Not necessarily. Seasonal working capital—current assets minus liabilities—spikes in businesses tied to cycles (e.g., a clothing brand peaking in winter). More cash gets tied up in inventory or AR, raising liquidity risk if trends shift or collections lag. It’s manageable with a solid revolver and predictable patterns—not a killer, just a watchpoint.

Switch LIFO to FIFO in rising costs for lower COGS; liquidate LIFO layers; shift fair value hedges to cash flow hedges; tweak depreciation (longer lives); loosen revenue recognition (boost AR with easy credit); capitalize questionable R&D or interest; use options over cash pay; or book one-time gains. AR tricks—like aggressive credit—pad revenue now, defer pain later.

“No income, no job, no assets”—subprime loans with minimal vetting, often to shaky borrowers. They fueled the housing bubble, bundled into CDOs, and crashed when the market oversupplied and slowed—lending standards’ warning sign.

It’s debt insurance—unregulated, over-the-counter. The buyer pays the seller yearly; if the company defaults, the seller pays out. Buyers hedge or speculate; sellers (banks, funds) pocket premiums. It’s a bet on distress—valuable when risk spikes.

A CDO bundles interest-paying assets (loans, bonds) into bonds sold to investors, who get coupon payments from the cash flows. It’s securitization—spreading risk, promising diversification, but dicey if the assets sour.

An MBS pays investors from mortgage cash flows—banks play middleman, letting investors fund homeowners. Many got AAA ratings pre-crisis, assuming housing wouldn’t tank universally. Oops.

It’s pooling assets (loans, mortgages) into a new financial instrument, sliced into tiers for sale. It turns illiquid stuff into tradable securities—spreading risk, raising cash.

NOL: Deductions exceed income, yielding negative taxable income—more expenses than revenue. Carryforward: Apply it to offset taxes up to 20 years ahead. Carryback: Recover taxes paid up to 2 years back. It’s a tax lifeline.

Record at net present value of future cash flows. Premium (coupon > rate): Interest revenue = rate × (face + premium – amortized amount). Discount (coupon < rate): Interest revenue = rate × (face – discount – amortized amount). It’s about time value.

Deferred taxes bridge GAAP vs. tax depreciation (e.g., MACRS). Deferred tax asset (DTA): You’ve paid more tax than booked—future offset. Deferred tax liability (DTL): You’ve paid less—future catch-up. They’re balance sheet placeholders.

It’s how long cash is tied up from inventory to sales to collection, in days. CCC = Days Inventory Outstanding (DIO) + Days Receivables Outstanding (DRO) – Days Payables Outstanding (DPO). Shorter is better—frees up cash faster.

DIO = (Inventory / COGS) × 365. It’s how long inventory sits before selling—lower means faster turnover. High DIO flags excess stock; compare to industry norms.

DRO = (Receivables / Sales) × 365. It’s the average days to collect AR—low is efficient, high suggests credit lag. A high ratio means free loans to customers; reassess credit policy.

DPO = (Accounts Payable / COGS) × 365. It’s how long you take to pay suppliers—longer delays cash outflow. Rising DPO means faster payments; falling means slower.

Asset Turnover = Revenue / Assets. It measures how efficiently assets generate sales—higher is better. Low-margin firms tend to have high turnover; high-margin ones, low.

Extraordinary: Rare and unusual (e.g., hurricane), post-tax, below the line. Special: Unusual or infrequent (e.g., layoffs), pre-tax, in operating income. One’s a freak event; the other’s a notable hiccup.

Passed in 2002 post-scandals, it tightened accounting rules for public firms—more controls, transparency. Supporters say it rebuilds trust; critics argue it burdens smaller companies with compliance costs.

EBIT drops $10 million, net income falls $6 million (40% tax), but free cash flow rises $4 million (depreciation added back). Valuation increases by the present value of $4 million—$4 / (1 + WACC)^4.

Purchase: Record acquisition at fair value, goodwill emerges—used now. Pooling: Combine book values, no goodwill—banned since 2001. Pooling was for “mergers of equals”; purchase fits most deals.

Strip it out as a one-time item—add back $12 million to net income (40% tax)—to reflect ongoing operations. It’s about showing the “normal” earnings baseline.

Capitalizing to expensing: Income statement—higher expenses now, lower net income. Cash flow—lower operating cash (no tax shield yet), but no investing outflow. Balance sheet—less assets, lower equity. Reverse for expensing to capitalizing—profits up, assets up, cash shifts.

I’d like you to summarize the transaction and highlight your contributions. Ideally, showcase how you went beyond your job title. For example, if you were an analyst in investment banking, maybe you built the financial model from scratch. If you were a vice president, share how you juggled daily oversight while keeping senior leadership informed of the big picture.

Growth could come from internal operations (organic), acquisitions, or financial restructuring (like recapitalization). Take a pharmaceutical company as an example: its revenue hinges on patented drugs. When a patent secures a monopoly, prices soar, but once it expires, growth depends on new drugs—either developed in-house or acquired. Consider trends like an aging population boosting demand for certain medications. What fueled this deal’s growth, and how was it executed?

