Wall Street LBO Guide Exam
Questions and Answers4
why do pe firms use leverage when buying companies? - ANSWERS-To amplify their returns.
Leverage does NOT "increase returns": Using leverage - borrowing money from others - to fund
a deal simplify makes positive returns even more positive and negative returns even more
negative.
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. - ANSWERS-In an LBO model, in Step 1, you make
assumptions for the Purchase Price, 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 & Other Intangibles to the Assets side to make everything
balance.
In Step 4, you project the company's Income Statement, Balance Sheet, and Cash Flow
Statement, and determine how much Debt it repays each year based on its Free Cash Flow.
Questions and Answers4
why do pe firms use leverage when buying companies? - ANSWERS-To amplify their returns.
Leverage does NOT "increase returns": Using leverage - borrowing money from others - to fund
a deal simplify makes positive returns even more positive and negative returns even more
negative.
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. - ANSWERS-In an LBO model, in Step 1, you make
assumptions for the Purchase Price, 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 & Other Intangibles to the Assets side to make everything
balance.
In Step 4, you project the company's Income Statement, Balance Sheet, and Cash Flow
Statement, and determine how much Debt it repays each year based on its Free Cash Flow.
