What a week

The past week has been one for the ages. We will probably never see another span of carnage on Wall Street like we have seen for the past 10 days. With Fannie and Freddie going under, followed by Lehman, Merrill, and now AIG, the entire finance world is changing. And with Morgan Stanley and Goldman down well over 20% today, who knows if they will even outlast this crazy time.

With all of this turmoil, it becomes even more necessary to have a great resume and be ready for interviews. A quick update - my kidney stone is no longer in my body, but the effects of the little rock are still being felt today. Kidney stones suck!! Also, I got some offers - one at another bulge bracket bank and one from a top boutique. So that was GREAT news given the other things going on this week. Now the tough part is deciding where to go. I am definitely blessed to have options this year.

So I thought I would write about some of the other interview questions I've faced over the past few months, as well as some of the ways I've answered these questions. Keep in mind that I'm not an expert and could very well miss some things. That said, I've received an offer from every firm with which I've interviewed, both for internships or full-time, so I feel like I can at least take a crack at some of these questions.

The most common technical question I've gotten at every bank I've interviewed with is "walk me through a DCF." I think everybody knows in their mind what a discounted cash flow model does, but what I've found is that there's a certain way to answer this question that makes your life easier. When I first started interviewing I really wanted to show people that I know what I'm talking about, and I went into great detail about every part of a DCF calc. What happened though was that I would get bogged down in the details and end up not sounding very smart.

Now when I answer this question, I like to begin with a very simple answer and allow the interviewer to drill down however he/she would like to. For example I might say something like this:

"The goal of a DCF model is to derive the enterprise value of the firm. I do this by calculating the unlevered free cash flows of the firm, then project them forward for about five years (or whatever time horizon you are looking at). I then calculate a terminal value (TV), and discount the TV and the FCFs back to the present value at the cost of capital to get my enterprise value."

Done. At this point, the interviewer knows that I understand the DCF, and they are free to ask me deeper questions. Some interviewers I've had will stop me as I go along to ask questions, but most let me go to this point and then say something like, "Ok great. Can you tell me how you would calculate the free cash flow of a company?"

"Sure. Starting with EBITDA, you subtract D&A, then multiply by (1-tax rate) to get rid of the tax cash, then add back D&A, take out CAPEX and the change in net working capital, and you have free cash flows."

"And what is net working capital?"

"Current assets less current liabilities."

"Great. How do you calculate a terminal value?"

"Well it depends on the deal. If it's a strategic deal, you'll probably use a perpetuity model since they want the asset for the long term. If it's a financial deal the sponsor will want to sell in the terminal year and you'll use a multiple, like EV/EBITDA."

You get the picture. I just give the answers in a way that shows that I know what I'm saying but I don't try to tell it all at once. They might ask you about how to calculate a discount rate (use WACC), how to calculate WACC, how to get CAPM, and even how to unlever/relever beta. Whatever it is, just be ready for it, but start basic and work your way into the nitty gritty.

One more question about accretion/dilution that I got this summer was something like this: "If you own a company and want to do a quick back-of-the-envelope calculation of acc/dil, how would you do it given a particular target? In other words, what information would you need to do a quick calc?"

"Well a P/E ratio would be great."

"That's right. So lets say your company has a P/E of 18 and the target's P/E is 21. Will the deal be accretive or dilutive? Why?"

"Dilutive because their P/E is higher than mine. In essence I would have to pay more per dollar of earnings than my own company is worth, so the EPS would decline."

Here are a few more random interview questions:

"What's the square root of 2,025?" (The answer doesn't have to be right on - it's 45 - but you just have to be close. They want to see how you can out loud reason through some mental math)

"What is 2/3 + 3/4?" (Just take a deep breath and think back to seventh grade - you can do this!)

"So you worked a little in a fund. Pitch me a stock." (On this one I pretty much always go with my favorite stock that I've bought - PARL - because it's an interesting company to talk about. I would suggest that you are ready to talk about a few investment ideas, and also that you pick companies that the interviewers have never heard of. You don't want to say "GM" and then find out that you're talking to the MD on that account)

"If you had $1 Billion to invest for your school, how would you do it?" (Again you can pretty much say whatever you want, but don't be stupid and say 'Short Goldman with the whole fund because I don't believe in the pure play model!' Just be rational with how you answer most questions and you'll be fine)

I'll be posting more questions/answers in the next little while. Sorry again for the long delay. I'm working at Treasury so you can all imagine what a week it's been around here with Fannie, Freddie, Lehman, Merrill, and AIG all blowing up. Anyway, keep the comments coming about the types of posts you'd like to see.