Explain the “why” behind the deal. What strategic goals did it aim to achieve—market expansion, cost synergies, or something else? Paint a clear picture of the reasoning that justified the transaction.

Tell a story about what made this deal shine—maybe it was a smart strategic fit or a chance for outsized returns. Back it up with specifics like projected growth rates or margin improvements. Then, shift gears: what were the hurdles? Focus on strategic risks, but feel free to weave in personal angles—like a great team or a tough learning curve—if it fits.

Walk me through the valuation process. You’ve got three core methods: discounted cash flow (DCF) for intrinsic value, trading comps for market benchmarks, and acquisition comps for transaction context. If it’s a private equity deal, toss in the LBO approach (a DCF variant). Explain how each method shaped the final number and how the market might view it based on comps.

Don’t trip over this one—it’s a classic oversight. Comps are picked based on similarities to the target: industry, region, cash flow patterns, and capital structure. Lay out the key multiples—like P/E, EV/EBITDA, D/E, or EV/sales for unprofitable firms. Tell me which companies you chose and what their trading levels were.

Break down the price-to-cash-flow metrics. Was it enterprise value or equity value divided by something like EBITDA? This gives a snapshot of the deal’s valuation relative to its cash-generating ability.

For an M&A deal, sources are the financing mix—debt, equity, cash, or option proceeds. Uses cover the purchase price, transaction fees, or debt repayment. Explain why this mix was chosen and detail the financing layers (e.g., senior vs. mezzanine debt) and their costs (interest rates or stock exchange ratios). For an offering, tie it to the instrument’s structure and purpose—like funding growth or paying down debt.

Show me the numbers that reveal the capital structure’s health: debt, EBITDA, capex, interest, and FFO. Combine them into ratios like debt/EBITDA (leverage), EBITDA/interest (coverage), or (EBITDA – Capex)/interest. For PE folks, this is gold—debt/EBITDA of 6.0x means six years to pay off debt at constant EBITDA. High leverage ratios signal risk; high coverage ratios signal safety (e.g., EBITDA/interest should stay above 2.0x).

If this was a public company acquisition, compare the offer price per share to the market price before the deal. Premiums typically range from 10% to 30%, but outliers exist. Argue whether it made sense—did the price exceed intrinsic value, or was it a bargain?

Focus on the internal rate of return (IRR)—cash inflows versus the initial outlay over time. Specify if it’s unlevered (for debt and equity holders) or levered (equity only, boosted by debt’s tax shield). What did the numbers promise?

Describe the Excel model that tied it all together: cash flows, financing, returns, and scenarios. Start with key line items leading to cash flow, then show how the transaction—like new debt or accounting tweaks—altered it. Prove you grasp how the pieces connect to the final output.

Cover historical patterns, current dynamics, and where the industry’s headed. Know the competitors—how they trade relative to the target—and whether the target should outpace, lag, or match its peers. If I throw in a curveball about an unfamiliar industry, stay poised and reason it out. I might just want to brainstorm with you.

Demonstrate you’ve mastered the company’s nuts and bolts. Share historical and projected financials: revenue growth, EBITDA growth, net income growth, and margins. Then, zoom out—how much market share do they command? Who’s buying, and who’s supplying?

Test the company’s durability. Fixed costs and maintenance capex are non-negotiable, even in tough times, while variable costs and growth capex can flex. A heavy fixed-cost burden raises risk—how does this company stack up?

Even if this was a solid deal, was there a better option? Great investors are picky. Highlight other targets that might’ve offered more growth or less risk, and explain why.

Bring a sharp, well-supported take. Was it a win? Lean on data—growth projections, comps, or post-deal performance—to make your case. Tie it to earlier answers for depth.

If you’re sell-side (banker or consultant), dig into what happened after your role ended—check stock performance or analyst reports if it’s public. Sell-side often moves on post-close, but buy-side tracks it to the exit. For traders or PE/HF folks, detail your track record: entry price, exit price, return percentage, and holding period.

Sellers love auctions for bidder competition; buyers prefer private sales or limited auctions to dodge rivals and keep prices down. But a private sale can reassure a committed buyer, raising closing odds. What drove this deal’s approach?

In a private sale, name aggressive players who might’ve bid higher. Even in an auction, a lower bid might win for certainty. Why would someone pay more—lower return hurdles or better cash flow potential? Strategic buyers might unlock synergies, while financial buyers (PE) juice returns with leverage. Who could’ve topped it?

Weave a narrative around the deal’s wins—think strategic fit, financial upside, or market positioning. Don’t just list; connect the dots. Support each point with hard evidence: growth rates, margins, or synergies. Show you’re not just parroting a CIM—you’ve internalized it.

Precedent Transactions (M&A Comps): This approach often results in a higher valuation compared to the Comparable Company method. When a company is acquired, the purchase price typically exceeds its current stock price due to a “control premium” (approximately 20%), reflecting the value of controlling the company. Additionally, if the buyer anticipates synergies, they may pay a synergy premium, further elevating the valuation. This control-based method contrasts with the minority interest-based public market valuation of Comparable Companies.

