LBO Modeling ExaM QUESTIONS AND CORRECT ANSWER
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,Walk me through an LBO - CORRECT ANSWER Step 1, Purchase Price, Debt and
Equity,
Interest Rate on Debt, and other variables such as the company's revenue growth and
margins. Step 2, you create a Sources & Uses schedule to show how much Investor
Equity the PE firm contributes and how items like the transaction fees and the
company's Cash balance affect this contribution.
Step 3, you project the company's Income Statement and its partial Cash Flow
Statement down to Free Cash Flow. Step 4, you use the Free Cash Flow, Beginning
Cash, and Minimum Cash to determine how much Debt principal the company repays
each year. You then link the Interest Expense on this changing Debt balance to the
Income Statement so that FCF deducts the Interest. Step 5, you make the exit
calculations, usually assuming an EBITDA Exit Multiple, and you calculate the IRR and
Money-on-Money multiple based on the proceeds the PE firm earns at the end vs.
its Investor Equity in the beginning."
LBO VS DCF Intentions - CORRECT ANSWER DCF: "What could this company be
worth, based on the Present Value of its future cash flows over the next 5, 10, or
20 years?" • LBO: "What's the maximum we could pay for this company if we
want to achieve an IRR of 20% or 25% over 5 years?"
How A PE firm can boost returns in LBO - CORRECT ANSWER Reduce purchase
multiple Increase revenue growth by cutting expenses
Use more leverage
Do debt paydown
factors that drive m&a activity - CORRECT ANSWER
what intuitivley is sellers yield - CORRECT ANSWER Sellers yield is same as cost of
equity
(E/P or net income/equity value)
This is why if its all stock you can just compare pe ratios because weight cost of
acuisition is just cost of equity
Sellers yield is the yield gained by the aquirer after the merger
,The 3 key reasons that an LBO works - CORRECT ANSWER 1. By using debt, you
reduce upfront cash payment for the company, which increases your returns
2. Using the company's cash flows to pay interest and repay debt principal
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 used to acquire the company in the first place
Unlike a merger model, you do not assume that the PE firm keeps the company for
______. If it did that, then you would not realize super high returns - CORRECT
ANSWER the long term
The Mechanics of an LBO -- Step 1 - CORRECT ANSWER PE firm calculates how
much it will cost to acquire all of the shares outstanding (public comp) or simply buy
the company (private comp)
The Mechanics of an LBO -- Step 2 - CORRECT ANSWER To raise the funds, the PE
firm will use a small amount of cash on-hand (usually less than 50% of the company's
total value) and then raise debt from investors to pay the rest
The Mechanics of an LBO -- Step 3 - CORRECT ANSWER It can raise debt from
investors bc they can say, "we're using debt to buy an income generating asset. and
we'll repay everything because "we will sell this company in the future and use the
proceeds to pay you back"
The Mechanics of an LBO -- Step 4 - CORRECT ANSWER PE firm raises debt from
investors, and then it combines that cash with its own cash to acquire the company
The Mechanics of an LBO -- Step 5 - CORRECT ANSWER PE firm operates the
company for years into the future, and uses its cash flow to pay the interest and
repay the debt that it borrowed The Mechanics of an LBO -- Step 6 - CORRECT
ANSWER At the end of 3-5 years, the PE firm sells the company or takes it public via
an IPO in order to realize a return
What makes a good LBO candidate? - CORRECT ANSWER - stable and predictable
cash flows - undervalued relative to peers in the industry
- low risk business
- not much need for ongoing investments such as CapEx
- Has an opportunity to cut costs and increase margins
- has a strong management team
, - solid base of assets to use as collateral for debt
the first point is the most important -- its why LBOs rarely happen in oil & gas/other
commodities industries ... the price of commodities is volatile and can push cash
flows up or down from year to year
How much cash do we have to repay debt each year after we have already paid
operating expenses and interest expense
Can all types of debt be repaid early ? - CORRECT ANSWER No - bank debt can, but
high yield debt cannot
If the company does not have enough cash flow for its minimum mandatory debt
repayments, it would need to borrow more via a _____ to make the mandatory
repayments - CORRECT
ANSWER Revolver
In order to determine how much the company can be sold for, you assume an ____ ,
which is usually close to or below the purchase EBITDA multiple - CORRECT ANSWER
exit EBITDA multiple
If PE firm doubles its money in 5 years, that is a ____ IRR - CORRECT ANSWER 15%
If a PE firm triples its money in 5 years, that is a ___ IRR - CORRECT ANSWER 25%
If a PE firm doubles its money in 3 years, that is a ___ IRR - CORRECT ANSWER 26%
If a PE firm triples its money in 3 years, that is a ____ IRR - CORRECT ANSWER 44%
The variables that have the most effect on IRR in an LBO are ... - CORRECT ANSWER
purchase price
% debt and % equity used
exit price
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