LBO Valuation Crash Course Questions and Correct Answers
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LBO Modeling
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LBO Modeling
What is multiple Expansion? Basically when a company valuation increase with the EBITDA not changing
What is Internal Rate of Return? A time-weighted metric that tells you what your compounded rate of return would be if you invested your money today and it grew at that rate over your investment ho...
lbo valuation crash course questions and correct a
what is multiple expansion basically when a comp
what is internal rate of return a time weighted
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LBO Valuation Crash Course Questions
and Correct Answers
What is multiple Expansion? ✅Basically when a company valuation increase with the
EBITDA not changing
What is Internal Rate of Return? ✅A time-weighted metric that tells you what your
compounded rate of return would be if you invested your money today and it grew at
that rate over your investment horizon
What is the difference between IRR and WACC? ✅WACC: It is the minimum expected
return one must expect given the risk profile of the asset / company
IRR: Is the actual rate of return on an investment
Should or should you not invest in a project if IRRR < WACC? ✅You should not
Would you rather have a 20% IRR over a 10-year time horizon or a 25% IRR over a 5
year time horizon? ✅The 20% over 10 years because once you put your money out
you have to go through the effort of reallocating it to a new investment and who's to say
you'll be able to do so for 25% again
Also, it takes time to allocate capital and you could be sitting on the cash for to long
What is a critique of IRR? ✅IRR does not capture risk (Think about the sharpe ratio:
Returns / Risk (Volatility))
Two investments with a 20% IRR may have very different risk profiles
Example: A recurring revenue software business versus a retail business
What makes a good LBO? ✅- Target company is undervalued
- Steady, predictable, and high free cash flow and defensible competitive position to
sustain debt payments
- Stable industry with positive trends and minimal technological disruption
- Competitive advantage to prevent margin erosion from competitors
- Opportunities for operational improvements and cost savings are a plus
- Minimal capex needs preferred
- Recurring revenue models often sought
- Strong management team
- Discernible Exit Opportunities
- If a business grow so large you'll have to probably IPO
- Fragmented Space
, - Being a larger player with minimal competition creates a "moat"
- Roll-up opportunities ("buying down" your multiple - Using the cash flow to buy up
smaller businesses in the same industry)
A Private Equity firm acquired a company at 5.0x EBITDA with 3.5x of leverage in an
LBO. If the company's EBITDA was $10 million, approximately what was the equity
invested in the deal ignoring all transaction and debt origination fees? ✅$15 million
Why does leverage magnify returns for private equity funds? ✅Less of the PE funds
own capital is required to enter into an investment
Why does WACC and IRR differ? ✅WACC is the minimum rate of return required to
make an investment worthwhile ("threshold"). IRR is the actual rate of return on an
investment
Which of these is a critique of IRR? ✅IRR does not factor in the size of an investment
or project
IRR ignores the cost associated with reinvestment or redeploying capital
What is some typical EBITDA adjustments you'll usually add back? ✅- Non-recurring
or one-time charges
- Additional planned expenses (Ex. Planned new hires if business is understaffed)
- Pro forma adjustments (Cost cutting initiative that has not been fully realized or was
implemented partway through the LTM period, or an acquisition that was completed
partway the LTM period so full year of added financials are not realized)
S&P estimates as much as 30% of EBITDA in recent deals to be in the form of
adjustments. True or False? ✅True
First thing you want to do when building out your LBO model? ✅You want to go from
your Enterprise value to Equity value as we build out our entry assumption. So find out
the EBITDA
When trying to figure out the company's Total Debt of the company do you grab the
long-term debt only? ✅No. You want to grab the short term debt as well which could
show up as current portion of long term debt.
What is the main components to the Entry Valuation? ✅EBITDA @ Acquisition
EBITDA Multiple
Enterprise Value
(-) Total Debt
(+) Cash
Equity Value
Fully Diluted Shares Outstanding
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