporations, governments, and institutions raise capital and execute strategic transactions. Bankers act as intermediaries between issuers of securities and investors, providing advisory services on mergers, acquisitions, and capital markets activity. The two core functions are typically grouped into advisory work (such as M&A) and capital raising through equity and debt offerings.
2. What are the main divisions within an investment bank?
A bulge-bracket investment bank is generally organized into three broad areas: the front office, middle office, and back office. The front office includes investment banking division (IBD), sales and trading, and research, where revenue is directly generated. The middle office handles risk management and compliance, while the back office covers operations, technology, and settlement of trades.
3. What is the difference between the sell-side and the buy-side?
The sell-side refers to firms that create, promote, and sell securities or advisory services, including investment banks, brokerages, and research firms. The buy-side refers to institutions that purchase securities and assets for investment purposes, such as hedge funds, private equity firms, mutual funds, and pension funds. In simple terms, the sell-side sells products and advice while the buy-side allocates capital to those products.
4. What does an investment banking analyst actually do day to day?
An analyst spends most of their time building financial models, preparing pitch books, conducting company and industry research, and creating presentation materials for clients. They support deal execution by gathering data, running valuation analyses, and drafting documents like the confidential information memorandum (CIM). The role is detail-intensive, and analysts are expected to ensure that every number in a model and deck is accurate and internally consistent.
5. What is a pitch book?
A pitch book is a presentation document that bankers use to market their services and ideas to prospective or existing clients. It typically includes an overview of the bank's credentials, market and industry analysis, valuation summaries, and a proposed transaction strategy. Pitch books are used both to win new mandates (a "pitch") and to update clients on ongoing processes or market conditions.
6. What are the primary ways a company can raise capital?
A company can raise capital primarily through equity, debt, or hybrid instruments. Equity financing involves selling ownership stakes, such as through an IPO or a follow-on offering, while debt financing involves borrowing through bonds or loans that must be repaid with interest. The choice depends on factors like the company's existing capital structure, cost of capital, control considerations, and current market conditions.
7. What is the difference between equity capital markets (ECM) and debt capital markets (DCM)?
Equity capital markets (ECM) teams advise companies on raising money by issuing equity, such as IPOs, follow-on offerings, and convertible securities. Debt capital markets (DCM) teams focus on raising money through debt instruments like investment-grade bonds, high-yield bonds, and loans. Both sit within the capital markets function and work closely with industry coverage groups to structure and price the offerings.
8. What is an underwriting and how do banks earn fees from it?
Underwriting is the process by which an investment bank agrees to purchase securities from an issuer and resell them to investors, taking on the risk that the securities may not sell at the expected price. In a firm-commitment underwriting, the bank buys the entire issue and bears the placement risk, whereas in a best-efforts arrangement it only agrees to sell as much as possible. Banks earn an underwriting spread or fee, which is the difference between the price paid to the issuer and the price received from investors.
9. Why do you want to work in investment banking?
A strong answer connects genuine interest in finance and deal-making with the specific skills the role develops, such as financial analysis, attention to detail, and exposure to high-stakes transactions. Candidates should highlight their motivation to learn how companies are valued, financed, and restructured while working in a fast-paced, performance-driven environment. It helps to reference a specific deal, sector, or experience that sparked your interest rather than giving generic answers about prestige or compensation.
10. What makes a deal successful from a banker's perspective?
A successful deal is one that closes at terms aligned with the client's strategic and financial objectives while withstanding due diligence and regulatory scrutiny. From the banker's perspective, success also means accurate valuation, a smooth execution process, and strong relationships that lead to repeat business. Ultimately, a good outcome creates value for the client and reflects well on the bank's reputation and advisory quality.
Accounting & Financial Statements
11. What are the three main financial statements?
The three core financial statements are the income statement, the balance sheet, and the cash flow statement. The income statement shows revenue, expenses, and profitability over a period, the balance sheet presents assets, liabilities, and equity at a point in time, and the cash flow statement tracks the movement of cash across operating, investing, and financing activities. Together they give a complete picture of a company's financial performance and position.
