LBO Model Guide Correct Questions & Answers(graded A+)

LBO Model Guide Correct Questions & Answers(graded A+) LBO Model Guide Correct Questions & Answers(graded A+) What is a leveraged buyout, and why does it work? - ANSWER In a leveraged buyout (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 and 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? - ANSWER They use leverage to increase their returns. Any debt raised for 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 other people than it is on $5 billion of your own money. A secondary benefit is that the firm also has more capital available to purchase other companies because they've used debt rather than their own funds. Walk me through a basic LBO model. - ANSWER "In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on Debt, and