In this article
Capital budgeting
All amounts below are in plain currency units and every input is illustrative, because the arithmetic is the point, not the market. Definitions follow the standard textbook treatment. For the wider set of banking technicals, see the investment banking interview guide.
What is net present value, and when do you accept a project?
Net present value (NPV) is the present value of a project's future cash flows minus the initial investment, using a discount rate that reflects the project's risk. Accept a project when its NPV is above zero, because it earns more than the capital costs. In an illustrative case, an investment of 1,000 returning 400 a year for four years at 8 percent has an NPV of 324.85.1
Why it is asked: it is the core decision rule, and weak answers forget the discount rate. Read the full explanation: financial modeling interview questions.
What is the internal rate of return, and how does it relate to NPV?
The internal rate of return (IRR) is the discount rate at which a project's NPV equals zero. A project is attractive when its IRR exceeds the required return. For the same illustrative cash flows the IRR is about 21.9 percent, well above the 8 percent used above.1 At any discount rate below the IRR, the NPV of a conventional project is positive.
Why it is asked: it checks that you see IRR and NPV as two views of one calculation. Read the full explanation: investment banking technicals.
Two projects conflict: the one with the higher IRR or the higher NPV?
Choose the higher NPV when the projects are mutually exclusive, because NPV measures the value added in currency, while IRR is a percentage that ignores scale. In an illustrative case, Project A (invest 100, receive 120 in a year) has an IRR of 20 percent and Project B (invest 1,000, receive 1,150) has 15 percent. At a 10 percent discount rate B adds 45.45 of value against 9.09 for A.1
Text description of the diagram
- At a 10 percent discount rate B adds 45.45 of value against 9.09 for A.
- Project A has an IRR of 20 percent and Project B has 15 percent.
Why it is asked: "highest IRR wins" is the classic wrong answer. Read the full explanation: financial modeling interview questions.
What are the weaknesses of IRR?
IRR can mislead in three ways. It ignores project scale, as the example above shows. It can have several solutions when cash flows change sign more than once, so no single rate describes the project. It also implicitly values interim cash as if it were reinvested at the IRR itself, which is optimistic for a very high IRR; the modified IRR, which uses an explicit reinvestment rate, is the usual fix. When these problems appear, fall back on NPV.
Why it is asked: it shows whether you know a metric's limits, not only its definition. Read the full explanation: investment banking technicals.
What is the payback period, and why is it not enough?
The payback period is the time a project takes to return its initial investment from cash flows. In the illustrative case above, 1,000 recovered at 400 a year takes 2.5 years.1 It is simple and signals liquidity risk, but it ignores the time value of money and every cash flow after payback, so it can reject a profitable long-lived project. Use it as a screen next to NPV, not instead of it.
Why it is asked: it tests whether you can explain a simple tool and its blind spot. Read the full explanation: financial modeling interview questions.
Cost of capital
How do you calculate the weighted average cost of capital?
The weighted average cost of capital (WACC) is the blended return a company must earn to pay its capital providers, weighting each source by its share of total value at market values. The formula is the equity share times the cost of equity, plus the debt share times the cost of debt times one minus the tax rate. With 600 of equity at 10 percent, 400 of debt at 6 percent and a 21 percent tax rate, all illustrative, WACC is 7.896 percent.1
Why it is asked: WACC links valuation, capital budgeting and capital structure. Read the full explanation: investment banking technicals.
How do you estimate the cost of equity with the capital asset pricing model?
The capital asset pricing model (CAPM) sets the cost of equity as the risk-free rate plus beta times the equity risk premium. Beta measures how strongly the stock moves with the market. With an illustrative risk-free rate of 4 percent, a beta of 1.2 and a premium of 5 percent, the cost of equity is 10 percent.1 Current rates and industry betas should come from a named, dated dataset.
Why it is asked: it checks that you can build an input rather than quote it. Read the full explanation: financial modeling interview questions.
Why is the cost of debt used in WACC after tax?
Interest on debt is tax-deductible, so each unit of interest costs the company less than its face amount. The after-tax cost of debt is the pre-tax cost times one minus the tax rate. At an illustrative 6 percent pre-tax cost and a 21 percent tax rate, it is 4.74 percent.1 Use the current market yield on the company's debt, not the coupon on old bonds. In the United States the federal corporate rate is 21 percent under 26 U.S.C. §11(b), the rate used in these examples.
Why it is asked: forgetting the tax adjustment is a frequent slip. Read the full explanation: investment banking technicals.
Are retained earnings free capital?
No. Retained earnings belong to shareholders, who could have received them and invested elsewhere, so they carry the cost of equity, without the issuance costs of new shares. Treating them as free makes projects look better than they are and pulls the WACC down incorrectly. The weights in WACC include all equity at market value, whether it was raised or retained.
Why it is asked: it separates accounting thinking from economic thinking. Read the full explanation: financial modeling interview questions.
Knowing it is half the job. Saying it is the other half.
Interview Clozo is an AI interview copilot for real interview rounds: it hears the question and puts a strong answer on your screen, and you say it in your own words. See the features or how it works.
Start Free Trial →Capital structure
What do Modigliani and Miller say about capital structure?
In a world with no taxes and no frictions, Modigliani and Miller (1958) show that a firm's value does not depend on how it is financed: cheaper debt is exactly offset by a rising cost of equity. Allowing for corporate taxes makes debt valuable because interest is deductible, so value rises with debt, as Modigliani and Miller (1963) corrected in Corporate Income Taxes and the Cost of Capital. Real-world costs of financial distress limit that gain, which is the trade-off theory.
