How to Answer “Do you include pension liabilities in enterprise value? Why or why not?” in Investment Banking Interviews
In investment banking interview prep, a common curveball is: “Do you include pension liabilities in enterprise value? Why or why not?” Interviewers ask this to see if you understand what Enterprise Value is meant to represent—and when an item behaves like debt versus an operating liability.
A strong answer explains the principle (claims on the business), states the practical convention (treat deficit like debt in many cases), and then highlights the judgment calls that show up in real enterprise value calculation work.
What Interviewers Test: Pension Liabilities and Valuation Judgment
First, they’re testing whether you understand Enterprise Value as the value of the core business available to all capital providers, and how you bridge from equity value to EV by adding/subtracting non-operating claims and assets. Pension accounting sits right on that boundary.
Second, they’re testing judgment and consistency. Pension obligations can be partially “operating” (ongoing employee compensation) but the underfunded portion is economically similar to debt: it’s a contractual-like claim that reduces value available to equity. Your answer should show you can pick a convention and apply it consistently across valuation multiples, leverage, and bridge items.
Third, they’re testing communication under ambiguity—typical of ib technical questions. The best candidates quickly frame the rule of thumb, then add the key nuance: funded status, whether you’re valuing the business on a cash-free/debt-free basis, how you treat pension expense in EBITDA, and comparability across peers for valuation interview prep.
Answer Framework for Pension Liabilities in Enterprise Value
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Step 1: Anchor on the EV definition (cash-free / debt-free logic)
Start with the principle: Enterprise Value is intended to reflect the value of operations independent of financing—often described as “cash-free, debt-free.” Then state the implication: items that are debt-like claims on the enterprise generally get added when bridging from equity value to EV.
In your first breath, be explicit that the treatment depends on what you’re trying to make comparable. If your EV is meant to be comparable to EV/EBITDA across companies, you want liabilities that function like financing (and aren’t already embedded in EBITDA) to be treated consistently as part of net debt-like adjustments.
This sets you up to treat pensions as potentially debt-like without sounding dogmatic. It also signals you know EV is a construct for comparability, not a single GAAP number.
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Step 2: Apply the rule of thumb—underfunded pensions are debt-like
Give the interview-ready convention: typically you include the pension deficit (i.e., underfunded defined benefit obligation) as a debt-like item in Enterprise Value, because it represents a claim that will require future cash contributions and reduces value to equity holders.
Be specific about what you include: usually the net funded status (PBO/DBO minus plan assets), not the gross obligation. If the plan is overfunded, many practitioners treat the surplus as a non-operating asset (sometimes added back like cash, but often discounted or excluded if it’s trapped).
Tie it back to the mechanics of enterprise value calculation: Equity Value + Net Debt + other debt-like items (including pension deficit) − non-operating assets.
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Step 3: Add the key nuance—avoid double counting with EBITDA and operating items
Now show judgment: pensions blur operating vs financing. If EBITDA already reflects pension expense (service cost) as part of employee costs, then adding the entire pension liability without adjusting earnings can double count some economics.
A clean interview explanation is: treat the underfunded amount as debt-like, but be mindful of what’s in the numerator/denominator of your multiple. If you adjust EV for pensions, you may also want to ensure your EBITDA is comparable (e.g., consider whether peers have different pension accounting, or whether you’re using EBITDA before/after pension service cost adjustments).
You can also mention that in practice, teams often stick to a consistent policy across a comp set—even if imperfect—because comparability is the goal in multiples-based valuation.
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Step 4: State when you might not include it (or include differently)
List the exceptions briefly and credibly:
- Immaterial funded status: if the deficit is small relative to EV, you may ignore it for simplicity.
- Data limitations: if funded status disclosure is limited, you may use book values or omit and flag.
- Operating-like view: for some businesses with long-standing pension plans, some practitioners treat pensions as part of operating working capital/employee compensation economics and do not adjust EV—but then you must be consistent across peers.