Discounted Cash Flow (DCF): Generally, DCF tends to produce higher valuations than Comparable Companies because it is also a control-based method where assumptions (often optimistic) about future cash flows drive the outcome. However, whether DCF exceeds Precedent Transactions depends on the inputs; DCF valuations are notably variable due to their sensitivity to assumptions like discount rates and growth projections.

Comparable Companies: This method relies on market trading multiples of similar firms, excluding control premiums or synergies, typically leading to lower valuations compared to control-based approaches.

Leveraged Buyout (LBO): Compared to DCF, LBO valuations are usually lower because they use a higher discount rate (required IRR, reflecting the cost of equity in a leveraged structure) versus the Weighted Average Cost of Capital (WACC) in DCF, which includes cheaper debt. Interviewers typically expect you to note that DCF and Precedent Transactions yield higher valuations than Comparable Companies and LBO due to the control premium and optimistic assumptions.

The ideal approach depends on context. A robust valuation often “triangulates” the three main methods—Precedent Transactions, Comparable Companies, and DCF—to arrive at a range. However, certain scenarios may justify favoring one method:

• DCF: Preferred when a company differs significantly from peers (e.g., unique growth or risk profile) and reliable cash flow projections are available.
• Comparable Companies: Useful when few precedent transactions exist or when the market has shifted since past deals (e.g., 2006 valuations inflated by leverage availability).

Precedent Transactions: Valuable when recent, relevant M&A data is available but may be less reliable if market conditions have changed.

Calculate a valuation range for each method—DCF, Comparable Companies, and Precedent Transactions—then triangulate these ranges to determine a final range for the company or asset. You might weight one or two methods more heavily if they seem more reliable. For instance, if you have strong comparable companies and precedent transactions but doubt your DCF projections, emphasize the former over the latter.

The most effective way to value a company is to blend all methods and refine the result into a cohesive valuation. If a precedent transaction feels highly relevant, it can carry more weight. Similarly, confidence in your DCF projections might tilt the balance toward that method. Valuation is as much an art as a science, requiring judgment to weigh the methods appropriately.

Liquidation Valuation: Assesses a company’s value by estimating proceeds from selling its assets and subtracting liabilities, determining residual value for equity holders.

Replacement Valuation: Values a company based on the cost to replicate its assets.

LBO Analysis: Estimates the price a private equity firm could pay to achieve a target IRR (typically 20-30%).

Sum-of-the-Parts (SOTP): Values each business segment separately using tailored comparables, then sums them for a total value.

Use SOTP when a company operates diverse, unrelated divisions (e.g., General Electric). Each segment is valued independently with its own set of comparable companies, and the results are aggregated for a combined valuation.

This method is typically used in bankruptcy scenarios to assess whether equity holders would receive proceeds after debts are settled. It helps struggling firms decide between selling assets individually or the entire business.

• P/E Ratio: Price per share divided by earnings per share; criticized for including interest and taxes, which may vary post-acquisition.
• TEV/Sales: Useful for understanding high market caps of low-profit firms.
• TEV/EBITDA: A widely used metric in banking for its focus on operating performance.
• EV/EBIT: Similar to TEV/EBITDA but includes depreciation and amortization.
• P/BV: Price to book value, often used for financial institutions. Note: The most relevant metric varies by industry.

The P/E ratio (price per share / earnings per share) gauges how the market values a company relative to its earnings (past 12 months or next 12 months) compared to peers. Analysts may refine this with the PEG ratio (P/E divided by growth rate) to account for growth differences.

EPS = (Net Income – Preferred Stock Dividends) / Common Shares Outstanding. It measures profit allocated to each common share after taxes and preferred obligations. Fully diluted EPS includes potential dilution from options, warrants, and convertibles, while basic EPS excludes these.

Convertible bonds trade at a premium to common stock due to their conversion option, lower transaction costs, and conversion delay, which add value. Preferred stock’s pricing depends on its features but often carries a fixed dividend, aligning it closer to debt than common equity.

• EV/Earnings: Enterprise Value (EV) reflects the total value to all capital providers and is capital-structure-neutral (unlevered). Earnings, however, include interest (levered), making this an inconsistent “apples-to-oranges” comparison. Metrics like Sales, EBIT, or EBITDA (unlevered) pair correctly with EV.
• Price/EBITDA: Price (equity value) is levered, reflecting capital structure, while EBITDA is unlevered, creating another mismatched comparison. Price/Earnings works because both are levered.

• Stock repurchase program.
• Dividend increase.
• Structural or strategic actions (e.g., M&A, divestitures).

• Enterprise Value (EV): Represents the total value of a company’s operations to all capital providers (debt and equity holders).
• Equity Value: A subset of EV, reflecting only the value attributable to shareholders, commonly seen in market capitalization.

EV captures the total value of a firm to all investors. Formula:
TEV = Market Value of Equity (MVE) + Debt + Preferred Stock + Minority Interest – Excess Cash.

