Hedge Fund Interview Questions and Answers

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1. How do you calculate free cash flow to the firm? To equity? To the firm (unlevered free cash flow): EBITDA less taxes less capital expenditures less increase in net working capital. To equity (levered free cash flow): Same as firm FCF and then less interest and any required debt amortization. 2. What are the four basic ways to value a company? Market comparisons/trading comps/comparable companies: Metrics, such as multiples of revenue, earnings and EBITDA like P/E and EV/EBITDA can be compared among companies operating in the same sector with similar business risks. Usually a discount of 10 percent to 40 percent is applied to private companies due to the lack of liquidity of their shares. Precedents/acquisition comps: At what metrics (same as above) were similar companies acquired? Discounted cash flow (“DCF”): Based on the concept that value of the company equals the cash flows the company can produce in the future. An appropriate discount rate is used to calculate a net present value of projected cash flows. Leveraged Buyout (“LBO”): Assuming an IRR (usually 20 percent to 30 percent), what would a financial buyer be willing to pay? Usually provides a floor valuation. 3. Of the valuation methodologies, which ones are likely to result in higher/lower value? Precedents usually yield higher valuations than trading comps because a buyer must pay shareholders more than the current trading price to acquire a company. This is referred to as the control premium (use 20 percent as a 31 Customized for: JJ (jchen59@wisc.edu) Vault Guide to Private Equity and Hedge Fund Interviews Finance benchmark). If the buyer believes it can achieve synergies with the merger, then the buyer may pay more. This is known as the synergy premium. Between LBOs and DCFs, the DCF should have a higher value because the required IRR (cost of equity) of an LBO should be higher than

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