LBO MODEL EXAM QUESTIONS AND ANSWERS WITH
COMPLETE SOLUTIONS VERIFIED RATED A++
What is a leveraged buyout, and why does it work?
in an LBO, a private equity firm acquires a company using a combination of debt and
equity (cash), operates it for several years, possibly makes operational improvements,
and then sells the company at the end of the period to realize a return on investment
during the period of ownership, the PE firm uses the company's cash flows to pay
interest expense from the debt and to pay off debt principal
an LBO delivers higher returns than if the PE firm used 100% cash for the following
reasons
1. by using debt, the PE firm reduces the up-front cash payment for the company which
boosts returns
2. using the company's cash flows to repay debt principal adn pay debt interest also
produces a better return than keeping the cash flows
3. the PE firm sells the company in the future, which allows it to regain the majority of
the funds spent to acquire it in the first place
why do PE firms use leverage when buying a company?
they use leverage because it increases their returns
any debt raised for an LBO is not "your money"; a secondary benefit is that the firm also
,has more capital available ot purchase other companies because they've used debt
rather than their own funds
walk me through a basic LBO model
step 1 is making assumptions about the purchase price, debt/equity ratio, interest rate
on debt, and other variables; you might also assume something about the company's
operations, such as revenue growth or margins, depending on how much information
you have
step 2 is to create a sources & uses section, which shows how the transaction is
financed and what the capital is used for; it also tells you how much investor equity
(cash) is required
step 3 is to adjust the company's balance sheet for the new debt and equity figures,
allocate the purchase price, and add in goodwill and other intangibles on the assets side
to make everything balance
step 4 you project out the company's income statement, balance sheet, and cash flow
statement, and determine how much debt is paid off each year, based on the available
cash low and the required interest payments
step 5 you make assumptions about the exit after several years, usually assuming an
EBITDA exit multiple and calculate the return based on how much equity is returned to
teh firm
, what variables impact a leveraged buyout the most?
purchase and exit multipiles (and therefore purchase and exit prices) have the greatest
impact, followed by the amount of leverage (debt) used
a lower purchase price equals a higher return, wheras a higher exit price results in a
higher return; generally, more leverage also results in higher returns
revenue growth, EBITDA margins, interest rates and principal repayment on debt all
make an impact as well, but they are less significant than those first 3 variables
how do you pick purchase multiples and exit multiples in an LBO model?
you look at what comparable companies are trading at, and waht multiples similar LBO
transactions ahve been completed at; show a range of purchase and exit multiples
using sensitivity tables
sometimes you set purchase and exit multiples based on a specific IRR target that
you're trying to achieve, but this is just for valuation purposes if you're using an LBO
model to value the company
what is an "ideal" candidate for an LBO?
ideal candidates should
- have stable and predictable cash flows (so they can repay debt)
- be undervalued relative to peers in the industry (lower purchase price)
- be low risk businesses (debt repayments)
- not have much need for ongoing investments such as CapEx
COMPLETE SOLUTIONS VERIFIED RATED A++
What is a leveraged buyout, and why does it work?
in an LBO, a private equity firm acquires a company using a combination of debt and
equity (cash), operates it for several years, possibly makes operational improvements,
and then sells the company at the end of the period to realize a return on investment
during the period of ownership, the PE firm uses the company's cash flows to pay
interest expense from the debt and to pay off debt principal
an LBO delivers higher returns than if the PE firm used 100% cash for the following
reasons
1. by using debt, the PE firm reduces the up-front cash payment for the company which
boosts returns
2. using the company's cash flows to repay debt principal adn pay debt interest also
produces a better return than keeping the cash flows
3. the PE firm sells the company in the future, which allows it to regain the majority of
the funds spent to acquire it in the first place
why do PE firms use leverage when buying a company?
they use leverage because it increases their returns
any debt raised for an LBO is not "your money"; a secondary benefit is that the firm also
,has more capital available ot purchase other companies because they've used debt
rather than their own funds
walk me through a basic LBO model
step 1 is making assumptions about the purchase price, debt/equity ratio, interest rate
on debt, and other variables; you might also assume something about the company's
operations, such as revenue growth or margins, depending on how much information
you have
step 2 is to create a sources & uses section, which shows how the transaction is
financed and what the capital is used for; it also tells you how much investor equity
(cash) is required
step 3 is to adjust the company's balance sheet for the new debt and equity figures,
allocate the purchase price, and add in goodwill and other intangibles on the assets side
to make everything balance
step 4 you project out the company's income statement, balance sheet, and cash flow
statement, and determine how much debt is paid off each year, based on the available
cash low and the required interest payments
step 5 you make assumptions about the exit after several years, usually assuming an
EBITDA exit multiple and calculate the return based on how much equity is returned to
teh firm
, what variables impact a leveraged buyout the most?
purchase and exit multipiles (and therefore purchase and exit prices) have the greatest
impact, followed by the amount of leverage (debt) used
a lower purchase price equals a higher return, wheras a higher exit price results in a
higher return; generally, more leverage also results in higher returns
revenue growth, EBITDA margins, interest rates and principal repayment on debt all
make an impact as well, but they are less significant than those first 3 variables
how do you pick purchase multiples and exit multiples in an LBO model?
you look at what comparable companies are trading at, and waht multiples similar LBO
transactions ahve been completed at; show a range of purchase and exit multiples
using sensitivity tables
sometimes you set purchase and exit multiples based on a specific IRR target that
you're trying to achieve, but this is just for valuation purposes if you're using an LBO
model to value the company
what is an "ideal" candidate for an LBO?
ideal candidates should
- have stable and predictable cash flows (so they can repay debt)
- be undervalued relative to peers in the industry (lower purchase price)
- be low risk businesses (debt repayments)
- not have much need for ongoing investments such as CapEx
