LBO Modelling Exam Questions With 100% Correct Answers

LBO Modelling Exam Questions With 100% Correct Answers What is the biggest difference between an LBO and an M&A? - answerUnlike an M&A, we're not assuming the PE firm will keep the company long term What makes a good LBO candidate? - answer-opportunity to cut costs -stable cash flows -good base of assets -undervalued/low-risk Walk me through a basic LBO model. - answer1. Make assumptions about the Purchase Price and how much debt to use 2. Create a Financial Sources & Uses section 3. Adjust the company's Balance Sheet 4. Project the company's statements and determine how much debt you can pay off each year 5. Calculate the IRR and an EBITDA exit multiple Why do you focus on Equity value in an LBO? - answerYou need to acquire all the outstanding shares of a public company What is Bank Debt vs. High-Yield Debt? - answer-Bank debt (Revolver, Term Loan A/B): Lower, floating interest rates, annual principal repayments, *maintenance* covenants (i.e. Total Debt/EBITDA must be below 4x), secured (collatoralized), allows prepayment -High-yield debt (Senior/Subordinate notes, Mezzanine): Higher, fixed interest rates, no annual repayments, *incurrence* covenants (i.e. the company can't acquire another and sell off assets), not secured, doesn't allow prepayment Why might a PE firm prefer High-Yield Debt? - answer-Don't want the risk of *floating* rates -Intend to *refinance* the debt -Aren't planning big expansions -Don't believe their returns are sensitive to interest payments How to assess the amount of debt to use: - answerYou can look at recent, similar LBOs and assess the terms, or you can look at your company's Leverage Ratio or Interest Coverage ratio, to see how much debt it can afford to take on. Leverage Ratio = - answerDebt / EBITDA Interest coverage ratio - answerEBITDA / Interest Expense What are reasonable Leverage and Coverage Ratios? - answerDebt/EBITDA should rarely exceed 10x. For Interest Coverage, you want a number where the company can pay for its interest without trouble, but also not high enough where it can't afford more debt. Why is it better to reduce the amount of cash PE firms pay up front? - answerThe returns go up because reducing the amount of cash you pay up-front for an asset has a disproportionate effect on your returns... since money today is worth more than money tomorrow. Common Uses of Funding - answer-Buyout of oldco's equity -Refinancing of oldco debt -Transaction & Financing fees Common Sources of Funding - answer-Excess cash -Debt (term loans, notes, etc.) -Preferred stock -Management rollover -Sponsor equity Do you pay the Equity Value or Enterprise Value in an LBO? - answer-If you *refinance* existing debt, the price will be closer to the Enterprise Value -if you *assume* the debt, the purchase price will be closer to the Equity value What happens if the PE firm pays off the debt? - answerThe PE firm must *increase* the funds required to buy the company, and the debt goes under the *uses* column (purchase price is closer to the EV) What happens if the PE firm assumes (takes on) the debt? - answerIt has no impact on the total funds it must raise, and it goes on the balance sheet of the PE firm and listed under *both* sources and uses (purchase price closer to the Equity Value)