12. How are the three financial statements connected?
Net income from the income statement flows into the cash flow statement as the starting point of operating cash flows and into the balance sheet through retained earnings. The cash flow statement reconciles the change in the cash balance, which then appears as the cash line on the balance sheet. Changes in balance sheet items like working capital and fixed assets drive adjustments on the cash flow statement, keeping all three statements fully linked.
13. If you could only use one financial statement to evaluate a company, which would you pick?
Most bankers would choose the cash flow statement because cash generation is ultimately what determines a company's ability to sustain operations, service debt, and create value. Unlike the income statement, it is harder to manipulate with accounting choices, and it reveals how much cash the business actually produces. While it lacks the full context of profitability and capital structure, cash flow is the clearest indicator of underlying financial health.
14. Walk me through what happens when depreciation increases by $10.
Assuming a 40% tax rate, a $10 increase in depreciation reduces pre-tax income by $10, lowering net income by $6 after the tax shield. On the cash flow statement, net income falls by $6 but depreciation of $10 is added back, so cash from operations rises by $4. On the balance sheet, cash increases by $4, net property, plant, and equipment falls by $10, and retained earnings decline by $6, keeping the statement in balance.
15. What is working capital and why does it matter?
Working capital is the difference between current assets and current liabilities, and it measures a company's short-term liquidity and operational efficiency. In modeling, changes in operating working capital (such as accounts receivable, inventory, and accounts payable) directly affect cash flow because an increase in net working capital ties up cash. Managing working capital well is important because excessive amounts can drain liquidity while too little can create solvency risk.
16. What is the difference between accounts payable and accrued expenses?
Both are current liabilities representing money the company owes, but accounts payable arise when the company has received an invoice from a vendor that it has not yet paid. Accrued expenses represent costs that have been incurred but not yet invoiced, such as wages earned but not yet paid or interest accrued but not yet due. The key distinction is that accounts payable are tied to received invoices while accrued liabilities are estimates of obligations that have built up over time.
17. What is deferred revenue and where does it appear?
Deferred revenue, also called unearned revenue, is cash a company receives before it has delivered the corresponding goods or services. It appears as a liability on the balance sheet because the company still owes the customer a product or service, and it is recognized as revenue on the income statement only when earned. This concept is common in subscription, software, and prepaid service businesses where customers pay upfront.
18. What is the difference between LIFO and FIFO inventory accounting?
FIFO (first-in, first-out) assumes the oldest inventory is sold first, while LIFO (last-in, first-out) assumes the most recently purchased inventory is sold first. In a period of rising prices, FIFO results in lower cost of goods sold and higher reported profits, whereas LIFO produces higher cost of goods sold and lower taxable income. The choice affects both reported earnings and the value of inventory remaining on the balance sheet.
19. What is goodwill and how does it arise?
Goodwill is an intangible asset that arises when one company acquires another for a price greater than the fair value of its identifiable net assets. It represents the premium paid for items like brand reputation, customer relationships, and synergies that are not separately recorded on the balance sheet. Goodwill is not amortized under current standards but is tested annually for impairment, which can result in a write-down if the acquired business underperforms.
20. How would a $10 increase in inventory purchased with cash affect the statements?
There is no immediate impact on the income statement because purchasing inventory is not an expense until the goods are sold. On the cash flow statement, the increase in inventory reduces cash from operations by $10. On the balance sheet, inventory rises by $10 while cash falls by $10, so total assets and the overall balance remain unchanged.
Valuation Methods
21. What are the main approaches to valuing a company?
The three most common approaches are comparable company analysis, precedent transactions analysis, and discounted cash flow (DCF) analysis. Comparable company analysis values a business using trading multiples of similar public companies, while precedent transactions uses multiples paid in past M&A deals. The DCF derives value from the present value of projected future cash flows, and bankers typically triangulate across all three methods.
