LBO Model Guide Exam 2026 Questions
and Answers
Does reducing the amount of cash you pay upfront increase or decrease your
returns? Why? - Correct answer-Increase; money today is worth more than money
tomorrow
Basic explanation of what a PE firm does - Correct answer-It buys a company
using some combination of debt and equity and then sell it in 3-5 years for a return.
The firm uses the company's cash flows to pay off interest and debt principal
The 3 key reasons that an LBO works - Correct answer-1. By using debt, you
reduce up-front cash payment for the company, which increases your returns
2. Using the company's cash flows to pay interest and repay debt principal
produces a better return than keeping the cash flow
3. You sell the company in the future, which allows you to gain back the majority
of the funds used to acquire the company in the first place
©COPYRIGHT 2025, ALL RIGHTS RESERVED 1
,Unlike a merger model, you do not assume that the PE firm keeps the company for
______. If it did that, then you would not realize super high returns - Correct
answer-the long term
The Mechanics of an LBO -- Step 1 - Correct answer-PE firm calculates how much
it will cost to acquire all of the shares outstanding (public comp) or simply buy the
company (private comp)
The Mechanics of an LBO -- Step 2 - Correct answer-To raise the funds, the PE
firm will use a small amount of cash on-hand (usually less than 50% of the
company's total value) and then raise debt from investors to pay the rest
The Mechanics of an LBO -- Step 3 - Correct answer-It can raise debt from
investors bc they can say, "we're using debt to buy an income generating asset. and
we'll repay everything because "we will sell this company in the future and use the
proceeds to pay you back"
The Mechanics of an LBO -- Step 4 - Correct answer-PE firm raises debt from
investors, and then it combines that cash with its own cash to acquire the company
The Mechanics of an LBO -- Step 5 - Correct answer-PE firm operates the
company for years into the future, and uses its cash flow to pay the interest and
repay the debt that it borrowed
©COPYRIGHT 2025, ALL RIGHTS RESERVED 2
,The Mechanics of an LBO -- Step 6 - Correct answer-At the end of 3-5 years, the
PE firm sells the company or takes it public via an IPO in order to realize a return
What makes a good LBO candidate? - Correct answer-- stable and predictable cash
flows
- undervalued relative to peers in the industry
- low risk business
- not much need for ongoing investments such as CapEx
- Has an opportunity to cut costs and increase margins
- has a strong management team
- solid base of assets to use as collateral for debt
the first point is the most important -- its why LBOs rarely happen in oil &
gas/other commodities industries ... the price of commodities is volatile and can
push cash flows up or down from year to year
3 major components of basic model assumptions - Correct answer-1. assume a
purchase price and the amount of debt and equity you will be using
2. figure out debt terms, including interest rate and annual repayment
©COPYRIGHT 2025, ALL RIGHTS RESERVED 3
, 3. create a Sources and Uses schedule that tracks where your funds are coming
from, and where they're going to
Bank debt generally has ___ interest rates bc it is less risky and secured by
collateral - Correct answer-lower
High yield debt tends to have _____ interest rates and no annual repayment bc it is
unsecured and therefore riskier so investors will demand higher returns as a result -
Correct answer-higher
Bank debt has maintenance covenants, which are... - Correct answer-e.g. total
debt/EBITDA must always be below 4x, or EBITDA/interest expense must always
be above 2x
financial requirements that the borrower must meet
High yield debt has incurrence covenants, which are ... - Correct answer-e.g. the
company cannot acquire another company and cannot sell off its assets
Leverage ratio - Correct answer-Debt/EBITDA
Interest Coverage Ratio - Correct answer-EBITDA / Interest Expense
Factors that go into decisions about an LBO - Correct answer-Leverage ratio and
how it stacks up against similar companies
©COPYRIGHT 2025, ALL RIGHTS RESERVED 4
and Answers
Does reducing the amount of cash you pay upfront increase or decrease your
returns? Why? - Correct answer-Increase; money today is worth more than money
tomorrow
Basic explanation of what a PE firm does - Correct answer-It buys a company
using some combination of debt and equity and then sell it in 3-5 years for a return.
The firm uses the company's cash flows to pay off interest and debt principal
The 3 key reasons that an LBO works - Correct answer-1. By using debt, you
reduce up-front cash payment for the company, which increases your returns
2. Using the company's cash flows to pay interest and repay debt principal
produces a better return than keeping the cash flow
3. You sell the company in the future, which allows you to gain back the majority
of the funds used to acquire the company in the first place
©COPYRIGHT 2025, ALL RIGHTS RESERVED 1
,Unlike a merger model, you do not assume that the PE firm keeps the company for
______. If it did that, then you would not realize super high returns - Correct
answer-the long term
The Mechanics of an LBO -- Step 1 - Correct answer-PE firm calculates how much
it will cost to acquire all of the shares outstanding (public comp) or simply buy the
company (private comp)
The Mechanics of an LBO -- Step 2 - Correct answer-To raise the funds, the PE
firm will use a small amount of cash on-hand (usually less than 50% of the
company's total value) and then raise debt from investors to pay the rest
The Mechanics of an LBO -- Step 3 - Correct answer-It can raise debt from
investors bc they can say, "we're using debt to buy an income generating asset. and
we'll repay everything because "we will sell this company in the future and use the
proceeds to pay you back"
The Mechanics of an LBO -- Step 4 - Correct answer-PE firm raises debt from
investors, and then it combines that cash with its own cash to acquire the company
The Mechanics of an LBO -- Step 5 - Correct answer-PE firm operates the
company for years into the future, and uses its cash flow to pay the interest and
repay the debt that it borrowed
©COPYRIGHT 2025, ALL RIGHTS RESERVED 2
,The Mechanics of an LBO -- Step 6 - Correct answer-At the end of 3-5 years, the
PE firm sells the company or takes it public via an IPO in order to realize a return
What makes a good LBO candidate? - Correct answer-- stable and predictable cash
flows
- undervalued relative to peers in the industry
- low risk business
- not much need for ongoing investments such as CapEx
- Has an opportunity to cut costs and increase margins
- has a strong management team
- solid base of assets to use as collateral for debt
the first point is the most important -- its why LBOs rarely happen in oil &
gas/other commodities industries ... the price of commodities is volatile and can
push cash flows up or down from year to year
3 major components of basic model assumptions - Correct answer-1. assume a
purchase price and the amount of debt and equity you will be using
2. figure out debt terms, including interest rate and annual repayment
©COPYRIGHT 2025, ALL RIGHTS RESERVED 3
, 3. create a Sources and Uses schedule that tracks where your funds are coming
from, and where they're going to
Bank debt generally has ___ interest rates bc it is less risky and secured by
collateral - Correct answer-lower
High yield debt tends to have _____ interest rates and no annual repayment bc it is
unsecured and therefore riskier so investors will demand higher returns as a result -
Correct answer-higher
Bank debt has maintenance covenants, which are... - Correct answer-e.g. total
debt/EBITDA must always be below 4x, or EBITDA/interest expense must always
be above 2x
financial requirements that the borrower must meet
High yield debt has incurrence covenants, which are ... - Correct answer-e.g. the
company cannot acquire another company and cannot sell off its assets
Leverage ratio - Correct answer-Debt/EBITDA
Interest Coverage Ratio - Correct answer-EBITDA / Interest Expense
Factors that go into decisions about an LBO - Correct answer-Leverage ratio and
how it stacks up against similar companies
©COPYRIGHT 2025, ALL RIGHTS RESERVED 4
