Life is hard. These questions are harder.

Have a go if you think you’re hard enough, mate.

This Decade’s Questions

1. Tell me a joke.
2. What is a fallen angel? Can you give me an example? (Debt Capital Markets)
3. What two companies should merge? Why? (Investment Banking)
4. A stock is trading at $5 and a stock is trading at $20 – which one do you recommend?
5. What are the three forms of the Efficient Market Hypothesis? Which forms do you believe in and why?

Last Decade’s Questions

How does Loan-to-Value drive an LBO’s returns? (Mergers & Acquisitions/Corporate Banking)

It depends. If cash flows cover debt service and the cost of debt is lower than the earnings yield of the target company, incremental debt will boost the internal rate of return.

Assuming the terms of the debt are exactly the same except for the amortization schedule (i.e. coupon, final maturity, seniority) would a financial sponsor prefer a Term Loan A or Term Loan B? (Private Equity)

The financial sponsor would prefer the term loan B bullet debt (the complete opposite from what the bank would prefer) as there is a longer period with relatively cheaper capital (see the first question).

The offer price moves up by $5 and the IRR falls by 25% – why?

Leveraged buy outs, as the name entails (and question 1), see greater returns on equity from debt. As such, if Walker Capital is looking to purchase Advanced Micro Devices (AMD) for $2 billion in equity (using term loans, high yield debt and preferred equity for the rest of the consideration) and the board of directors at AMD asks for $5 more, it is now paying $3 billion – which means substantially more equity must be put up.

What are some historical LBO failures?

TXU was a good recent example where components have resurfaced with Warren Buffett’s Berkshire and Paul Singer’s Elliott Management are now tangling over the Oncor asset.

Walk through purchase price allocation in an acquisition. (Accounting/Mergers & Acquisitions)

This is a fairly question for M&A groups but less so elsewhere (because industry bankers do not really understand accounting). 500 years ago in the Jurassic Period when I went on a coffee chat with a BMO Capital Markets M&A banker this was the next question after what do you like to do for fun.

When Tencent purchases League of Legends/Riot Games (which is not distressed), it pays a sizable premium over the net identifiable value of assets (assets less existing goodwill of the company less liabilities). Generally, companies pay market value which exceeds tangible book value (an accounting construct) as the present value of the future earnings of the firm exceed initial capital and retained earnings. For this example, assume Riot has net identifiable assets of $2 billion and Tencent pays $10 billion.

The $2 billion balance sheet figure is appraised by Deloitte Transaction Advisory for $5 billion, so they are written up (on an accounting basis) to $5 billion in fair market value (FMV). This asset write-up is depreciated later. Anything above this $5 billion (also $5 billion from $10 billion – $5 billion) is the goodwill (which theoretically reflects synergies or more aggressive assumptions. Assuming a corporate purchase in this case, the depreciable asset write-up must be reflected later on an accounting basis but not a tax basis (the government does not care about this exchange of money). This gives rise to a deferred tax liability (as the theoretical gain from the write up of asset price is not realized).

So the asset side has been determined – Net identifiable assets + write up + goodwill.  Liabilities will increase by the deferred tax liability (asset write up multiplied by tax rate). Equity will go up by the difference.

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