MVE = Share Price × Fully Diluted Shares Outstanding.

• FCFF (Unlevered): Available to all capital providers: EBITDA – Taxes – Capital Expenditures – Increase in Net Working Capital. Alternatively: EBIT(1 – T) + Depreciation & Amortization (D&A) – Capex – Change in NWC. Discount with WACC to find EV.
• FCFE (Levered): Available to equity holders: FCFF – Interest – Required Debt Amortization +/– Net Debt Issuance. Discount with cost of equity to find equity value.

FCF is the cash a company generates after covering operating expenses and capital investments, available for distribution to investors or reinvestment.

FCF = Net Income + D&A – Capex – Change in Net Working Capital (NWC).

UFCF = EBITDA – [EBIT(1 – T)] – Capex – Change in NWC.

• Assumes a stable capital structure over time.
• Estimating an appropriate terminal growth rate is challenging.
• Designed for project valuation, its application to entire firms can be less precise.

• Discount projected UFCF at the unlevered cost of equity (rU, derived via CAPM).
• Separately discount the debt tax shield (DTS = Tax Rate × Cost of Debt × Debt) or approximate as APV w/o DTS × Tax Rate × Debt-to-Value Ratio.
• Sum the present values of UFCF and DTS.

• WACC: Incorporates tax shields into the discount rate, suited for stable capital structures, using historical balance sheet data.
• APV: Adds tax shield value to an all-equity NPV, ideal for complex financing or changing capital structures (e.g., LBOs). Its drawback is difficulty in estimating financial distress costs.

• Basic Shares: Current outstanding common shares.
• Fully Diluted Shares: Basic shares plus potential shares from options, warrants, or convertibles. Use diluted shares for MVE to reflect market valuation.

• Cash is netted against debt to calculate net debt:
• It’s a non-operating asset.
• Market cap implicitly includes cash.
• In acquisitions, cash reduces the effective purchase price by offsetting debt or funding dividends. This assumes all cash is excess, which may not hold if significant cash is needed for operations.

• Relative Valuation: Compare to similar apple trees’ market values.
• Intrinsic Valuation: Discount projected cash flows from apple sales.

• Industry classification.
• Financial metrics (e.g., revenue, EBITDA).
• Geographic relevance. Precedent transactions are typically limited to the past 3-4 years.

When a parent company owns >50% of a subsidiary, it consolidates 100% of the sub’s financials, but minority interest reflects the portion of the sub’s equity not owned by the parent. Adding it to EV ensures valuation metrics (e.g., EV/EBITDA) align with consolidated operating figures (100% of EBITDA), maintaining consistency. Adjusting operating metrics instead is theoretically viable but impractical due to limited subsidiary data.

Earnings Before Interest, Taxes, Depreciation, and Amortization—a proxy for operating cash flow. It’s key in debt investing (less so for equity) as it removes financing and accounting distortions, aiding cross-firm comparisons.

1. Project Unlevered Free Cash Flows (e.g., 5 years): UFCF = EBIT(1 – T) + D&A – Capex – Change in NWC.

2. Determine WACC: (E/V) × rE + (D/V) × rD × (1 – T) + (P/V) × rP.

3. Estimate Terminal Year (TY) Value:

• Terminal Multiple: Apply an EBITDA multiple (from comps) to year 5 EBITDA.

• Gordon Growth: TY Value = UFCF5 × (1 + g) / (WACC – g), using a modest growth rate (~3%).

4. Discount UFCF and TY Value to present using WACC, summing to get EV.

WACC is the blended cost of capital (debt, equity, preferred) used to discount cash flows in DCF, reflecting the firm’s risk.
Formula: WACC = (E/V) × rE + (D/V) × rD × (1 – T) + (P/V) × rP.

• rP (cost of preferred): Based on dividend yields.

• rE (cost of equity): Estimated via CAPM.

• rD (cost of debt): Based on yields of similar debt.

• Unpredictable cash flows (e.g., tech startups).
• Firms where debt and working capital function uniquely (e.g., banks, where debt isn’t reinvested and WC is significant).

• Using CAPM: rE = Risk-Free Rate (rF) + Beta × Equity Risk Premium (rM – rF).
• rF: 10- or 20-year U.S. Treasury yield.
• Beta: Levered, measuring stock risk vs. the market.
• Equity Risk Premium: ~6-7%, stocks’ expected outperformance over rF.

• Beta measures a stock’s volatility relative to the market (e.g., S&P 500, Beta = 1). Beta > 1 indicates higher risk (e.g., tech); Beta < 1 indicates lower risk (e.g., utilities). Calculated as Covariance(Stock, Market) / Variance(Market).

Debt increases equity risk by:

• Raising bankruptcy risk.
• Limiting funds for growth.
• Reducing managerial flexibility.
  Thus, levered Beta exceeds unlevered Beta.

A company may consider acquiring another if it believes the acquisition will improve
its overall position. For instance:

The Seller’s asking price is lower than its Implied Value, which is the Present Value
of its projected future cash flows.

