WALL STREET PREP LBO MODELING
EXAM QUESTIONS AND CORRECT
ANSWERS WITH RATIONALES 2026
1. What is typically the largest source of financing in an LBO transaction?
A) Mezzanine debt
B) Equity contribution
C) Bank debt
D) Seller financing
Bank debt (senior debt) is usually the largest component of an LBO
capital structure because it is cheaper than other forms of financing.
2. Which of the following characteristics make a company a good LBO
candidate?
A) High CapEx requirements
B) Strong, predictable cash flows
C) High customer churn
D) Low asset base
Predictable cash flows allow for reliable debt service in an LBO.
,3. What is the primary driver of returns in an LBO model?
A) Revenue growth
B) Exit multiple expansion
C) Dividend recapitalization
D) Purchase price
The majority of LBO returns typically come from multiple expansion
and debt paydown, not just growth.
4. Which of the following is true about IRR in an LBO?
A) It measures net profit margin
B) It is independent of the holding period
C) It represents the annualized return to equity investors
D) It accounts only for operating income
IRR reflects the time-weighted return to equity investors, including exit
proceeds.
5. Why is a "debt schedule" important in an LBO model?
A) To track equity returns
B) To monitor debt repayment and interest expense
C) To calculate EBITDA
D) To value the company
The debt schedule ensures that debt service (interest and principal) is
properly modeled.
6. What happens to IRR if the exit occurs earlier, assuming the same
MOIC?
A) IRR decreases
B) IRR stays the same
C) IRR increases
D) IRR is unaffected
IRR increases with shorter holding periods when MOIC is constant.
, 7. What is the typical holding period for a private equity LBO
investment?
A) 1-2 years
B) 2-3 years
C) 5-7 years
D) 10-12 years
Most LBOs target an exit within 5–7 years.
8. Which ratio is most important for lenders in an LBO deal?
A) PE ratio
B) Debt/EBITDA
C) Net income margin
D) ROE
Lenders focus on Debt/EBITDA as a measure of leverage and
repayment capacity.
9. What does "cash sweep" mean in an LBO context?
A) Using cash for dividends
B) Sweeping cash into treasury
C) Using excess cash to pay down debt
D) Transferring cash to equity holders
Cash sweep automatically allocates excess cash to debt prepayment.
10. What is a typical feature of mezzanine debt?
A) Fully secured
B) Lowest interest rate
C) Subordinated with equity-like features
D) Paid off first in liquidation
Mezzanine debt sits between senior debt and equity and often includes
warrants or PIK interest.
EXAM QUESTIONS AND CORRECT
ANSWERS WITH RATIONALES 2026
1. What is typically the largest source of financing in an LBO transaction?
A) Mezzanine debt
B) Equity contribution
C) Bank debt
D) Seller financing
Bank debt (senior debt) is usually the largest component of an LBO
capital structure because it is cheaper than other forms of financing.
2. Which of the following characteristics make a company a good LBO
candidate?
A) High CapEx requirements
B) Strong, predictable cash flows
C) High customer churn
D) Low asset base
Predictable cash flows allow for reliable debt service in an LBO.
,3. What is the primary driver of returns in an LBO model?
A) Revenue growth
B) Exit multiple expansion
C) Dividend recapitalization
D) Purchase price
The majority of LBO returns typically come from multiple expansion
and debt paydown, not just growth.
4. Which of the following is true about IRR in an LBO?
A) It measures net profit margin
B) It is independent of the holding period
C) It represents the annualized return to equity investors
D) It accounts only for operating income
IRR reflects the time-weighted return to equity investors, including exit
proceeds.
5. Why is a "debt schedule" important in an LBO model?
A) To track equity returns
B) To monitor debt repayment and interest expense
C) To calculate EBITDA
D) To value the company
The debt schedule ensures that debt service (interest and principal) is
properly modeled.
6. What happens to IRR if the exit occurs earlier, assuming the same
MOIC?
A) IRR decreases
B) IRR stays the same
C) IRR increases
D) IRR is unaffected
IRR increases with shorter holding periods when MOIC is constant.
, 7. What is the typical holding period for a private equity LBO
investment?
A) 1-2 years
B) 2-3 years
C) 5-7 years
D) 10-12 years
Most LBOs target an exit within 5–7 years.
8. Which ratio is most important for lenders in an LBO deal?
A) PE ratio
B) Debt/EBITDA
C) Net income margin
D) ROE
Lenders focus on Debt/EBITDA as a measure of leverage and
repayment capacity.
9. What does "cash sweep" mean in an LBO context?
A) Using cash for dividends
B) Sweeping cash into treasury
C) Using excess cash to pay down debt
D) Transferring cash to equity holders
Cash sweep automatically allocates excess cash to debt prepayment.
10. What is a typical feature of mezzanine debt?
A) Fully secured
B) Lowest interest rate
C) Subordinated with equity-like features
D) Paid off first in liquidation
Mezzanine debt sits between senior debt and equity and often includes
warrants or PIK interest.
