LBO MODEL EXAM QUESTIONS AND ANSWERS WITH
COMPLETE SOLUTIONS VERIFIED GUARANTEED PASS
GRADED A++
Walk me through a basic LBO model.
"In an 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 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.
,Finally, in 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.
A secondary benefit is that the firm also has more capital available to purchase other
companies because they've used leverage.
What variables impact an LBO model the most?
Purchase and exit multiples have the biggest impact on the returns of a model. After
that, the amount of leverage (debt) used also has a significant impact, followed by
operational characteristics such as revenue growth and EBITDA margins.
How do you pick purchase multiples and exit multiples in an LBO model?
The same way you do it anywhere else: you look at what comparable companies are
trading at, and what multiples similar LBO transactions have had. As always, you also
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 have stable and predictable cash flows, low‐risk businesses, not
much need for ongoing investments such as Capital Expenditures, as well as an
opportunity for expense reductions to boost their margins. A strong management team
also helps, as does a base of assets to use as collateral for debt.
The most important part is stable cash flow.
How do you use an LBO model to value a company, and why do we sometimes
say that it sets the “floor valuation” for the company?
You use it to value a company by setting a targeted IRR (for example, 25%) and then
back‐solving in Excel to determine what purchase price the PE firm could pay to
achieve that IRR.
This is sometimes called a "floor valuation" because PE firms almost always pay less
for a company than strategic acquirers would.
Give an example of a “real‐life” LBO.
The most common example is taking out a mortgage when you buy a house. Here’s
how the analogy works:
Down Payment: Investor Equity in an LBO
Mortgage: Debt in an LBO
Mortgage Interest Payments: Debt Interest in an LBO
Mortgage Repayments: Debt Principal Repayments in an LBO
Selling the House: Selling the Company / Taking It Public in an LBO
COMPLETE SOLUTIONS VERIFIED GUARANTEED PASS
GRADED A++
Walk me through a basic LBO model.
"In an 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 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.
,Finally, in 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.
A secondary benefit is that the firm also has more capital available to purchase other
companies because they've used leverage.
What variables impact an LBO model the most?
Purchase and exit multiples have the biggest impact on the returns of a model. After
that, the amount of leverage (debt) used also has a significant impact, followed by
operational characteristics such as revenue growth and EBITDA margins.
How do you pick purchase multiples and exit multiples in an LBO model?
The same way you do it anywhere else: you look at what comparable companies are
trading at, and what multiples similar LBO transactions have had. As always, you also
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 have stable and predictable cash flows, low‐risk businesses, not
much need for ongoing investments such as Capital Expenditures, as well as an
opportunity for expense reductions to boost their margins. A strong management team
also helps, as does a base of assets to use as collateral for debt.
The most important part is stable cash flow.
How do you use an LBO model to value a company, and why do we sometimes
say that it sets the “floor valuation” for the company?
You use it to value a company by setting a targeted IRR (for example, 25%) and then
back‐solving in Excel to determine what purchase price the PE firm could pay to
achieve that IRR.
This is sometimes called a "floor valuation" because PE firms almost always pay less
for a company than strategic acquirers would.
Give an example of a “real‐life” LBO.
The most common example is taking out a mortgage when you buy a house. Here’s
how the analogy works:
Down Payment: Investor Equity in an LBO
Mortgage: Debt in an LBO
Mortgage Interest Payments: Debt Interest in an LBO
Mortgage Repayments: Debt Principal Repayments in an LBO
Selling the House: Selling the Company / Taking It Public in an LBO
