LBO- IB 400 Basic exam questions with
complete resolved answers
"In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio,
Interest Rate on Debt and other variables; you might also assume something about the
company's operations, such as Revenue Growth or Margins, depending on how
much information you have.
Step 2 is to create a Sources & Uses section, which shows how you finance thetransaction and
what you use the capital for; this also tells you how much Investor
Equity is required.
Step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figures, and also
add in Goodwill & Other Intangibles on the Assets side to make everything balance.
In Step 4, you project out the company's Income Statement, Balance Sheet and CashFlow
Statement, and determine how much debt is paid off each year, based on the available Cash
Flow and the required Interest Payments.
Finally, in Step 5, you make assumptions about the exit after several years, - answers✔✔Walk
me through a basic LBO model.
To boost your return.
Remember, any debt you use in an LBO is not "your money" - so if you're paying $5 billion for a
company, it's easier to earn a high return on $2 billion of your own money and $3 billion
borrowed from elsewhere vs. $3 billion of your own money and $2 billion
of borrowed money.
A secondary benefit is that the firm also has more capital available to purchase other companies
because they've used leverage. - answers✔✔Why would you use leverage when buying a
company?
, Purchase and exit multiples have the biggest impact on the returns of a model. After that, the
amount of leverage (debt) used also has a significant impact, followed by operational
characteristics such as revenue growth and EBITDA margins. - answers✔✔What variables
impact an LBO model the most?
The same way you do it anywhere else: you look at what comparable companies are trading at,
and what multiples similar LBO transactions have had. As always, you also show a range of
purchase and exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific IRR target that you're trying
to achieve - but this is just for valuation purposes if you're using an LBO model to value the
company. - answers✔✔How do you pick purchase multiples and exit multiples in an LBO
model?
"Ideal" candidates have stable and predictable cash flows, low-risk businesses, not much need
for ongoing investments such as Capital Expenditures, as well as an
opportunity for expense reductions to boost their margins. A strong management team also
helps, as does a base of assets to use as collateral for debt.
The most important part is stable cash flow. - answers✔✔What is an "ideal" candidate for an
LBO?
You use it to value a company by setting a targeted IRR (for example, 25%) and then back-
solving in Excel to determine what purchase price the PE firm could pay to achieve that IRR.
This is sometimes called a "floor valuation" because PE firms almost always pay less for a
company than strategic acquirers would. - answers✔✔How do you use an LBO model to value a
company, and why do we sometimes say that it sets the "floor valuation" for the company?
The most common example is taking out a mortgage when you buy a house. Here's how the
analogy works:
• Down Payment: Investor Equity in an LBO
• Mortgage: Debt in an LBO
• Mortgage Interest Payments: Debt Interest in an LBO
complete resolved answers
"In an LBO Model, Step 1 is making assumptions about the Purchase Price, Debt/Equity ratio,
Interest Rate on Debt and other variables; you might also assume something about the
company's operations, such as Revenue Growth or Margins, depending on how
much information you have.
Step 2 is to create a Sources & Uses section, which shows how you finance thetransaction and
what you use the capital for; this also tells you how much Investor
Equity is required.
Step 3 is to adjust the company's Balance Sheet for the new Debt and Equity figures, and also
add in Goodwill & Other Intangibles on the Assets side to make everything balance.
In Step 4, you project out the company's Income Statement, Balance Sheet and CashFlow
Statement, and determine how much debt is paid off each year, based on the available Cash
Flow and the required Interest Payments.
Finally, in Step 5, you make assumptions about the exit after several years, - answers✔✔Walk
me through a basic LBO model.
To boost your return.
Remember, any debt you use in an LBO is not "your money" - so if you're paying $5 billion for a
company, it's easier to earn a high return on $2 billion of your own money and $3 billion
borrowed from elsewhere vs. $3 billion of your own money and $2 billion
of borrowed money.
A secondary benefit is that the firm also has more capital available to purchase other companies
because they've used leverage. - answers✔✔Why would you use leverage when buying a
company?
, Purchase and exit multiples have the biggest impact on the returns of a model. After that, the
amount of leverage (debt) used also has a significant impact, followed by operational
characteristics such as revenue growth and EBITDA margins. - answers✔✔What variables
impact an LBO model the most?
The same way you do it anywhere else: you look at what comparable companies are trading at,
and what multiples similar LBO transactions have had. As always, you also show a range of
purchase and exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific IRR target that you're trying
to achieve - but this is just for valuation purposes if you're using an LBO model to value the
company. - answers✔✔How do you pick purchase multiples and exit multiples in an LBO
model?
"Ideal" candidates have stable and predictable cash flows, low-risk businesses, not much need
for ongoing investments such as Capital Expenditures, as well as an
opportunity for expense reductions to boost their margins. A strong management team also
helps, as does a base of assets to use as collateral for debt.
The most important part is stable cash flow. - answers✔✔What is an "ideal" candidate for an
LBO?
You use it to value a company by setting a targeted IRR (for example, 25%) and then back-
solving in Excel to determine what purchase price the PE firm could pay to achieve that IRR.
This is sometimes called a "floor valuation" because PE firms almost always pay less for a
company than strategic acquirers would. - answers✔✔How do you use an LBO model to value a
company, and why do we sometimes say that it sets the "floor valuation" for the company?
The most common example is taking out a mortgage when you buy a house. Here's how the
analogy works:
• Down Payment: Investor Equity in an LBO
• Mortgage: Debt in an LBO
• Mortgage Interest Payments: Debt Interest in an LBO