22. What is comparable company analysis?
Comparable company analysis, often called "comps" or "trading comps," values a company based on how similar publicly traded companies are currently priced by the market. Bankers select a peer set with similar industry, size, and growth profiles, then apply valuation multiples such as EV/EBITDA or P/E to the target's metrics. This method reflects current market sentiment but does not capture control premiums since it uses minority-stake trading prices.
23. What is precedent transactions analysis?
Precedent transactions analysis values a company by examining the multiples paid in comparable past acquisitions of similar businesses. Because these transactions involve a change of control, the multiples typically include a control premium and reflect synergies the acquirer expected to realize. As a result, precedent transaction values are usually higher than trading comparables, though they may be less relevant if market conditions have changed since the deals occurred.
24. What is the difference between enterprise value and equity value?
Equity value represents the value attributable to a company's shareholders, calculated as share price times diluted shares outstanding. Enterprise value represents the total value of the business to all capital providers and is calculated as equity value plus debt, preferred stock, and minority interest, minus cash and equivalents. Enterprise value is capital-structure neutral, which makes it useful for comparing companies with different levels of debt.
25. Why do you subtract cash when calculating enterprise value?
Cash is subtracted because it is a non-operating asset that an acquirer could effectively use to reduce the net purchase price of the business. Enterprise value is meant to represent the cost of acquiring the core operating business, so cash on hand offsets the debt or purchase price that would otherwise be required. Conceptually, the buyer could pay down debt or recoup part of the price using the target's existing cash.
26. What are some common valuation multiples and when do you use them?
Common multiples include EV/EBITDA, EV/EBIT, EV/Revenue, and P/E (price-to-earnings). EV-based multiples are paired with metrics available to all capital providers, like EBITDA, while equity-based multiples like P/E are paired with metrics after interest and taxes that belong to shareholders. The appropriate multiple depends on the industry, with EV/Revenue often used for unprofitable high-growth companies and P/E common for mature, stable businesses.
27. Why is EV/EBITDA often preferred over P/E?
EV/EBITDA is often preferred because it is capital-structure neutral and excludes the effects of differing tax rates, depreciation policies, and financing decisions. This allows for cleaner comparisons across companies with different debt levels and accounting treatments. The P/E ratio, by contrast, is affected by leverage and non-operating items, which can distort comparisons between otherwise similar firms.
28. Which valuation method typically produces the highest valuation?
There is no fixed answer, but precedent transactions often produce higher valuations because they include control premiums and synergy expectations. A DCF can also produce a high value if optimistic growth or terminal assumptions are used, since it is highly sensitive to inputs. Comparable company analysis tends to be lower because it reflects minority trading prices without a control premium.
29. How would you value a private company?
Valuing a private company uses similar methods, but it requires adjustments because there is no public share price and financial data may be limited. Bankers rely on comparable public companies and precedent transactions while often applying a discount for lack of marketability and liquidity. A DCF can also be used, though estimating an appropriate cost of capital is more challenging without observable market data.
30. What is a "football field" chart in valuation?
A football field chart is a horizontal bar chart that displays the range of valuations produced by different methodologies side by side. Each bar represents the low-to-high range from a method such as comps, precedent transactions, or DCF, allowing the audience to compare them visually. It helps clients and bankers see where the methods overlap and arrive at a reasonable valuation range for negotiation.
DCF Analysis
31. Walk me through a discounted cash flow analysis.
A DCF estimates a company's value by projecting its unlevered free cash flows over a forecast period, typically five to ten years, and discounting them to present value. You then calculate a terminal value to capture cash flows beyond the explicit forecast and discount that back as well, using the weighted average cost of capital (WACC) as the discount rate. Summing the present value of the projected cash flows and the terminal value gives the enterprise value, from which you can derive equity value.
