Merger Model And DCF Drill
This conversation was generated using Cook'd AI's career assistant and reviewed by Fallon Han from our editorial team for accuracy.
I need an interview simulation that starts with a tough valuation question and then drills into every assumption. I am a second-year econ student in the US, no visa issues, and I am trying to pivot from retail banking internships into investment banking at a bulge-bracket firm. Make it feel like a real mock interview.
Absolutely. We will keep it realistic and technical. I will start with a classic merger model and DCF valuation prompt, then press you on the assumptions, the math, and the places candidates usually make mistakes.
First question: Walk me through how you would value a target in a merger model and how that differs from a standalone DCF. Start with the sequence of steps, then explain where synergies and purchase accounting matter.
I would start by building a standalone DCF for the target using projected free cash flow, a discount rate, and a terminal value. Then I would look at trading and transaction comps to frame valuation ranges. In a merger model, I would estimate the purchase price, financing mix, synergies, and deal accounting to see the impact on the acquirer’s EPS and return. The DCF gives intrinsic value, while the merger model shows the accretion or dilution and strategic impact of the acquisition.
Good structure, but now I want precision. In the DCF, what exactly goes into unlevered free cash flow, and why do we use unlevered rather than levered cash flow for enterprise value? Also, tell me one common mistake candidates make when forecasting it.
Unlevered free cash flow is usually EBIT times one minus tax rate, plus D and A, minus capex, minus changes in net working capital. We use unlevered cash flow because enterprise value belongs to all capital providers, so the discount rate should be WACC and not just equity cost. A common mistake is double counting interest or forgetting that working capital is a use of cash when it increases.
Better. Now suppose I challenge your terminal value. If you use a perpetual growth method, what assumptions must hold for it to make sense, and how would you defend the growth rate? Then tell me when you would prefer an exit multiple instead.
The perpetual growth method assumes the company grows at a stable rate forever that is below long-term nominal GDP or a sensible market ceiling, and that margins and capital intensity stay stable. I would defend the growth rate by linking it to long-run inflation and real growth, usually keeping it conservative. I would prefer an exit multiple if the company is in a cyclical industry, if comparables are more reliable, or if the business has not reached a steady state yet.
Now I am going to pressure-test the merger model. If the target is bought with a mix of cash and stock, how do you determine whether the deal is accretive or dilutive? Be specific about the biggest drivers. And if the deal is dilutive on day one, does that automatically mean it is a bad deal?
I would compare the acquirer’s standalone EPS to the pro forma EPS after adding the target’s earnings, synergies, financing costs, and purchase accounting effects like amortization. The biggest drivers are purchase price, financing cost, synergy timing, and the target’s contribution to earnings. A dilutive deal is not automatically bad if it creates strategic value, strong synergies, or long-term return on invested capital above the cost of capital.
Good answer. Final check: if I ask you to spot two errors in a rough merger model, what are the most likely ones you would look for first? I want the practical debugging mindset, not a textbook answer.