How to Answer “How do interest rates affect valuation multiples?” in Investment Banking Interviews

Start by stating the typical directional impact: higher interest rates generally compress valuation multiples; lower rates tend to expand them. Then define what you mean by “multiples” so your answer stays grounded—e.g., EV/EBITDA, EV/Revenue, P/E.

Bridge to first principles: a multiple is a shorthand for a present value relationship. For EV/EBITDA-type multiples, the market is implicitly capitalising a stream of future cash flows; if the required return increases, the present value falls, and the multiple usually falls.

Keep it crisp: one sentence for direction, one sentence for intuition, then note you’ll break it into (i) discount rate/WACC channel and (ii) cash flow and sentiment/comps channel. That framing is often what distinguishes “valuation multiples explained” from a generic macro answer.

Walk through the impact of interest rates on DCF valuation: the risk-free rate is a building block for the cost of equity (via CAPM), and higher base rates often raise the cost of debt as well. Together, these typically increase WACC.

In a DCF, a higher WACC does two things: (1) it reduces the present value of explicit forecast cash flows and (2) it often has an even larger effect on terminal value because terminal value is “long duration.” That’s why long-growth businesses (more value in later years) tend to see bigger multiple compression when rates rise.

Add one important nuance: rates moving up can coincide with changes in equity risk premium or credit spreads. In practice, “all-in discount rate” can move more (or less) than the government yield, so you should reference required return rather than pretending there’s a one-for-one mapping.

Next, address how rates can change the business itself—this is the part many candidates miss. Higher rates can slow demand (hurting revenue growth), raise interest expense for floating-rate debt, and make refinancing more expensive. Those effects can lower earnings/FCF, which can further pressure equity value.

Tie it back to multiples: even if the multiple stayed constant, lower earnings would reduce price; but markets often also de-rate the multiple when growth visibility drops or leverage risk rises.

Qualify by company type: firms with strong pricing power and low leverage may see less fundamental damage; banks and insurers can behave differently because net interest margins can improve with rising rates (at least initially), which can offset some multiple pressure. The goal is to show you can discuss the interest rates impact on valuation beyond a single sentence.

Bring it back to day-to-day banking work: observed multiples are set by public market comparables and recent transactions, which embed investor expectations about rates, growth, and risk.

Explain that when rates rise, the market often rotates toward nearer-term cash flows and higher “quality,” and it may pay lower EV/Revenue or P/E for long-duration growth. Cyclicals may also de-rate if investors expect a slowdown.

Offer a practical interview-friendly line: “In comps, you’ll usually see sector-level multiple compression in rising-rate regimes, but the magnitude depends on duration, leverage, and how rates affect end-demand.” This shows you know how to discuss interest rates in investment banking interviews in a way that maps to comps/precedents rather than only to theory.

End with a simple numerical or verbal example to prove you can operationalise the logic. For instance: “If WACC increases by 100 bps, the present value of long-dated cash flows drops materially, so EV/EBITDA implied by a DCF typically falls—especially if terminal value is a large share of EV.”

Add a sanity check: if you see multiples expanding while rates rise, what could explain it? Possible answers: earnings revisions up (numerator effect dominates), risk premium/spreads tightening, inflation passing through to nominal growth, or sector-specific tailwinds.

This closure turns the “valuation multiples and interest rates relationship explained” into a complete, interview-ready response: direction → drivers → nuance → example → checks.