32. What is free cash flow and how do you calculate unlevered free cash flow?
Free cash flow is the cash a company generates after accounting for operating expenses and capital expenditures, representing cash available to investors. Unlevered free cash flow is calculated by starting with EBIT, applying taxes to get net operating profit after tax, adding back depreciation and amortization, subtracting capital expenditures, and adjusting for changes in net working capital. It is "unlevered" because it is calculated before the impact of interest and debt, making it available to all capital providers.
33. What is WACC and how is it calculated?
The weighted average cost of capital (WACC) is the blended required rate of return for all of a company's capital providers, weighted by the proportion of debt and equity in its capital structure. It is calculated as the cost of equity times the equity weight plus the after-tax cost of debt times the debt weight. WACC is used as the discount rate in an unlevered DCF because the unlevered cash flows belong to both debt and equity holders.
34. How do you calculate the cost of equity?
The cost of equity is most commonly estimated using the Capital Asset Pricing Model (CAPM), which adds the risk-free rate to the product of the company's beta and the equity risk premium. The risk-free rate is typically the yield on a long-term government bond, beta measures the stock's volatility relative to the market, and the equity risk premium is the expected excess return of the market over the risk-free rate. The formula is cost of equity equals risk-free rate plus beta times equity risk premium.
35. What is beta and what is the difference between levered and unlevered beta?
Beta measures the sensitivity of a stock's returns to movements in the overall market, with a beta of 1.0 indicating it moves in line with the market. Levered beta reflects both business risk and the additional risk from a company's debt, while unlevered beta removes the effect of leverage to isolate business risk. In a DCF, bankers often unlever the betas of comparable companies and then relever using the target's capital structure to get an appropriate beta.
36. What are the two main methods for calculating terminal value?
The two methods are the Gordon Growth (perpetuity growth) method and the exit multiple method. The Gordon Growth method assumes free cash flows grow at a constant rate forever and divides the final year's cash flow by WACC minus the growth rate. The exit multiple method applies a market-based multiple, such as EV/EBITDA, to a terminal-year metric to estimate the business's value at the end of the forecast period.
37. What is a reasonable terminal growth rate to use?
A reasonable terminal growth rate is typically aligned with the long-term expected growth rate of the broader economy, often in the range of 2% to 3% in developed markets. It should never exceed the long-run GDP or inflation rate plus real growth, because no company can grow faster than the overall economy indefinitely. Using too high a terminal growth rate is a common error that significantly overstates the valuation.
38. Why is terminal value often such a large portion of a DCF valuation?
Terminal value frequently represents 60% to 80% of the total enterprise value because it captures all cash flows beyond the explicit forecast period, which extends into perpetuity. Since the forecast horizon is usually only five to ten years, the vast majority of a company's value lies in its long-term future cash generation. This is why the terminal value assumptions are scrutinized heavily and why sensitivity analysis around them is essential.
39. How does an increase in WACC affect the DCF valuation?
An increase in WACC raises the discount rate, which reduces the present value of both the projected cash flows and the terminal value. Because cash flows in the future are discounted more heavily, the overall enterprise value declines as WACC rises. This inverse relationship makes the DCF highly sensitive to the discount rate, so small changes in WACC assumptions can meaningfully shift the valuation.
40. What are the main strengths and weaknesses of a DCF?
The main strength of a DCF is that it is grounded in a company's intrinsic ability to generate cash and is less dependent on current market sentiment than multiples-based methods. Its primary weakness is its sensitivity to assumptions, particularly growth rates, margins, and the discount rate, which can produce widely varying outputs. Because of this, a DCF is best used alongside comparable company and precedent transaction analyses rather than in isolation.
M&A and Deal Processes
41. What is the difference between a merger and an acquisition?
A merger occurs when two companies combine to form a new single entity, typically among parties of relatively similar size, often described as a "merger of equals." An acquisition occurs when one company purchases and absorbs another, with the acquirer remaining the surviving entity. In practice the terms are often used interchangeably, but the legal and structural distinction lies in whether a new entity is created or one company takes control of another.
