LBO Modeling Fundamentals Quiz Questions and Answers Verified and Updated 2026.docx

LBO Modeling
Fundamentals
Quiz Questions
and Answers
Verified and
Updated 2026

, Which of the following statements below are TRUE regarding why an LBO works
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conceptually?

a. By using debt, the PE firm reduces up-front cash required, thereby boosting returns
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b. Using cash flows produced by the company to pay down debt and make interest payments
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produces a better return for the PE firm than simply keeping the cash flows k k k k k k k k k k k k k




c. Since the PE firm sells the entire company in the future, it's guaranteed to at least get back
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100% of its original capital k k k k




d. The PE firm sells the company in the future, which allows it to get back (at least some of) the
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funds that it used to acquire the company in the first place - correct answerExplanation:
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Statements A, B, and D are all true. By using little of its own cash and borrowing heavily to k k k k k k k k k k k k k k k k k k k




purchase the company, the PE fund significantly boosts its returns for the simple reason that k k k k k k k k k k k k k k k




money today is worth more than money tomorrow due to the interest that it could earn. In an
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LBO, the PE fund uses the cash flows of the company it acquires to pay debt principal and debt
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interest, which is a much better use of those funds than keeping the money for itself, again
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boosting returns. The other reason LBOs work in practice and earn such high returns is k k k k k k k k k k k k k k k




because the PE fund only operates the company for 3 to 5 years before it sells it off and regains k k k k k k k k k k k k k k k k k k k k




its money plus profit; if the PE fund were to keep the companies it purchased indefinitely, it
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would not be possible to earn the returns that PE funds seek. C is incorrect because there's no
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"guarantee" that the PE fund will get back 100% of its original capital - if the company's k k k k k k k k k k k k k k k k k




EBITDA declines or if the exit multiple declines significantly, for example, that may not k k k k k k k k k k k k k k




happen.

What's the best analogy to use when thinking of how a leveraged buyout works?
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a. A homeowner buys a house to live in with a down payment and mortgage,
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and then sells the house in the future once the mortgage is repaid
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b. An investor buys a house to rent out to tenants, using a down payment and mortgage, then
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uses the rental income to repay the mortgage, and then sells
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the house in the future
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c. A person buys a car using cash and a car loan, drives it for several years, repays the debt,
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and then sells the car k k k k




d. None of the above - correct answerExplanation: B is correct because that is exactly what
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happens in an k k




LBO - you buy a company that generates cash flows, you use the cash flows to repay debt, and
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then sell it off at the end of several years. A is incorrect because a house that you live in is not an
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income-generating asset. So it is not the best way to think of an LBO. C is incorrect because k k k k k k k k k k k k k k k k k k




unlike a house, cars always depreciate in value and you'll likely lose a lot of money after buying
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it, running it, and selling it... plus cars do not generate income, unlike rental houses.
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