Finance interview questions you need to know
With the start of a new academic year, we know that finance interviews are again at the forefront of many of your minds. This article is part of a series on the most frequently asked technical finance interview questions and answers across a variety of topics.
If you’re looking for interview prep resources beyond this article, be sure to take a look at our interview prep training package, and if you feel as though your technical skills need some strengthening ahead of your interview, our financial modeling training will get you where you need to be. Without further ado …
Table of Contents
- 1. How do you value a company?
- 2. What is the appropriate discount rate to use in an unlevered DCF analysis?
- 3. What is typically higher – the cost of debt or the cost of equity?
- 4. How do you calculate the cost of equity?
- 5. How would you calculate beta for a company?
- 6. How do you calculate unlevered free cash flows for DCF analysis?
- 7. What is the appropriate numerator for a revenue multiple?
- 8. How would you value a company with negative historical cash flow?
- 9. When should you value a company using a revenue multiple vs. EBITDA?
- 10. Two companies are identical in earnings, growth prospects, leverage, returns on capital, and risk. Company A is trading at a 15 P/E multiple, while the other trades at 10 P/E. which would you prefer as an investment?
1. How do you value a company?
This question, or variations of it, should be answered by talking about 2 primary valuation methodologies: Intrinsic value (discounted cash flow valuation), and Relative valuation (comparables/multiples valuation).
Intrinsic value (DCF)
This approach is the more academically respected approach. The DCF says that the value of a productive asset equals the present value of its cash flows. The answer should run along the line of “project free cash flows for 5-20 years, depending on the availability and reliability of information, and then calculate a terminal value.
Discount both the free cash flow projections and terminal value by an appropriate cost of capital (weighted average cost of capital for unlevered DCF and cost of equity for levered DCF). In an unlevered DCF (the more common approach) this will yield the company’s enterprise value (aka firm and transaction value), from which we need to subtract net debt to arrive at equity value. Divide equity value by diluted shares outstanding to arrive at equity value per share.
Relative valuation (Multiples)
The second approach involves determining a comparable peer group – companies that are in the same industry with similar operational, growth, risk, and return on capital characteristics. Truly identical companies of course do not exist, but you should attempt to find as close to comparable companies as possible. Calculate appropriate industry multiples.
Apply the median of these multiples on the relevant operating metric of the target company to arrive at a valuation.Common multiples are EV/Rev, EV/EBITDA, P/E, P/Book, although some industries place more emphasis on some multiples vs. others, while other industries use different valuation multiples altogether. It is not a bad idea to research an industry or two (the easiest way is to read an industry report by a sell-side analyst) before the interview to anticipate a follow-up question like “tell me about a particular industry you are interested in and the valuation multiples commonly used.”