How do you treat an underfunded pension deficit in the EV-to-equity bridge, and what's the subtlety on tax?
A core Valuation interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
An unfunded pension obligation is a debt-like claim: it's a future cash call that ranks ahead of shareholders, so I deduct the net deficit (obligation minus plan assets) in the bridge from EV to equity value, just like net debt. The subtlety is tax: pension contributions are usually tax-deductible, so the economic burden is the after-tax deficit — I apply the marginal tax rate and deduct the net-of-tax figure. I also check whether the deficit is already reflected in the cash flows (e.g., service cost in EBITDA) to avoid double-counting, and use the IAS 19 net liability rather than a stale actuarial number.
WHAT INTERVIEWERS LISTEN FOR
- ✓Pension deficit is debt-like — deduct in bridge
- ✓Use net deficit (obligation minus assets)
- ✓Adjust for tax-deductibility — after-tax figure
- ✓Avoid double-counting with service cost in EBITDA
COMMON MISTAKES
- ✗Ignoring pension deficit
- ✗Using gross deficit pre-tax
- ✗Double-counting service cost and the liability
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