LBO Analysis Practice Exam Questions and 100% Correct Answers
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LBO Modeling
Institution
LBO Modeling
What are characteristics of a good candidate for an LBO? Steady Cash flows Limited Business Risk Low CAPEX / Working Capital Strong Management Opportunity for Cost Reduction High asset base value Low R&D Steady industry
What are some way to increase the IRR of an LBO? Reduce the purchase Price Inc...
what are characteristics of a good candidate for a
low capex working capital strong management oppo
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LBO Analysis Practice Exam Questions
and 100% Correct Answers
What are characteristics of a good candidate for an LBO? ✅Steady Cash flows
Limited Business Risk
Low CAPEX / Working Capital
Strong Management
Opportunity for Cost Reduction
High asset base value
Low R&D
Steady industry
What are some way to increase the IRR of an LBO? ✅Reduce the purchase Price
Increase Debt
Increase the exit multiple
Increase the company's growth rate
Cut more costs
Dividend recap
Leverage
Reduce Capex and Working Capital
Why is leverage used by private equity firms when buying a company? ✅Results in the
financial sponsor not having to provide as much capital for the deal, allowing for it to
increase its rate of return
Walk me through an LBO analysis ✅- Begin by making assumptions about purchase
price, amount & types of debt, the rateson that debt, as well as purchase price
- Build a sources & uses table that links the sources of your capital (cash, debt &
equity)to make changes in the pro-forma balance sheet of the company
- Project out the financial statements making key assumptions like in any operating
model
- Calculate FCF and assume you use FCF to pay off debt at the end of each year
- Make assumption about exit multiple (usually conservative here), calculate EV at end
of exit, and subtract remaining debt to find new equity value
- Find IRR, sensitize all assumptions
- To use for valuation, assume an IRR and back-solve in Excel with goal seek to find
required purchase multiple, leverage ratio, etc.
,What is a leveraged buyout? ✅The acquisition of a company, division, or collection of
assets using debt as a large portion of the purchase price. The remaining portion of the
purchase price consists of equity put forth by the financial sponsor. The target's excess
free cash flow is used to pay down this debt and ultimately expand the % equity
ownership of the financial sponsor. The buyer then will later try to resell the asset while
earning an IRR of somewhere close to 20%
On average, what percent of the financing structure of an LBO is debt? ✅60-70%
Why are targets with high assets good targets for an LBO? ✅There tangible assets
can be used as collateral and allow them to take on increased debt, therefore amplifying
returns
What is a financial Sponsor? ✅Typically refers to a PE firm that raise investment
capital from third part investors
What role do investment banks play in LBOs? ✅Investment banks help the financial
sponsor develop and market and optimal capital structure for the buy out. Can also help
with buyside M&A advisory. Also can serve as sellside advisers when it is time to exit
the company
What is an MBO? ✅An LBO originated and led by the target's existing management
Would you rather have a company with high r low fixed costs when evaluating an LBO
candidate? ✅Low fixed costs because this would imply lower operating leverage
On a basic level, what is an LBO? ✅A buyout by a financial sponsor or management in
which the company is taken private using high amounts of leverage to boost returns.
From here, excess FCF is used to pay down the debt and increase the owners equity
stake in the company.
What is a dividend recapitalization? ✅When additional debt is taken on to pay out a
large special dividend to management in order to increase the IRR of the project
What are the different tranches of bank debt a financial sponsor could employ in an
LBO? Pros and Cons of each type? ✅
How could a financial sponsor use mezz in an LBO? ✅Could use Mezz debt to
increase you leverage and boost your overall return. While Mezz debt is the most
subordinated trache of debt, it reduces cash outflows through things like convertible
debt and PIK debt
Why would a company use high yield debt in an LBO when it has a higher interest rate?
✅Company thinks that interest rates will fall so it will just refinance the debt at lower
, interest rates. Company also could have reached it capacity on the amount of debt
banks will loan then so therefore they have to resort to more expensive forms of
financing in order to boost IRR. They also could be interest in things like PIK debt or
non-amortizable debt
What are senior notes? ✅Broad category of debt. Typically they fall under secured
debt that is senior to unsecured debt, causing them to have a lower interest rate.
How would you determine the amount of leverage used in an LBO? ✅Would look at
leverage and interest coverage ratios for the industry along with debt or LBO comps.
Could also back solve with an LBO model by inputing a purchase price and a target IRR
and back solving for a debt to equity ratio
True or False? You combine the financial statements of the financial sponsor and target
company in an LBO? ✅False. The PE firm technically is invested in a holding company
which acquires the target. As a result, the PE firm is never responsible for the targets
debt. This is what allows the PE firm to sell off the company when it still has debt on it's
balance sheet.
What are the souces of funding / forms of consideration a PE firmc an use to finance an
LBO? ✅Cash and debt. It cannot issue stock to pay for the deal since it is a private
company. It uses cash to take on an equity stake in the company and uses debt to
finance the rest of the acquisiton.
True or false? you look at foregone interest on cash in an LBO model? ✅False
What is the idea behind recap accounting? ✅Don't record goodwill, as a result making
shareholder's equity very negative. No assets are written up to their fair value. Used for
things like purchasing and retiring exsisting stock, issueing new equity, or issuing debt
(overall anytime you change your capital structure)
Difference between LBOs and mergers? ✅LBOS- buying it to resell it which is why you
employ leverage. Synergies if ther are portfolio companies
Look a metrics based off selling the asset to look at your return
Mergers- buying to hold it for the long term which is why they use the cheapest form of
financing. Can also sometimes realize synergies. Look at metrics like EPS
What is an LBO? How does it work? ✅In an LBO a financial sponsor uses a
combination of debt and equity to acquire another firm. The financial sponsor then uses
the firms FCF to pay down debt and increase its equity stake in the company over the
holding period of the business. The financial sponsor will also try to improve operational
efficiencies to boost FCF. The company is then sold, allowing the sponsor to realize
returns on its intial investment.
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