The anticipated Internal Rate of Return (IRR) from the deal surpasses the Buyer’s
Discount Rate.

Buyers often pursue acquisitions to cut costs through consolidation and economies
of scale, expand into new regions or increase market share, gain access to new
customers or distribution networks, or broaden their product and service offerings.
Synergies—such as the ability to lower costs through streamlined operations or
increase revenue through enhanced sales opportunities—also drive many
transactions.

Calculating an IRR for the transaction and comparing it to the Company hurdle rate. If it
exceeds the hurdle rate, the project will create value, and if not, it will destroy value.

EPS GAAP and Cash Accretion / Dilution analysis is an alternative way to analyze the
merits of an acquisition. Buyers look for either immediately accretive deals, or line of site
to accretion.

First you start by creating a sources and uses, detailing the sources of funding (ie. Cash,
debt, equity) used to fund the transaction.
You then create a purchase price allocation schedule to determine effects of the deal on
the financial statements (ie. This is when you would determine the amount of Goodwill
created in the deal and the intangible asset allocation for which you can amortize)
You then combine balance sheets of the perspective target and the acquirer, reflecting the
funding source components (ie. Cash, debt, equity) and pro forma capitalization.

A deal is accretive when the incremental acquired pre-tax income exceeds any foregone
interest in cash, interest on new debt, and any incremental shares issued to fund the
deal

By comparing yields, or the “inverse” of a buyer and seller’s P/E multiple. For example, if
Company A with a P/E of 20x is acquiring Company B at 10x in a 100% stock transaction,
with no other information provided, the deal will be accretive because Company B’s yield is
10% (1÷10) vs. Company A 5% (1÷20).

In some cases, ie. If both companies do not generate positive net income, EPS is not a
factor. When they do, EPS is the most comprehensive metric to compare for accretion
purposes because it includes interest and pro forma shares.

Standard methodologies, such as DCF, LBO, trading comparables, and transaction comps
should be employed to triangulate and determine the fair purchase price for a company.

If the company is public, typically a premium is warranted for the Seller to tender shares. In
an all cash or majority cash transaction, this premium is lower (think 20-50% as an
example). In an all, or majority stock transaction, the premium is typically lower. The reason
being is that there are less taxes in a stock deal, and by trading shares, you are offering
upside in the pro forma Company post-transaction.

Cash is the cheapest way to fund a transaction (since cash online yields a small amount of
interest income, so an acquirer may opt to using cash subject to it’s minimum cash balance
required to fund near term obligations. Advantages: cash transactions are faster since you
do not need to access the capital markets. Furthermore, you do not have to cede ownership
control of the business. Disadvantages: using cash can affect your pro forma net leverage
multiple and also restrict the business from deploying cash for other projects such as capital
expenditures. Furthermore, if cash is held in accounts in different countries, there exists
repatriation taxes to access the funds.

Debt is typically the second cheapest option (more expensive than cash because it comes
with interest, and cheaper than stock because debtholders have claim to assets ahead of
equity holders). Advantages: debt also preserves ownership and control compared to
equity financing and it creates a tax shield on interest deductions, reducing taxable income,
where dividends aren’t deductible. Furthermore, increased leverage boosts a company’s
return on equity (“ROE”) which amplifies returns to shareholders. Disadvantages: debt
increases financial risk, especially amplifying losses if the transaction does not perform, or if
synergies are not attained. This can put pressure on credit metrics such as net leverage and
interest coverage ratios, potentially triggering debt covenants or causing a credit downgrade
on the business. Furthermore, it can take longer to consummate a transaction as there is a
process to market the debt.

Finally, stock can be issued and there is no theoretical limit on the amount of stock an
acquirer might issue, typically up to the point where the deal either becomes dilutive or the
Company is losing majority or 51% control of the business. Advantages: advantages of
issuing stock include no debt burden and preserving cash reserves, keeping liquidity and
credit risk intact. Depending on how the Company has traded in relation to the target’s stock
(the exchange ratio over time) it may be in the company’s best interest to issue stock,
especially if it is trading at highs. Stock deals also aligns interest since both target and
acquirer share the risk and upside in the deal and have “skin in the game” in relation to the
pro forma entity’s success. Disadvantages: Issuing new shares reduces ownership
percentage of existing shareholders and can put pressure on EPS. Furthermore, stock deals
hinge on an exchange ratio and share value, which complicate negotiations (fixed vs.
floating rate) and are subject to volatile markets and calls into question historical share
performance when dictating a fair exchange ratio. A fixed ratio is in the buyers interest since
the number of buyer shares per seller share is set when the deal is signed, so the total value
received by the seller fluctuates with the buyer’s stock price until closing. Furthermore, if a
company issues shares equivalent to 20% or more of it’s current equity value, it is required
to go to a shareholder vote.

