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Questions and Answers
Which step in building an LBO model involves calculating the implied entry valuation based on an entry multiple assumption?
Which step in building an LBO model involves calculating the implied entry valuation based on an entry multiple assumption?
What is the primary purpose of an LBO model?
What is the primary purpose of an LBO model?
What does the sources & uses schedule in an LBO model approximate?
What does the sources & uses schedule in an LBO model approximate?
Which of the following is NOT one of the steps involved in an LBO model?
Which of the following is NOT one of the steps involved in an LBO model?
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What is the purpose of using multiple tranches of debt in an LBO deal?
What is the purpose of using multiple tranches of debt in an LBO deal?
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Which type of investors are typically willing to make loans with higher risk appetite in an LBO deal?
Which type of investors are typically willing to make loans with higher risk appetite in an LBO deal?
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What does Debt/EBITDA represent in the context of an LBO deal?
What does Debt/EBITDA represent in the context of an LBO deal?
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Which step in an LBO model involves projecting the financial performance of the company for a minimum five-year time horizon?
Which step in an LBO model involves projecting the financial performance of the company for a minimum five-year time horizon?
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Which assumption regarding the exit is typically made in an LBO model?
Which assumption regarding the exit is typically made in an LBO model?
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Which step in an LBO model involves considering different operating cases and sensitivity analyses?
Which step in an LBO model involves considering different operating cases and sensitivity analyses?
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What is the purpose of an LBO model?
What is the purpose of an LBO model?
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Step 1. The first step in a LBO model is to determine the ______ valuation. We need to know how much the PE firm will pay to buy the company.
Step 1. The first step in a LBO model is to determine the ______ valuation. We need to know how much the PE firm will pay to buy the company.
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Step 2. Second, we need to build the Sources and Uses section, so that we know how the PE will finance the transaction, like how much ______ they’ll be using.
Step 2. Second, we need to build the Sources and Uses section, so that we know how the PE will finance the transaction, like how much ______ they’ll be using.
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Step 3. Third, we should project out the company’s future Levered Free Cash Flow over its holding period, usually 5-7 years. Once that’s done, we can perform the last step, building the returns analysis to calculate the ______ and the IRR.
Step 3. Third, we should project out the company’s future Levered Free Cash Flow over its holding period, usually 5-7 years. Once that’s done, we can perform the last step, building the returns analysis to calculate the ______ and the IRR.
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Step 4. In the final step, different operating cases must be considered – e.g. a “Base Case”, “Upside Case”, and a “Downside Case” – along with sensitivity analyses to assess how adjusting certain assumptions impacts the implied returns from the LBO model. The entry multiple and exit multiples are usually the two assumptions with the most impact on returns, followed by the ______ multiple and other operational characteristics (e.g. revenue growth, margins).
Step 4. In the final step, different operating cases must be considered – e.g. a “Base Case”, “Upside Case”, and a “Downside Case” – along with sensitivity analyses to assess how adjusting certain assumptions impacts the implied returns from the LBO model. The entry multiple and exit multiples are usually the two assumptions with the most impact on returns, followed by the ______ multiple and other operational characteristics (e.g. revenue growth, margins).
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Step 1: Make basic transaction assumptions. At the most basic level, you need to know the purchase enterprise value and the proportion of debt and equity used. To calculate the acquisition price (or enterprise value) for a public company, you would calculate the purchase equity value and then adjust for cash and debt in order to arrive at the ______.
Step 1: Make basic transaction assumptions. At the most basic level, you need to know the purchase enterprise value and the proportion of debt and equity used. To calculate the acquisition price (or enterprise value) for a public company, you would calculate the purchase equity value and then adjust for cash and debt in order to arrive at the ______.
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In making assumptions about how much debt is required for a deal, analysts often use multiple tranches of debt depending on investors’ risk appetite. PE firms might be risk-seeking and go up to 6x Debt/EBITDA. They have to find investors who are willing to make loans that are similar to them in their risk appetite. These more aggressive investors might be hedge funds, merchant banks, or mezzanine funds; they could also be institutional investors that specialize in ______-risk Debt.
In making assumptions about how much debt is required for a deal, analysts often use multiple tranches of debt depending on investors’ risk appetite. PE firms might be risk-seeking and go up to 6x Debt/EBITDA. They have to find investors who are willing to make loans that are similar to them in their risk appetite. These more aggressive investors might be hedge funds, merchant banks, or mezzanine funds; they could also be institutional investors that specialize in ______-risk Debt.