Why it is asked: it tests whether you know the benchmark theory and which assumptions break it. Read the full explanation: investment banking interview guide.
What is the debt tax shield?
The debt tax shield is the tax a company saves because interest is deducted before tax is computed. Each year it equals the interest paid times the tax rate. With an illustrative 400 of debt at 6 percent, interest is 24, and at a 21 percent tax rate the shield is 5.04 a year.1 It is the main reason a company can lower its WACC by adding some debt.
Why it is asked: it explains why the capital structure is not irrelevant in practice. Read the full explanation: investment banking technicals.
Does more debt always lower WACC?
No. Debt is cheaper than equity and its interest is deductible, so a first dose of debt lowers WACC. But as leverage rises, lenders and shareholders demand higher returns because financial distress becomes likelier, and the cost of equity climbs. The trade-off theory says a company balances the tax gain against the expected cost of distress, so an optimal mix exists and "more debt" is not the answer.
Why it is asked: the one-sided "debt is cheap" answer is the standard mistake. Read the full explanation: investment banking interview guide.
Payouts
Dividends or share buybacks: how does a company choose?
Both return cash to shareholders. A dividend is a regular payment that signals commitment and which investors expect to continue, so cutting it is costly. A buyback is flexible and can be paused, and it raises each remaining shareholder's stake in the company. In theory with no frictions the choice does not change value (Miller and Modigliani, 1961); in practice taxes, signaling and flexibility decide, and a company should only pay out cash it cannot invest above its cost of capital.
Why it is asked: it tests judgment on a question with no single correct answer. Read the full explanation: mergers and acquisitions questions.
Valuation and working capital
How does a discounted cash flow valuation work, and what is the terminal value?
A discounted cash flow (DCF) valuation forecasts free cash flow (FCF), the cash a business generates after operating costs, taxes and investment, discounts it at the WACC and adds a terminal value for the years beyond the forecast. With a growing perpetuity, terminal value is next year's FCF divided by the discount rate minus the growth rate. With an illustrative current FCF of 100, next year's FCF is 102 at 2 percent growth, and 102 divided by (8 − 2) percent gives a terminal value of 1,700.1
Why it is asked: terminal value is often a large share of the value, so interviewers probe it. Read the full explanation: walk me through a DCF.
Why does net working capital matter for cash flow?
Net working capital is current operating assets, such as receivables and inventory, minus current operating liabilities, such as payables. When it grows, cash is tied up, so an increase in working capital reduces free cash flow even if profit is unchanged. A company that sells on credit and holds stock can report profit while running short of cash.
Why it is asked: it shows you connect the income statement to cash. Read the full explanation: three-statement walkthrough questions.
What is the difference between enterprise value and equity value?
Enterprise value is the value of a company's operating business to all its capital providers; equity value is the part that belongs to shareholders. Enterprise value equals equity value plus net debt (debt minus cash), plus preferred stock and minority interest. A DCF at the WACC discounts cash flows available to all capital providers, so it gives enterprise value; subtract net debt to reach equity value. With illustrative equity value 1,000, debt 400 and cash 100, enterprise value is 1,300.1
Why it is asked: mixing the two is a common slip when comparing valuations. Read the full explanation: mergers and acquisitions questions.
Follow-up questions
What are the common corporate finance interview questions?
The sixteen above recur most: NPV and IRR, the NPV-versus-IRR conflict, WACC and its inputs, the capital structure debate, the payout choice and DCF. Practice saying each answer in under a minute, and explain the logic before the formula. The investment banking guide shows how these fit a full banking loop.
How do you prepare for a corporate finance interview?
Learn each formula from its meaning, then rebuild one worked example by hand for NPV, WACC and a DCF until you can do it without notes. Rehearse the answers aloud, since speaking exposes gaps that reading hides. Pair this page with the financial modeling questions and browse the full set of interview guides.
Which formulas should you memorize for a corporate finance interview?
Memorize the NPV sum, the WACC formula, CAPM, the after-tax cost of debt and the growing-perpetuity value. Know what each input means and which way each moves the result. A formula recited without its assumptions is weaker than a rougher answer that states them.
How is corporate finance different from investment banking technicals?
Corporate finance questions ask how a company should invest and finance itself, so they center on project choice, cost of capital and payouts. Banking technicals add deal mechanics, such as how an acquisition changes earnings per share, covered in mergers and acquisitions questions.
- Accept projects with positive NPV; for mutually exclusive projects, choose NPV over IRR.
- WACC weights the cost of equity and the after-tax cost of debt at market values.
- Interest is tax-deductible, which creates a debt tax shield, but distress costs limit how much debt helps.
- Retained earnings are not free: equity has an opportunity cost.
- Terminal value is often a large share of a DCF, so state your growth and discount rate assumptions.
Sources
- Modigliani and Miller (1958), The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review 48(3) — American Economic Review, 1 Jun 1958
- Modigliani and Miller (1963), Corporate Income Taxes and the Cost of Capital: A Correction, American Economic Review 53(3) — American Economic Review, 1 Jun 1963
- Miller and Modigliani (1961), Dividend Policy, Growth, and the Valuation of Shares, Journal of Business 34(4) — Journal of Business, 1 Oct 1961
- 26 U.S.C. §11, Tax imposed on corporations (rate in subsection (b)) — Legal Information Institute, Cornell Law School, 22 Dec 2017
