LBO MODEL EXAM QUESTIONS AND ANSWERS
WITH COMPLETE SOLUTIONS VERIFIED GRADED A+
+ RATED
What is an LBO in simple terms/an analogy? (use analogy in terms of a house)
It's like buying a house for 500k, operating it for a few years, and selling it at a higher
value
What is the main idea of an LBO in real life?
Private equity firms buy a company using a combination of debt and equity, and then
they sell it 3-5 years into the future to realize a return.
How do PE firms pay off the interest and debt principal that arise from an LBO?
PE firms will use the company's cash flows to pay it off.
Why do PE firms use the company's cash flows to repay debt principal and pay
interest instead of just keeping the company's cash flows? (Give 3 Reasons)
For Debt, Use This Example:
-Purchase EV was $500
-LBO financed with 50% debt, 50% equity
-Zero value creation from EBITDA Growth
-Zero value creation from Multiple Expansion
-All debt is paid off after 5 years
,How is this creating value?
Give 2 More Reasons, not related to example
1. By paying off the debt, the sponsors equity contribution raises by $250 because
sponsors initial/exit equity= EV-Net Debt-Fees. Higher equity means higher return on
investment.
-Sponsors initial equity=$250
-Sponsors exit equity = $500
2. Reduces interest expense, which can lead to higher net income and potentially
increase a company's valuation.
3. If a company pays off its debt, it is valued more highly by investors.
Why do PE firms use leverage when buying a company? Why is it better to pay
less cash up front or more cash up front?
Give 2 Reasons
1. If you pay less cash up front, you end up with a higher IRR/internal rate of return if
the company increases in value.
, 2. Time Value of Money. The PE firm can use the cash for other investments to
generate additional returns.
3 Key Reasons Why an LBO Works
How long do PE firms keep company?
What is considered a solid % for IRR?
1. Using debt, you reduce up-front cash payment, boosting returns.
2. Using the company's cash flows to repay debt principal and pay interest also
produces a better return than keeping the cash flow.
3. You sell the company in the future, which allows you to gain back the majority of the
funds you spent to acquire it in the first place.
3-5 Years
Above 15%
Mechanics of an LBO (6 Steps)
1. Calculate how much it will cost to acquire all the shares outstanding of the company
or if private, to simply acquire the company
2. To raise the funds, the PE firm will always use a small amount of cash, less than 50%
of the company's total value, and raid debt from investors to pay for the rest.
WITH COMPLETE SOLUTIONS VERIFIED GRADED A+
+ RATED
What is an LBO in simple terms/an analogy? (use analogy in terms of a house)
It's like buying a house for 500k, operating it for a few years, and selling it at a higher
value
What is the main idea of an LBO in real life?
Private equity firms buy a company using a combination of debt and equity, and then
they sell it 3-5 years into the future to realize a return.
How do PE firms pay off the interest and debt principal that arise from an LBO?
PE firms will use the company's cash flows to pay it off.
Why do PE firms use the company's cash flows to repay debt principal and pay
interest instead of just keeping the company's cash flows? (Give 3 Reasons)
For Debt, Use This Example:
-Purchase EV was $500
-LBO financed with 50% debt, 50% equity
-Zero value creation from EBITDA Growth
-Zero value creation from Multiple Expansion
-All debt is paid off after 5 years
,How is this creating value?
Give 2 More Reasons, not related to example
1. By paying off the debt, the sponsors equity contribution raises by $250 because
sponsors initial/exit equity= EV-Net Debt-Fees. Higher equity means higher return on
investment.
-Sponsors initial equity=$250
-Sponsors exit equity = $500
2. Reduces interest expense, which can lead to higher net income and potentially
increase a company's valuation.
3. If a company pays off its debt, it is valued more highly by investors.
Why do PE firms use leverage when buying a company? Why is it better to pay
less cash up front or more cash up front?
Give 2 Reasons
1. If you pay less cash up front, you end up with a higher IRR/internal rate of return if
the company increases in value.
, 2. Time Value of Money. The PE firm can use the cash for other investments to
generate additional returns.
3 Key Reasons Why an LBO Works
How long do PE firms keep company?
What is considered a solid % for IRR?
1. Using debt, you reduce up-front cash payment, boosting returns.
2. Using the company's cash flows to repay debt principal and pay interest also
produces a better return than keeping the cash flow.
3. You sell the company in the future, which allows you to gain back the majority of the
funds you spent to acquire it in the first place.
3-5 Years
Above 15%
Mechanics of an LBO (6 Steps)
1. Calculate how much it will cost to acquire all the shares outstanding of the company
or if private, to simply acquire the company
2. To raise the funds, the PE firm will always use a small amount of cash, less than 50%
of the company's total value, and raid debt from investors to pay for the rest.
