LBO MODEL REVIEW EXAM QUESTIONS AND ANSWERS WITH COMPLETE SOLUTIONS VERIFIED GRADED A++
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LBO MODEL REVIEW EXAM QUESTIONS AND ANSWERS WITH COMPLETE SOLUTIONS VERIFIED GRADED A++
Key Rule #1: What is an LBO and Why does it work
A leveraged buyout is essentially kind of like buying a house to rent out to other people. You are better off paying less in cash up-front and using the prope...
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LBO MODEL REVIEW EXAM QUESTIONS AND ANSWERS
WITH COMPLETE SOLUTIONS VERIFIED GRADED A++
Key Rule #1: What is an LBO and Why does it work
A leveraged buyout is essentially kind of like buying a house to rent out to other people.
You are better off paying less in cash up-front and using the property's income to pay off
interest and debt principal. By using debt, you reduce the up-front cash payment for the
company, which boosts your returns. Using the company's cash flows to repay debt
principal and pay interest also produces a better return than keeping the cash flow. 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.
Mechanics of LBO
1. The private equity firm calculates how much it will cost to acquire all the shares
outstanding of the company (if it's public) or to simply acquire the company (if it's
private).
2. To raise the funds, the PE firm will use a small amount of its cash on-hand (almost
always less than 50% of the company's total value) and then raise debt from investors
to pay for the rest...
3. ...And it can raise debt from investors because it says to them, "We're using the debt
to buy an income-generating asset - this company. And we'll repay everything because
we'll sell this company in the future and use the
proceeds to pay you back."
, 4. The PE firm raises the debt from investors, and then it combines that cash
with its own cash to acquire the company.
5. The PE firm operates the company for years into the future, and uses its
cash flow to pay the interest and repay the principal on the debt that it
borrowed to buy the company.
6. Then at the end of 3-5 years, the PE firm sells the company or takes it
public via an IPO and realizes a return like that.
What Makes for a Good LBO Candidate?
Have stable and predictable cash flows (so they can repay debt);
Be undervalued relative to peers in the industry (lower purchase price);
Be low-risk businesses (debt repayments);
Not have much need for ongoing investments such as CapEx;
Have an opportunity to cut costs and increase margins;
Have a strong management team;
Have a solid base of assets to use as collateral for debt.
Key Rule #2: How to Make Basic Model Assumptions
You need to do 3 major things here:
Assume a purchase price and the amount of debt and equity you'll be using.
Figure out the debt terms, including interest rates and annual repayment.
Create a Sources & Uses schedule that tracks where your funds are
coming from, and where they're going to.
Purchase Price
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