LBO Model Guide Questions and Answers

LBO Model Guide Questions and Answers Does reducing the amount of cash you pay upfront increase or decrease your returns? Why? - ANSWER ️️ Increase; money today is worth more than money tomorrow Basic explanation of what a PE firm does - 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 - 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 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 - ANSWER ️️ the long term The Mechanics of an LBO -- Step 1 - 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 - 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 - 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 - ANSWER ️️ PE firm raises debt from investors, and then it combines that cash with its own cash to acquire the company