7 - Leveraged Buyouts and LBO models Exam Questions and Answers

7 - Leveraged Buyouts and LBO models Exam Questions and Answers 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, operates it for several years, and then sells the company at the end of the period to realize a return on its investment. It works because leverage amplifies returns: If the deal performs well, the PE firm will realize higher returns than if it had bought the company with 100% Equity. But leverage also presents risks because it means the returns will be even worse if the deal does not perform well. " Why do PE firms use leverage when buying companies? - ANSWER ️️ "To amplify their returns. All PE firms aim for positive returns above a certain IRR, and using leverage makes it easier to get there... if the deal goes well. A secondary benefit is that the PE firm has more capital available to buy other companies since it won't use up all its funds on acquiring one company. " Walk me through a basic LBO model? - ANSWER ️️ "In an LBO model, in Step 1, you make assumptions for the Purchase Price, the % Debt and Equity, Interest Rate on Debt, and other variables such as the company's revenue growth and margins. In Step 2, you create a Sources & Uses schedule to show exactly how much how much in Investor Equity the PE firm contributes; you also create a Purchase Price Allocation Schedule to calculate the Goodwill. In Step 3, you adjust the company's Balance Sheet for the new Debt and Equity figures, allocate the purchase price, and add Goodwill