Investment banking interviews can be challenging, particularly for first-time candidates. A quick online search might reveal accounts of intense questioning and high-pressure scenarios. While the process may seem intimidating, understanding its structure and key focus areas can significantly improve your chances of success.
This guide provides a detailed overview of common investment banking interview questions, along with optimal strategies for answering them.
Understanding the Investment Banking Interview Process
Investment banking interviews differ from standard job interviews as they place a strong emphasis on technical knowledge and financial acumen. While interpersonal skills matter, the primary focus is on your grasp of valuation methodologies, financial modeling, and key industry concepts.
Expect the process to be rigorous and structured, often including multiple interview rounds, technical assessments, and behavioral evaluations.
Common Investment Banking Interview Questions and How to Answer Them
Below are some frequently asked questions, along with the best approaches to answering them:
1. Is the Cost of Equity Higher Than the Cost of Debt?
Answer: Yes, the cost of equity is generally higher than the cost of debt because debt interest is tax-deductible, creating a tax shield. Additionally, equity investors demand higher returns as they assume greater risk, given that equity does not have guaranteed payments like debt.
2. How Do You Calculate Beta for a Company?
Answer: Beta measures a company’s stock volatility relative to the market. The standard approach involves:
- Identifying publicly traded comparable companies.
- Unlevering their Betas using the formula: βunlevered=βlevered1+(DebtEquity)(1−Tax Rate)\beta_{\text{unlevered}} = \frac{\beta_{\text{levered}}}{1 + \left(\frac{\text{Debt}}{\text{Equity}}\right) (1 – \text{Tax Rate})}
- Averaging the unlevered Betas and then relevering based on the company’s own capital structure: βlevered=βunlevered×(1+(DebtEquity)(1−Tax Rate))\beta_{\text{levered}} = \beta_{\text{unlevered}} \times \left(1 + \left(\frac{\text{Debt}}{\text{Equity}}\right) (1 – \text{Tax Rate})\right)
3. How Do You Calculate the Cost of Equity?
Answer: The most common approach is the Capital Asset Pricing Model (CAPM): Cost of Equity=Risk-Free Rate+β×Market Risk Premium\text{Cost of Equity} = \text{Risk-Free Rate} + \beta \times \text{Market Risk Premium}
Where:
- The risk-free rate represents the return on government bonds.
- Beta measures stock volatility.
- The market risk premium is the excess return over the risk-free rate.
4. How Do You Value a Company with Negative Historical Cash Flow?
Answer: Traditional valuation methods relying on profitability, such as Price-to-Earnings (P/E) multiples, may not be applicable. Instead, valuation is typically done using:
- Discounted Cash Flow (DCF) analysis, forecasting when the company is expected to turn cash-flow positive.
- Revenue multiples (e.g., EV/Revenue) for industry benchmarking.
- Precedent transactions of similar loss-making companies.
5. What is the Appropriate Numerator for a Revenue Multiple?
Answer: The correct numerator is enterprise value (EV). This is because revenue is a company-wide metric, and enterprise value reflects the total value of a firm, including both debt and equity.
6. How Do You Calculate Unlevered Free Cash Flow for a DCF Analysis?
Answer: Unlevered Free Cash Flow=EBIT×(1−Tax Rate)+Depreciation+Amortization−Capital Expenditures−Change in Working Capital\text{Unlevered Free Cash Flow} = \text{EBIT} \times (1 – \text{Tax Rate}) + \text{Depreciation} + \text{Amortization} – \text{Capital Expenditures} – \text{Change in Working Capital}
This metric reflects cash flow before interest payments, making it useful for evaluating a company independent of its capital structure.
7. How Do You Value a Company?
Answer: There are two primary valuation methodologies:
- Relative Valuation – Comparing the company to similar businesses using multiples such as EV/EBITDA, P/E, and EV/Revenue.
- Intrinsic Valuation – Using DCF analysis to estimate the company’s value based on future cash flows.
8. When Should a Company Issue Debt Instead of Equity?
Answer: Companies typically prefer debt issuance when:
- Interest payments are tax-deductible, reducing overall costs.
- The company has stable cash flows to service debt obligations.
- Equity issuance would dilute existing shareholders.
However, excessive debt increases financial risk, so companies must balance leverage carefully.
9. How Does a Debt-Funded Share Buyback Impact EPS?
Answer: Share buybacks reduce the number of outstanding shares, potentially increasing Earnings Per Share (EPS). However, if the cost of debt outweighs the earnings boost from reduced shares, EPS may decline due to increased interest expenses.
10. What Are the Three Financial Statements?
Answer:
- Balance Sheet – Shows assets, liabilities, and equity at a specific point in time.
- Income Statement – Reports revenue, expenses, and profitability over a period.
- Cash Flow Statement – Tracks cash inflows and outflows from operating, investing, and financing activities.
11. What Makes a Strong Financial Model?
Answer: A good financial model should be:
- Dynamic – Adaptable to different scenarios.
- Accurate – Based on realistic assumptions.
- Clear – Well-structured with logical flows.
- Flexible – Easily modifiable for various inputs.
12. What Are the Most Common Valuation Multiples?
Answer:
- EV/EBITDA – Used for capital-intensive industries.
- P/E Ratio – Measures earnings in relation to stock price.
- EV/Revenue – Common for startups and companies with negative earnings.
- P/BV – Compares market price to book value, often used in financial sectors.
13. What is a Leveraged Buyout (LBO)?
Answer: An LBO occurs when a company is acquired primarily using borrowed funds, with the acquired company’s assets serving as collateral. The goal is to enhance returns through debt financing while minimizing initial equity investment.
Behavioral Questions: Demonstrating Soft Skills
Investment banks also assess candidates through behavioral questions to evaluate their problem-solving abilities, leadership skills, and personality fit. Some common questions include:
- What are your weaknesses, and how do you address them?
- Describe a leader you admire and why.
- How do you approach risk-taking in your personal life?
- If money were not a constraint, where would you choose to live and why?
For these questions, provide structured, thoughtful responses that reflect your analytical thinking and decision-making process.
Investment banking interviews are demanding but manageable with the right preparation. Success requires a solid grasp of technical concepts, financial modeling, and valuation methodologies, as well as the ability to handle behavioral questions confidently.
By mastering the questions outlined in this guide, you can improve your performance and position yourself as a strong candidate in the competitive investment banking industry.
