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Hey, future bankers!

Hope everyone is doing well! Today we’re covering a comparison between the cost of debt and the cost of equity, a time you had a high attention to detail, and Nvidia’s stellar earnings.

🚀 Let’s get into it.

🔢 Technical Question

Why is the cost of debt generally cheaper than the cost of equity for a company?

The cost of debt is generally cheaper than the cost of equity for a company due to several key reasons related to risk, tax benefits, and the structure of debt and equity. Here's an intuitive walkthrough:

1. Risk and Priority of Claims

- Risk to Investors: Debt holders take on less risk compared to equity holders. This is because debt holders are promised fixed interest payments and have priority over equity holders in the event of bankruptcy. In other words, if a company faces financial distress, debt holders are paid before equity holders.

- Priority of Claims: In the capital structure, debt is considered senior to equity. If a company goes bankrupt, debt holders have the first claim on the company's assets. Equity holders only get whatever remains after all debts are paid off. This priority reduces the risk for debt holders, allowing companies to offer a lower return (interest rate) on debt compared to the higher returns expected by equity holders.

2. Tax Benefits

- Interest Deductibility: One of the most significant advantages of debt is that interest payments are tax-deductible. This means that the company can subtract interest expenses from its taxable income, effectively reducing the amount of taxes it pays. This tax shield reduces the overall cost of debt for the company.

- No Tax Shield for Equity: Dividends paid to equity holders are not tax-deductible. Therefore, the company does not receive any tax benefits for distributing profits to shareholders, making the effective cost of equity higher compared to debt.

3. Required Return by Investors

- Fixed Payments vs. Residual Claims: Debt holders expect fixed interest payments, which are generally lower than the returns expected by equity holders. Equity investors take on more risk as their returns depend on the company's profitability and growth. They are residual claimants, meaning they get paid after all other obligations are met, so they demand a higher rate of return to compensate for this higher risk.

- Risk Premium: Equity investors require a risk premium for the higher uncertainty and variability of returns. This premium is over and above what debt holders would require, reflecting the higher cost of equity.

4. Default Risk and Agency Costs

- Default Risk: While debt does increase the risk of default if a company cannot meet its interest obligations, the cost of debt remains lower because the likelihood of default is generally assessed to be lower than the variability in equity returns. Credit rating agencies and market conditions play a role in determining this default risk, but typically, companies with solid cash flows can secure debt at lower rates.

- Agency Costs: Debt can sometimes align management's interests with those of shareholders by imposing discipline through regular interest payments. However, issuing new equity can dilute existing shareholders' ownership and can signal that the company may be overvalued or in need of funds, potentially increasing the cost of equity.

To sum up, the cost of debt is generally cheaper than the cost of equity because:

• Debt is less risky for investors due to fixed payments and priority in claims during bankruptcy.

• Interest payments on debt are tax-deductible, providing a tax shield that lowers the effective cost.

• Equity holders require a higher return due to the residual nature of their claims and the higher risk they bear.

These factors collectively make debt a more attractive and cheaper source of financing for companies compared to equity.

🗣 Behavioral Question

Tell me about a time when you had to complete a task that required a high attention to detail.

When responding to the interview question "Tell me about a time when you had to complete a task that required a high attention to detail," it's crucial to illustrate your meticulousness, your approach to ensuring accuracy, and the positive outcomes resulting from your attention to detail. Here are a couple of best practices to keep in mind:

1. Use the STAR Method

The STAR method (Situation, Task, Action, Result) provides a structured way to answer behavioral questions clearly and concisely.

- Situation: Briefly describe the context or background of the task.

- Task: Explain what your specific responsibility or objective was.

- Action: Detail the steps you took to ensure accuracy and precision.

- Result: Highlight the positive outcomes or benefits of your meticulous approach.

2. Choose a Relevant Example

Select an example that is relevant to the role you're applying for. If possible, pick a situation from a professional setting, such as a previous job, internship, or significant project.

Example Response Using Best Practices

Situation: During my internship at XYZ Financial Services, I was assigned the task of preparing a report for a major client. This report involved compiling and analyzing large amounts of data from various sources.

Task: My specific responsibility was to ensure that all the data was accurately entered and that the final report was error-free before presenting it to the client.

Action: To manage this, I implemented a multi-step process. First, I cross-referenced data from multiple sources to verify its accuracy. I then used Excel formulas and pivot tables to analyze the data, double-checking my work at each stage. Additionally, I conducted a thorough review and had a co-worker perform a peer review to catch any potential errors I might have missed.

Result: Thanks to this meticulous approach, the final report was delivered without any errors. The client was highly impressed with the accuracy and professionalism of our work, leading to increased trust and a stronger business relationship. This experience underscored the importance of attention to detail.

Additional Tips

- Be Specific: Avoid vague statements. Detail the specific actions you took to ensure accuracy.

- Highlight the Impact: Emphasize the positive results of your attention to detail, such as avoiding errors, saving time, improving processes, or receiving praise from a supervisor or client.

- Relate to the Role: Tie your example back to the skills required for the investment banking role. Highlighting your analytical skills, precision, and ability to handle complex data will show your suitability for the internship.

🗞 Industry News

📈 Nvidia Blows Out Expectations

Nvidia recently made headlines with a stellar revenue forecast that sent its stock soaring by 9%, reflecting the continued investor confidence in the AI boom. The company's robust outlook, driven by the high demand for its advanced AI chips, has lifted not only Nvidia's shares but also those of other semiconductor companies like AMD, Arm, and Broadcom. This optimism extends beyond Nvidia, indicating a broader positive impact on the tech sector. Analysts are particularly enthusiastic about Nvidia's new Blackwell AI chips, which are set to ship this quarter, and are expected to sustain high demand well into the next year.

Adding to the excitement, Nvidia announced a 10-for-one stock split and a 150% increase in its quarterly dividend, further boosting its appeal to investors. The company's impressive performance, with shares nearly tripling in 2023 and continuing to rise, underscores its dominant position in the market. Nvidia's CEO, Jensen Huang, anticipates that the next generation of AI models will drive even more demand for their processors, maintaining the company's competitive edge. Analysts are confident in Nvidia's ability to defend its market share against competitors, ensuring its continued growth in the rapidly expanding AI landscape.

Read more about this story below.

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