Goodwill & Other Intangibles represent the value over the “fair market value” that the buyer
has paid. The high level calculation is subtracting the book value of equity from it’s equity
purchase price. This value represents things like intellectual property, trademarks, and
customer relationships, things that are not explicitly valued on a Company’s balance sheet.
Goodwill stays the same over many years and is tested for impairment, where intangibles
are amortized over several years, creating a tax shield for the business.

Two types of synergies can be attained in a transaction:

Cost Synergies: the combined business may be able to consolidate it’s footprint (ie.
moving inventory into a single location, saving lease costs) or there could be redundancy
in certain corporate functions that can be synergized, such as HR or accounting and
finance, once the companies are integrated
Synergies are often included in EPS accretion dilution, as well as sometimes fully
capitalized in a value creation exercise. For example, run-rate synergies reported by the
company can be added to pro forma EBITDA so Company A with an EBITDA of $20 and
Company B with an EBITDA of $15, both trading at 10x, their pro forma run-rate enterprise
value would be $350 pre synergies. If synergies of $5 are created in the deal, the company
would capitalize those at 10x and the combined entity total enterprise value (“TEV”) would
be $400.

Revenue Synergies: the pro forma business may gain channel access, giving it the
ability to sell it’s products through the seller’s new channel network. An example of this is
Company A buying Company B who has distributor network which Company A can
exploit. Cross selling opportunities may also lead to potential synergies for instance,
Company A may sell a product or service which Company A does not currently provide,
or create a bundled solution for the pro forma entity.

To figure out how much of the seller’s NOLs can be utilized annually, you apply Section 382
limitations. The formula is:
Usable NOLs = Equity Purchase Price × Highest Adjusted Long-Term Rate from the Past 3
Months.
For example, if the equity purchase price is $800 million and the highest adjusted long-term
rate over the prior three months is 4%, the calculation would be: $800 million × 4% = $32
million of NOLs available each year.
If the seller brings $160 million in total NOLs to the table, the combined entity could tap into
$32 million annually, spreading that benefit over 5 years to reduce taxable income.

Cost Synergies: the combined business may be able to consolidate it’s footprint (ie.
moving inventory into a single location, saving lease costs) or there could be redundancy
in certain corporate functions that can be synergized, such as HR or accounting and
finance, once the companies are integrated
Synergies are often included in EPS accretion dilution, as well as sometimes fully
capitalized in a value creation exercise. For example, run-rate synergies reported by the
company can be added to pro forma EBITDA so Company A with an EBITDA of $20 and
Company B with an EBITDA of $15, both trading at 10x, their pro forma run-rate enterprise
value would be $350 pre synergies. If synergies of $5 are created in the deal, the company
would capitalize those at 10x and the combined entity total enterprise value (“TEV”) would
be $400.

Typically in a change of control situation, these instruments are all converted and treated as
equity. In the case of options, you would use the treasury stock method to figure for how
much cash the Company received when issuing and how many shares they can buy back.
For convertible debt, you would convert this to equity, but convert into normal shares using
the conversion price, not the treasury stock method. Typically there is a make-whole
provision on convertible debt to protect from early call risk which increases the conversion
price.
Example:

Cash Alternative: Redeem at $315M (e.g., discounted cash flows + premium), funded by
new debt, raising interest expense but avoiding dilution.

Deal: Buyer acquires Target for $1B (stock), Target has $300M convertible debt,
conversion price $50, buyer stock $60, make-whole at 125% of conversion price
($62.50).

Without Make-Whole: $300M ÷ $50 = 6M target shares, buyer issues 6M shares ($360M
value).

With Make-Whole: $300M × 125% = $375M value, buyer issues 6.25M shares ($375M ÷
$60).

Result: 0.25M extra shares issued, goodwill rises by $15M ($375M – $360M assumed
debt value), dilution increases.

• Company X’s EPS is $12 ÷ 8 = $1.50.
• To fund the deal, Company X issues new shares: $120 ÷ $30.00 = 4 shares, making the
  Combined Share Count 8 + 4 = 12.
• With no cash or debt involved and equal tax rates, the Combined Net Income is
  Company X Net Income + Company Y Net Income = $12 + $8 = $20.
• Thus, the Combined EPS is $20 ÷ 12 = $1.67 (rounded), increasing EPS by ($1.67 –
  $1.50) ÷ $1.50 = 11.33% (rounded).

The Weighted Cost of Acquisition is 7% × (1 – 30%) = 4.9%, keeping the deal accretive
since this cost is below Company Y’s yield of 6.67% ($8 ÷ $120).
For the deal to become dilutive, the After-Tax Cost of Debt must exceed 6.67%. Solving for
the threshold: 6.67% ÷ (1 – 30%) = 9.53% (rounded), meaning the deal turns dilutive at an
interest rate of 9.53% or higher.

For this question, you need to ask some follow up questions, but all else equal, you would
likely prefer the costs to go down $100mm. Why? Unless sales are pulling through at 100%
margin, this likely won’t have the same impact as costs. So if the contribution margin on new
sales is 80%, you are only getting a bump of $80mm, as opposed to the $100mm bump to
EBITDA that the reduction in costs provides.

