LBO MODEL - BASICS EXAM QUESTIONS WITH DETAILED
ANSWERS COMPLETE SOLUTIONS VERIFIED
Walk me through a basic LBO model.
Always See Big Financial Exits
- 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 you finance the
transaction and what you use the capital for; this also tells you how much Investor
Equity is required.
- Step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figures,
, and also add in Goodwill & Other Intangibles on the Assets side to make everything
balance.
- In 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 Flow 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
the firm.
Why would you use leverage when buying a company?
To boost your return.
Remember, any debt you use in an LBO is not 'your money' - so if you're paying $5
billion for a company, it's easier to earn a high return on $2 billion of your own money
and $3 billion borrowed from elsewhere vs. $3 billion of your own money and $2 billion
of borrowed money.
ANSWERS COMPLETE SOLUTIONS VERIFIED
Walk me through a basic LBO model.
Always See Big Financial Exits
- 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 you finance the
transaction and what you use the capital for; this also tells you how much Investor
Equity is required.
- Step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figures,
, and also add in Goodwill & Other Intangibles on the Assets side to make everything
balance.
- In 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 Flow 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
the firm.
Why would you use leverage when buying a company?
To boost your return.
Remember, any debt you use in an LBO is not 'your money' - so if you're paying $5
billion for a company, it's easier to earn a high return on $2 billion of your own money
and $3 billion borrowed from elsewhere vs. $3 billion of your own money and $2 billion
of borrowed money.
