LBO Practice Test Questions and
Correct Answers
Leveraged Buyout (LBO) ✅an attempt by employees, management, or a group of
investors to purchase an organization primarily through borrowing (debt)
total debt capacity ✅Debt capacity refers to the total amount of debt a business can
incur and repay according to the terms of a debt agreement
this is normally however much debt the company has
Purchase Price (aka Enterprise Value) ✅Purchase price is usually determined by
applying an EV / EBITDA multiple to the company's EBITDA. For example, if a company
has a $20 million EBITDA and is valued at 5.0x, the purchase price for the company
would be $100 million.
Or just debt + equity
Example 1:
The following information is available about an LBO deal:
Total debt capacity: USD 2,000 million
Debt financing: 80%
Equity financing: 20%
Entry EV/EBITDA multiple: 10x
What is the entry EBITDA? ✅2000/80% = 2500M
2500/10 = **250M**
Example 2:
EBITDA 200M
Net Debt 50M
What is the max about of debt that the financial sponsor can borrow if the leverage
multiple is 7.0x EBITDA? ✅A leverage ratio of 7.0x means the company can borrow
seven times the target company's EBITDA, so the debt capacity of the financial sponsor
is 1400M
Example 2b:
If the financial sponsor will invest 30% of its own equity and 70% of debt, what is the
total purchase price? ✅70% of the deal is 1400M debt
So the total purchase price is 1400/.7 = 2000M
Entry EV/EBITDA multiple ✅expression of the relative value of the deal
, Example 2c:
The total purchase price is 2000M, and the target company's EBITDA is 200M ✅the
entry EV/EBITDA multiple is 10x
Example 2d: Returns ✅1. Deleveraging
Equity Value = Enterprise - Debt
Deleveraging has increased the equity value by 1550M/600M = 258.33%
2. Deleveraging + Increase EBITDA
-600M Debt
+100M EBITDA (now its 30M)
Residual Value = 3500 - 200 = 3300M
hurdle rates ✅A pre-established minimum rate of return that general partners must
achieve before they are allowed to claim carried interest.
The hurdle rate for LBOs are typically 20-30% IRR, with a repayment within 3-5 years
Sources of Returns ✅1. Deleveraging
2. Margin Growth
3. Multiple Expansion
Deleveraging ✅If the target company is able to make scheduled debt repayments and
de-lever over time, the equity value of the company will increase, directly flowing to the
financial sponsor as it will be holding an equity position in the target.
Margin Growth ✅Margins should improve as a result of the financial sponsor's
investment as the target company ought to be able to grow revenues using the cash
investment. The financial sponsor also pushes for margin improvement through more
careful cost control and operating improvements. It may also help the target to improve
margin by making acquisitions of other companies.
Multiple Expansion ✅If the financial sponsor's investment can improve the prospects of
the company, then it may create a more attractive investment over the time horizon of
the investment. If the sponsor does this, it will achieve multiple expansion. This means
that the sponsor may have been able to acquire the company for (say) 7.5x EBITDA but
may be able to sell it for 9.0x EBITDA, increasing the return.
Measuring Returns ✅1. Money Multiple
2. IRR
Money Multiple ✅aka cash multiple or cash-on-cash multiple
measures ratio of equity value at exit to equity value on entry
Correct Answers
Leveraged Buyout (LBO) ✅an attempt by employees, management, or a group of
investors to purchase an organization primarily through borrowing (debt)
total debt capacity ✅Debt capacity refers to the total amount of debt a business can
incur and repay according to the terms of a debt agreement
this is normally however much debt the company has
Purchase Price (aka Enterprise Value) ✅Purchase price is usually determined by
applying an EV / EBITDA multiple to the company's EBITDA. For example, if a company
has a $20 million EBITDA and is valued at 5.0x, the purchase price for the company
would be $100 million.
Or just debt + equity
Example 1:
The following information is available about an LBO deal:
Total debt capacity: USD 2,000 million
Debt financing: 80%
Equity financing: 20%
Entry EV/EBITDA multiple: 10x
What is the entry EBITDA? ✅2000/80% = 2500M
2500/10 = **250M**
Example 2:
EBITDA 200M
Net Debt 50M
What is the max about of debt that the financial sponsor can borrow if the leverage
multiple is 7.0x EBITDA? ✅A leverage ratio of 7.0x means the company can borrow
seven times the target company's EBITDA, so the debt capacity of the financial sponsor
is 1400M
Example 2b:
If the financial sponsor will invest 30% of its own equity and 70% of debt, what is the
total purchase price? ✅70% of the deal is 1400M debt
So the total purchase price is 1400/.7 = 2000M
Entry EV/EBITDA multiple ✅expression of the relative value of the deal
, Example 2c:
The total purchase price is 2000M, and the target company's EBITDA is 200M ✅the
entry EV/EBITDA multiple is 10x
Example 2d: Returns ✅1. Deleveraging
Equity Value = Enterprise - Debt
Deleveraging has increased the equity value by 1550M/600M = 258.33%
2. Deleveraging + Increase EBITDA
-600M Debt
+100M EBITDA (now its 30M)
Residual Value = 3500 - 200 = 3300M
hurdle rates ✅A pre-established minimum rate of return that general partners must
achieve before they are allowed to claim carried interest.
The hurdle rate for LBOs are typically 20-30% IRR, with a repayment within 3-5 years
Sources of Returns ✅1. Deleveraging
2. Margin Growth
3. Multiple Expansion
Deleveraging ✅If the target company is able to make scheduled debt repayments and
de-lever over time, the equity value of the company will increase, directly flowing to the
financial sponsor as it will be holding an equity position in the target.
Margin Growth ✅Margins should improve as a result of the financial sponsor's
investment as the target company ought to be able to grow revenues using the cash
investment. The financial sponsor also pushes for margin improvement through more
careful cost control and operating improvements. It may also help the target to improve
margin by making acquisitions of other companies.
Multiple Expansion ✅If the financial sponsor's investment can improve the prospects of
the company, then it may create a more attractive investment over the time horizon of
the investment. If the sponsor does this, it will achieve multiple expansion. This means
that the sponsor may have been able to acquire the company for (say) 7.5x EBITDA but
may be able to sell it for 9.0x EBITDA, increasing the return.
Measuring Returns ✅1. Money Multiple
2. IRR
Money Multiple ✅aka cash multiple or cash-on-cash multiple
measures ratio of equity value at exit to equity value on entry