For NWC, this gets more tricky, but in the context of negotiating a purchase agreement, the
buyer and seller negotiate what is called a net working capital “peg”. The peg is meant to
reflect the level of assets and liabilities delivered to the buyer upon closing of the
transaction. If the NWC comes in higher than the peg, the benefit goes to the Seller. In the
alternative case, if it is lower, the Seller owes the Buyer the difference.

Analyzing and negotiating the working capital is done by looking at historical current assets
and liabilities, and normalizing for any debt like items or scrubbing for one-time items. If the
$100mm inflow is caught during this negotiation, it is normalized for and accounted for in the
peg and thus there isn’t an immediate benefit to the buyer

1. What defines a merger?

A merger occurs when two entities combine, typically with Company A offering its
securities to Company B’s shareholders in exchange for their shares, creating a unified
entity.

An acquisition involves one company purchasing a controlling stake (often most or all) in another company to assume ownership. It’s frequently more efficient than organic growth and can be finance with cash, stock, or a mix of both.

• Horizontal Merger: Combining with a competitor, often yielding synergies like cost savings or increased market power.
• Vertical Merger: Joining with a supplier or distributor, typically reducing costs by streamlining the supply chain.
• Conglomerate Merger: Merging with an unrelated business, usually for diversification, risk reduction, or market/product expansion.

A stock swap occurs when the target company’s shareholders accept shares in the merged
entity instead of cash, betting on the future success of the combined company. This is
more common in bullish markets when the acquirer’s stock price is high, providing a
valuable currency for the deal.

In robust markets, stock swaps dominate because high valuations make stock an attractive
payment method, and target shareholders often prefer equity in a growing entity over cash.

Key motivators include:

• Undervalued targets.
• Synergies (e.g., reduced overhead, streamlined management).
• Enhanced industry resilience or competitiveness.
• Stalled organic growth needing alternative expansion.
• Excess cash deployment.
• CEO ambitions (e.g., ego, legacy, compensation).
• New market entry or product offerings.
• Industry consolidation, brand enhancement, or acquiring unique assets.
• Financial incentives (e.g., tax shields, NOLs, breakup value)

• Operational Challenges: Anticipated synergies may be hard to achieve.
• Cultural Risks: Clashing management styles or corporate cultures.
• Financial Barriers: High advisory fees or dilution from overpayment if synergies
  falter.

A tender offer is a public bid, often hostile, where an acquirer offers to buy shares of a
target at a premium to the market price, bypassing management to gain control.

No, acquiring a majority stake typically requires a control premium (10-30% above market
price) to persuade shareholders to sell, as the current price reflects minority interest value

• Poison Pill: Allows existing shareholders to buy additional shares at a discount,
  diluting the acquirer’s stake.
• Pac-Man Defense: The target attempts to acquire the hostile bidder.
• White Knight: A friendly third party makes a counteroffer to thwart the hostile bid.
• Golden Parachutes: Expensive severance packages for executives, raising takeover
  costs.

This analysis evaluates how an acquisition affects the acquirer’s EPS:

• Sum the projected net incomes of both companies.
• Add pre-tax synergies.
• Subtract interest expense from new debt or lost interest income from cash used.
• Deduct additional depreciation and amortization (D&A) from asset write-ups.
• Add tax benefits from merger adjustments.
• Divide by pro forma fully diluted shares to get pro forma EPS.
• Compare pre- and post-deal EPS to determine accretion (increase) or dilution
  (decrease). Notes:
• In a stock deal, pro forma shares include new shares issued; in a cash deal, the
  share count stays constant.
• Typically assesses EPS impact over two years.

You can’t simply add line items due to adjustments:

• Revenue and Operating Expenses: Combine, adding synergies (more likely in fixed
  costs like SG&A than variable costs).
• D&A: Increases beyond the sum due to asset write-ups and financing fees.
• Interest Income/Expense: Adjusts based on cash usage or new/refinanced debt.
• Taxes: Vary due to prior changes and potential NOL offsets, preventing a simple
  addition.

A merger model assesses the financial profiles of two companies, the purchase price,
financing method, and the resulting impact on the acquirer’s pro forma EPS (accretive or
dilutive).

• Target has negative net income.
• Target’s P/E ratio exceeds the acquirer’s.
• Significant intangible amortization post-deal.
• Higher interest expense from new debt.
• Reduced interest income from cash spent.
• Minimal or negative synergies.

This is accretive. The acquirer pays less per dollar of earnings than its own valuation, so pro
forma earnings rise more than the share count, boosting EPS.

This is dilutive. The acquirer pays more per dollar of earnings than its own valuation,
increasing shares more than earnings, thus lowering EPS.

• Company A: Accretive (30 > 18); pays less per earnings dollar, boosting EPS.
• Company B: Dilutive (12 < 18); pays more per earnings dollar, reducing EPS. Note: In
  all-cash or all-debt deals, P/E comparisons don’t apply without stock issuance.