42. What is the difference between a stock sale and an asset sale?
In a stock sale, the buyer purchases the target company's shares and assumes ownership of all its assets and liabilities, including any hidden or contingent ones. In an asset sale, the buyer selects specific assets and liabilities to acquire, leaving the rest with the seller, which provides more protection against unknown liabilities. Buyers often prefer asset sales for the liability protection and stepped-up tax basis, while sellers usually prefer stock sales for simpler tax treatment.
43. What are synergies and what types exist in M&A?
Synergies are the additional value created when two companies combine that exceeds the sum of their standalone values. Cost synergies come from eliminating redundant operations, such as consolidating facilities, headcount, or procurement, while revenue synergies come from cross-selling products or accessing new markets. Cost synergies are generally considered more reliable and easier to quantify than revenue synergies, which are often viewed skeptically by analysts.
44. What does it mean for a deal to be accretive or dilutive?
A deal is accretive if it increases the acquirer's earnings per share (EPS) after the transaction and dilutive if it decreases EPS. Accretion or dilution depends on the relative valuations of the two companies, the form of consideration (cash, debt, or stock), and the financing costs involved. A common rule of thumb is that if the acquirer's P/E is higher than the target's, an all-stock deal will generally be accretive.
45. Why might a company choose to pay with stock instead of cash in an acquisition?
A company may pay with stock when it believes its own shares are fairly or overvalued, allowing it to preserve cash and avoid taking on additional debt. Stock consideration also shares transaction and integration risk with the target's shareholders, who retain an interest in the combined entity. However, issuing stock dilutes existing shareholders and can signal that management views the shares as expensive, so the decision balances financing flexibility against ownership dilution.
46. What are the main steps in a typical sell-side M&A process?
A sell-side process usually begins with preparation, including drafting marketing materials like the teaser and confidential information memorandum (CIM) and identifying potential buyers. The bank then contacts buyers, manages the exchange of information through a data room, and solicits initial non-binding indications of interest. The process advances through management presentations, due diligence, and final binding bids, culminating in negotiation of the purchase agreement and closing.
47. What is due diligence and why is it important?
Due diligence is the in-depth investigation a buyer conducts to verify the target's financial, legal, operational, and commercial condition before completing a transaction. It is important because it confirms the assumptions underlying the valuation, uncovers risks or liabilities, and informs the structure and terms of the deal. Findings from due diligence can lead to price adjustments, additional warranties, or even termination of the transaction if material issues emerge.
48. What is a hostile takeover and how can a company defend against it?
A hostile takeover occurs when an acquirer attempts to gain control of a target against the wishes of its board of directors, often by appealing directly to shareholders through a tender offer or proxy fight. Defensive measures include the "poison pill," which allows existing shareholders to buy discounted shares to dilute the acquirer, as well as staggered boards, white knights, and golden parachutes. These defenses are designed to make the takeover more expensive or difficult so the board can negotiate better terms or remain independent.
LBO & Leveraged Finance
49. What is a leveraged buyout (LBO)?
A leveraged buyout is the acquisition of a company using a significant amount of borrowed money, with the target's assets and cash flows often used to secure and repay the debt. Private equity firms use LBOs to acquire businesses with a relatively small equity contribution, amplifying returns through the use of leverage. The firm typically improves operations and pays down debt over a holding period of three to seven years before exiting through a sale or IPO.
50. What characteristics make a company a good LBO candidate?
An ideal LBO candidate has stable and predictable cash flows that can reliably service a heavy debt load, along with low existing leverage and strong margins. Other attractive features include a strong market position, low capital expenditure requirements, opportunities for operational improvement, and tangible assets that can serve as collateral. A clear path to exit and the potential for value creation through cost reductions or growth initiatives also make a target appealing to private equity buyers.