Moelis IB Interview Questions

We use EV/Revenue because revenue stays positive and meaningful when profit measures like EBITDA (earnings before interest, taxes, depreciation and amortization) and net income are negative or distorted. That is common at early-stage, fast-growing, or cyclically depressed companies. Revenue pairs with enterprise value (EV, the value of the whole business to both lenders and shareholders) because revenue is earned before any interest is paid. So it belongs to all capital providers.

Debt is borrowed money the company must pay back with interest. Each kind of debt has its own place in the capital structure, the ranking of who gets paid first if the company fails. Firms layer tranches (slices of debt with different terms) because it usually lowers the blended cost of borrowing a given total. It also spreads out maturities and lets them borrow more in total than any single lender would provide.

Build it bottom-up as volume times price, off the grove itself. Volume is planted acres times trees per acre, times the share of trees old enough to bear fruit, times yield per bearing tree, less an allowance for crop loss from freeze, drought, disease and fruit drop. Set price separately for each channel the farm sells into, since fruit sent to a juice processor typically fetches a different price per box than fruit sold into the fresh grocery market. Both are grower prices, what the farm receives, not what a shopper pays at the store.

The most common multiples (a company's value divided by one of its financial figures) are EV/Revenue, EV/EBITDA and EV/EBIT on the enterprise value side, plus P/E (price to earnings) and P/BV (price to book value) on the equity value side. Bankers use EV/EBITDA most. Enterprise value (EV) is what the whole business is worth to lenders and shareholders together, so it gets divided by figures that come before interest is paid: revenue, EBIT (operating income) and EBITDA (earnings before interest, taxes, depreciation and amortization, a rough proxy for operating cash flow). Equity value is what the shareholders' stake alone is worth, so it gets divided by figures that belong to shareholders: net income for P/E, and book value (the shareholders' equity on the balance sheet) for P/BV.

A casino game has a beta of zero. Beta measures how much an asset's returns move with the broad stock market. Whether a roulette spin or a blackjack hand wins does not depend on what the market does, so the game's covariance with the market is zero, and so is its beta. The game is very volatile and has a negative expected return for the player. Neither one is beta. The volatility is idiosyncratic risk (risk specific to each bet that averages out across many bets), and the negative return is the house edge (the built-in advantage in the payout odds).

A lower tax rate usually increases the valuation. In a DCF (discounted cash flow valuation), free cash flow (the cash the business generates after taxes and reinvestment) goes up because the company pays less tax on its operating profit. That lifts every projected year and the terminal value. WACC (weighted average cost of capital, the blended return lenders and shareholders require, used as the discount rate) rises slightly, because the interest tax shield (the tax saved because interest is deductible) is worth less. That offset is small, so the cash flow gain normally outweighs it.

Net income falls $15, cash rises $5, net PP&E falls $20, retained earnings fall $15. Depreciation is a non-cash charge that spreads the cost of a long-lived asset over its useful life, so the $20 charge takes $20 off pre-tax income and, at a 25% tax rate, $15 off net income. Cash rises $5 anyway, because the company pays $5 less in tax. The balance sheet holds: assets fall $15 (cash +$5, PP&E -$20) against retained earnings down $15.

Share price is earnings per share times the P/E ratio, so almost all the work is getting from revenue down to EPS. Multiply revenue by the operating margin for operating income (EBIT). Subtract interest expense to reach pre-tax income, apply the tax rate to reach net income, then divide net income by diluted shares outstanding for EPS. Multiply that EPS by the P/E multiple and you have the price per share. The multiple multiplies earnings. It does not divide into them.

The terminal value is 772.5. Unlevered free cash flow in the last discrete period is 75. EBIT is 100 (EBITDA of 125 minus D&A of 25), which is 75 after 25% tax. Add back D&A of 25, subtract CapEx of 25, and subtract a working capital change of 0. Grow that 75 by 3% to 77.25, then divide by the 10% spread between the 13% required return and the 3% growth rate.

Diluted equity value is $15.8bn. At the $10.00 share price the 80mm options struck at $2.50 are in the money, so the treasury stock method applies. They bring in $200mm of exercise proceeds, that cash buys back 20mm shares, and 60mm net new shares land. RSUs typically carry no exercise price, so all 20mm of them come in. Diluted shares are 1,500 + 60 + 20 = 1,580mm, and 1,580mm × $10.00 = $15.8bn.

The share price is $60.00. Revenue of $3,000 at a 50% gross margin gives $1,500 of gross profit. Take out $950 of SG&A and EBIT is $550. Total interest of $150 leaves $400 pre-tax, and a 25% tax rate leaves $300 of net income, which is $3.00 of earnings per share across 100 shares. Twenty times $3.00 is $60.00. A P/E is price over earnings per share, so price equals the multiple times EPS.

Start with revenue, subtract operating costs and D&A to get EBIT, then tax it to get NOPAT. Add back D&A and subtract CapEx and the increase in net working capital. That's unlevered free cash flow. From there, subtract after-tax interest and add net borrowing to get levered free cash flow, also called free cash flow to equity (FCFE).