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There are ______ steps involved in an LBO model. Step 1: Make basic transaction assumptions. Step 2: Project the financial performance of the company. Step 3: Determine the financing structure. Step 4: Analyze the investment returns.
There are ______ steps involved in an LBO model. Step 1: Make basic transaction assumptions. Step 2: Project the financial performance of the company. Step 3: Determine the financing structure. Step 4: Analyze the investment returns.
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PE firms might be risk-seeking and go up to ______ Debt/EBITDA.
PE firms might be risk-seeking and go up to ______ Debt/EBITDA.
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Step 1. LBO Entry Valuation: To calculate the enterprise value at entry, the entry multiple is multiplied by either the last twelve months (LTM) EBITDA of the target company or the next twelve months (NTM) EBITDA. If we assume a 'cash-free, debt-free' transaction, then the calculated enterprise value is the purchase price of the LBO target.
Step 1. LBO Entry Valuation: To calculate the enterprise value at entry, the entry multiple is multiplied by either the last twelve months (LTM) EBITDA of the target company or the next twelve months (NTM) EBITDA. If we assume a 'cash-free, debt-free' transaction, then the calculated enterprise value is the purchase price of the LBO target.
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Step 2. Sources and Uses Schedule: The majority of the 'uses' side will be attributable to the buyout of the target’s existing ______.
Step 2. Sources and Uses Schedule: The majority of the 'uses' side will be attributable to the buyout of the target’s existing ______.
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An LBO model estimates the implied returns from the buyout of a target company by a financial sponsor – i.e. private equity firm – in which a significant portion of the purchase price is funded with ______ capital.
An LBO model estimates the implied returns from the buyout of a target company by a financial sponsor – i.e. private equity firm – in which a significant portion of the purchase price is funded with ______ capital.
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Study Notes
LBO Model Overview
- An LBO model estimates the implied returns from a private equity firm's buyout of a target company, with a significant portion of the purchase price funded by debt capital.
- The firm operates the post-LBO company for around 5-7 years, using free cash flows to pay down debt each year.
Steps to Build an LBO Model
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Step 1: LBO Entry Valuation
- Calculate the implied entry valuation based on an entry multiple assumption.
- Multiply the entry multiple by either the last twelve months (LTM) EBITDA or the next twelve months (NTM) EBITDA of the target company.
- The calculated enterprise value is the purchase price of the LBO target, assuming a "cash-free, debt-free" transaction.
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Step 2: Sources and Uses Schedule
- Approximate the majority of the "uses" side, which will be attributable to the buyout of the target's existing equity.
- Make transaction assumptions, such as:
- Financing assumptions regarding the sources of funds (e.g., debt, equity).
- The remaining amount is the equity contributed by the financial sponsor (the "plug").
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Step 3: Financial Forecast and Debt Schedule
- Project the financial performance of the company for a minimum 5-year time horizon.
- Create a complete 3-statement model to impact the income statement and cash flow statement.
- The debt schedule tracks the debt paid down in each period and the ending balances.
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Step 4: LBO Exit Valuation and Returns Schedule (IRR and MOIC)
- Make assumptions regarding the exit, including the exit EV/EBITDA multiple.
- Calculate the exit enterprise value using the exit multiple assumption and exit year EBITDA.
- Deduct the remaining net debt on the balance sheet as of the presumed date of exit to arrive at the exit equity value.
- Calculate the key LBO return metrics: internal rate of return (IRR) and multiple of money (MoM).
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Step 5: LBO Sensitivity Analysis
- Consider different operating cases (e.g., "Base Case", "Upside Case", and "Downside Case").
- Perform sensitivity analyses to assess how adjusting certain assumptions impacts the implied returns from the LBO model.
Interview Tips
- When asked to "walk me through an LBO model", focus on the key steps and assumptions involved.
- Avoid diving into detailed 3-statement models or balance sheet adjustments.
- Highlight the purpose of the LBO model, which is to estimate the returns a private equity firm can earn from investing in the company.
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Test your knowledge on the advantages and disadvantages of payment-in-kind agreements! Discover why companies use these agreements to leverage their capital structure and avoid cash flow pressures. Explore how payment-in-kind agreements can benefit companies with long cash conversion cycles and slow inventory turnover.