- Trapped surplus: an overfunded plan may not be readily accessible to shareholders; you might not treat it like cash.
This answers “why or why not” with a clear default plus sensible boundaries—exactly what interviewers want for advanced questions.
Model Answer (Associate): pension liabilities enterprise value
Generally, I would include the underfunded pension liability in enterprise value by treating the pension deficit as debt-like. The reason is that an underfunded defined benefit plan represents a real claim on the business—future cash contributions that reduce value available to equity—so it fits the cash-free/debt-free logic behind Enterprise Value.
Mechanically, I’d take Equity Value and add net debt, then add other debt-like items, which often includes the net pension deficit (obligation minus plan assets), rather than the gross pension liability. If the plan is overfunded, you could view the surplus as a non-operating asset, but in practice you’re cautious because the surplus can be trapped and not fully distributable.
The main nuance is consistency and avoiding double counting. EBITDA already captures pension service cost in operating expenses, so I wouldn’t blindly add large pension numbers without thinking about whether my earnings metric is comparable across the peer set. For comps, I’d apply one policy across all companies—either adjust EV for pension deficits or don’t—and I’d sanity-check that leverage and multiples still make sense.
So my default in valuation interview settings is: include the pension deficit in EV as a debt-like adjustment, explain the comparability rationale, and call out materiality and access-to-surplus as the key exceptions.
- Lead with the default treatment (deficit is debt-like), then add the nuance—don’t start with exceptions.
- Use “net funded status” language to show you’re not adding the gross obligation without plan assets.
- Name the double-counting risk: pensions touch both EV (balance sheet) and EBITDA (P&L).
- Emphasise consistency across a comp set; that’s the practical interviewer-friendly takeaway.
Common Pitfalls in IB Technical Questions on EV Adjustments
- Saying “always include pensions” or “never include pensions” with no mention of funded status, materiality, or comparability.
- Adding the *gross* pension liability to EV without netting plan assets, which overstates the debt-like claim.
- Treating an overfunded plan as cash-equivalent without acknowledging that the surplus may be restricted or difficult to extract.
- Ignoring double counting: adjusting EV for pensions while also using an earnings metric that already embeds pension economics inconsistently across peers.
- Talking only accounting (GAAP/IFRS terminology) and not the valuation principle—future cash claims and who they belong to.
Follow-Ups: Enterprise Value Calculation Nuances
In an EV bridge, where exactly would you put pension liabilities—net debt or a separate line item?
Often as a separate debt-like adjustment alongside net debt, especially to keep bank debt/leases distinct; economically it’s still part of net debt-like claims.
Would you adjust EBITDA if you include the pension deficit in EV?
Not automatically; the key is consistency across peers. If pension accounting meaningfully distorts comparability, you might normalise EBITDA (e.g., focus on operating performance metrics) and keep the EV adjustment consistent.
How do pensions affect EV/EBITDA comps versus a DCF?
In comps, the goal is comparability, so a consistent EV treatment matters most. In a DCF, you can model expected pension contributions in cash flows, which may reduce the need for a separate EV adjustment if handled explicitly.
What if the company has a large overfunded pension asset—do you add it to EV like cash?
Only with caution; you’d consider whether the surplus is accessible to shareholders and whether extracting it has costs or restrictions—otherwise you may discount it or exclude it.
Valuation Interview Prep: Make This Answer Sound Natural
- Build a 20-second “headline” version: deficit is debt-like → include in EV; surplus may not be cash. Then add nuance only if prompted.
- Practise stating the net funded status correctly (obligation minus plan assets) and using “debt-like adjustment” language.
- Rehearse one comparability line for enterprise value calculation comps: “pick a policy, apply across peers, and sanity-check multiples.”
- In AceTheRound, run this as a 2–3 minute drill and ask for feedback specifically on: (1) clarity of the default rule, (2) double-counting explanation, and (3) confidence with exceptions.
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