LBO Concept Mastery Study Questions with Accurate Answers 2026.docx

LBO Concept Mastery
Study Questions with
Accurate Answers 2026

, Lower Purchase Price, Less Equity, Higher Revenue Growth, Higher EBITDA Margins, Lower Interest Rates,
k k k k k k k k k k k k k k




Lower CapEx - correct answerChanges That Increase IRR k k k k k k k




Higher Purchase Price, More Equity, Lower Revenue Growth, Lower EBITDA Margins, Higher Interest Rates,
k k k k k k k k k k k k k k




Higher CapEx - correct answerChanges That Reduce IRR: k k k k k k k




In a leveraged buyout (LBO), a private equity firm acquires a company using a combination of debt and equity
k k k k k k k k k k k k k k k k k k k




(cash), operates it for several years, possibly makes operational improvements, and then sells the company at
k k k k k k k k k k k k k k k k




the end of the period to realize a return on investment. During the period of ownership, the PE firm uses the
k k k k k k k k k k k k k k k k k k k k k




company's cash flows to pay interest expense from the debt and to pay off debt principal. k k k k k k k k k k k k k k k




An LBO delivers higher returns than if the PE firm used 100% cash for the following reasons:
k k k k k k k k k k k k k k k k




1. By using debt, the PE firm reduces the up-front cash payment for the company, which boosts returns.
k k k k k k k k k k k k k k k k k




2. Using the company's cash flows to repay debt principal and pay debt interest also produces a better return
k k k k k k k k k k k k k k k k k k k




than keeping the cash flows. k k k k




3. The PE firm sells the company in the future, which allows it to regain the majority of the funds spent to
k k k k k k k k k k k k k k k k k k k k k k




acquire it in the first place. - correct answerWhat is a leveraged buyout, and why does it work?
k k k k k k k k k k k k k k k k k




They use leverage to increase their returns. Any debt raised for an LBO is not "your money" - so if you're paying
k k k k k k k k k k k k k k k k k k k k k k




$5 billion for a company, it's easier to earn a high return on $2 billion of your own money and $3 billion
k k k k k k k k k k k k k k k k k k k k k k




borrowed from other people than it is on $5 billion of your own money. A secondary benefit is that the firm also k k k k k k k k k k k k k k k k k k k k k




has more capital available to purchase other companies because they've used debt rather than their own
k k k k k k k k k k k k k k k k k




funds. - correct answerWhy do PE firms use leverage when buying a company?
k k k k k k k k k k k k




"In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio, Interest Rate on
k k k k k k k k k k k k k k k k k k




Debt, and other variables; you might also assume something about the company's operations, such as
k k k k k k k k k k k k k k k




Revenue Growth or Margins, depending on how much information you have. k k k k k k k k k k




Step 2 is to create a Sources & Uses section, which shows how the transaction is financed and what the capital
k k k k k k k k k k k k k k k k k k k k k




is used for; it also tells you how much Investor Equity (cash) is required.
k k k k k k k k k k k k k




Step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figures, allocate the purchase
k k k k k k k k k k k k k k k k k k k




price, and add in Goodwill & Other Intangibles on the Assets side to make everything balance.
k k k k k k k k k k k k k k k




In Step 4, you project out the company's Income Statement, Balance Sheet and Cash Flow Statement, and
k k k k k k k k k k k k k k k k k




determine how much debt is paid off each year, based on the available Cash Flow and the required Interest k k k k k k k k k k k k k k k k k k k




Payments.

Finally, in Step 5, you make assumptions abou - correct answerWalk me through a basic LBO model.
k k k k k k k k k k k k k k k k