• Consolidated financials with potential synergies.
• Added interest expense if debt-financed.
• Lost interest income if cash-financed.
• New shares issued if stock-financed.
• Goodwill creation.
• Other intangibles (e.g., IPR&D expenses, deferred revenue write-offs).

• Income Statement: Adds goodwill amortization, increases interest expense (debt),
  or reduces interest income (cash).
• Cash Flow Statement: Lowers net income (offset by adding back amortization),
  reduces investing cash (purchase price), increases financing cash (debt/equity
  issuance).
• Balance Sheet: Reduces cash, increases goodwill/debt/equity as applicable.

It’s the sum of both balance sheets plus goodwill (an intangible asset) to reflect any
premium paid over Company B’s net assets.

• IPR&D: In-process R&D requiring expense recognition.
• Deferred Revenue Write-Off: Pre-collected cash not yet earned, adjusted to avoid
  double-counting.

Goodwill is an intangible asset reflecting the excess value paid in an acquisition beyond the
target’s fair market net assets.
Formula: Goodwill = Equity Purchase Price – Fair Value of Target’s Net Identifiable Assets.
It’s not amortized but tested annually for impairment.

• Start with the equity purchase price.
• Add advisory fees.
• Include existing goodwill.
• Subtract book value (adjusted to fair market value).
• Deduct PP&E step-up.
• Subtract newly identified intangibles.
• Add deferred tax liability from the step-up.

Excessive goodwill and intangibles may require impairment write-downs, potentially
causing significant losses (e.g., eBay’s Skype acquisition).

Enterprise value, as it reflects the total cost to the acquirer, including debt repayment,
rather than just the equity portion.

Fully Diluted Shares = Basic Shares + In-the-Money Options – Shares Repurchased via
Treasury Stock Method (TSM).
TSM: Assumes in-the-money options are exercised, with proceeds used to buy back shares
at the current price.
Notes: Use all options outstanding for control-based valuations (e.g., M&A); use only
exercisable options for minority valuations (e.g., comps).

When options are exercised, new shares are issued, but the company receives cash
(exercise price) to repurchase shares, reducing net dilution to a fraction of a share per
option.

• Shares Outstanding: Current issued common shares.
• Fully Diluted Shares: Includes potential shares from exercised in-the-money
  options/warrants after TSM adjustment.

In M&A, all outstanding options typically vest immediately, requiring the acquirer to buy out
all holders, not just those with vested (exercisable) options

Cash is preferred because:

• It’s cheaper (foregone interest < debt interest, typically <5%).
• It’s less risky (no funding uncertainty).
• Stock is costlier and riskier due to price volatility.

• Avoids large tax liabilities.
• Target owners want continued stake in the merged entity.
• Belief in future success.
• High acquirer stock price or strong market conditions.

A competitor (strategic buyer) typically pays more due to synergies boosting cash flows,
unlike an LBO fund (financial buyer) focused on returns without operational overlap.

Estimate using:

• Combined LTM EBITDA.
• Median Debt/EBITDA ratio from comps or precendent deals.
• Apply ratio to combined EBITDA (e.g. $50M EBITDA x 4x- $200M debt).

• Public Company: Offer a premium (15-30%) over the current share price for shareholder approval.
• Private Company: Use traditional valuation methods (e/g/ DCF, comps).

• Strategic synergies justify the premium.
• Alternatively, debt could be used for a tax shield, avoiding stock dilution.

Use the target’s WACC to value it independently, reflecting its industry risk profile.
However, some argue the acquirer’s WACC is relevant post-merger as the target’s capital
structure dissolves.

The combined company’s EPS exceeds the acquirer’s standalone EPS (Acquirer P/E >
Target P/E), with earnings growing more than shares.

The combined EPS falls below the acquirer’s standalone EPS (Acquirer P/E < Target P/E),
with shares increasing more than earnings.

Assume a 40% tax rate:

• Target Cost of Equity = 1/10 = 10%
• After-tax Cost of Debt = 10% × (1 – 0.4) = 6%.
• Acquirer P/E = 1/[10% × 0.9 + 6% × 0.1] ≈ 10.5x < 15x. Since acquirer P/E > target P/E, it’s accretive.

Integration challenges, unrealized synergies, and difficulties turning the target profitable
often destroy shareholder value instead of creating it.

Synergies occur when the combined entity outperforms the sum of its parts (2 + 2 = 5),
boosting EPS.

• Cost Synergies: Savings from consolidation (e.g., closing duplicate offices, reducing
  staff).
• Revenue Synergies: Increased sales or pricing power (e.g., cross-selling, reduced
  competition). Note: Cost synergies are easier to achieve than revenue synergies.

Cost synergies, being more predictable and achievable (e.g., consolidating facilities),
outweigh revenue synergies, which are harder to forecast.

Consider:

• Price offered.
• Payment form (cash, stock, debt).
• Acquirer’s future plans vs. your vision.
• Market conditions and acquirer’s stock performance.

• Valuation and price.
• Deal structure (cash/stock/debt).
• Strategic and cultural fit.
• Market/industry trends.
• Regulatory hurdles (especially cross-border).