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LBO Modeling Exam From Wall Street (Version 1& 2) Newest 2025 Exam Complete Questions And Correct Detailed Answers (Verified Answers) |Already Graded A+
Walk me through a basic LBO model? -correct answer -->> 1) Assumptions of purchase price, debt/equity ratio, interest rate on debt, and other variables and you might assume something about company's revenue growth or margins. 2)Create sources & uses section 3) Adjust company's balance sheet for the new debt, equity, Goodwill, and other intangibles. 4) Project company's income statement, balance sheet, and cash flow statement and determine debt schedule. 5)Assumptions about EBITDA exit multiple and calculate return based on how much equity is returned to the firm
Why would you use leverage when buying a company? -correct answer -->> 1) Boost return, since debt is not "your money". Easier to earn a higher return on a $5 bil company with $2 bil of your money and $3 bil than $3 bil of your money and $2 bil. 2)Firm also has more capital available to purchase other companies because they've used leverage.
What variables impact an LBO model the most? -correct answer -->> 1) Purchase and exit multiples biggest return
2)leverage used 3)operational characteristics such as revenue growth and EBITDA margins
How do you pick purchase multiples and exit multiples in an LBO model? -correct answer -->> 1)Same as others, look at comparable companies are trading at and what multiples similar LBO transactions have had. Sensitivity analysis of purchase and exit multiples.
2)Sometimes you set purchase and exit multiples based on specific IRR target that you're trying to achieve.
What is an "ideal" candidate for an LBO? -correct answer -->> 1) Stable and predictable cash flows 2) low-risk businesses 3) low capex 4) opportunity for expense reductions to boost margins 5)Strong management team 6) base of assets to use as a collateral for debt
When use LBO model for valuation and why is it low? -correct answer -->> Use it to value a company by setting a targeted IRR and then back-solving in Excel to determine purchase price for PE firm. Low because PE firms almost always pay less than a strategic acquirer would
the company assumes the risk. Strategic acquisition, buyer buys the debt so greater risk.
Any shortcuts building an LBO model? -correct answer -->> Yes shortcuts. You can make assumptions on the Net Change in Working Capital rather than look at each individual item. Need some income statement to track debt balance and changes. need some cash flow to show cash available to repay debt.
How do you determine how much debt can be raised in an LBO and how many tranches there would be? -correct answer -- >> Usually look at Comparable LBOs to see terms of the debt and how many tranches each of them used. Look at similar size and industry to estimate debt you can raise
Analyzing how much debt a company a company can take on. and what the terms of debt should be. What are reasonable leverage and coverage ratios? -correct answer -->> Dependent on comparable LBO transactions. Look at "debt comps" showing the types, tranches, and terms of debt. Suggested to never lever a company 50x EBITDA and leverage rarely exceeds 5-10x EBITDA.
What is the difference between bank debt and high-yield debt? -correct answer -->> High level these are the two types of debt. Some differences: 1)H-YD tends to have higher interest rates. 2)H-YD interest rates usually fixed whereas BD floating based on LIBOR or FED interest rate 3) H-YD has incurrence covenants while BD has maintenance covenants 4)HY-D bullet maturity (entire principal paid in the end) but BD is usually amortized (paid off over time) 5)Usually use both types, there are other types of debt yet.
What are incurrence covenants and maintenance covenants? - correct answer -->> Incurrence covenants: prevent you from doing something. ie. buying a factory. Maintenance covenants: require you to maintain a min financial performance ie. Debt/EBITDA < 5x
Why would a PE firm prefer high-yield debt instead? -correct answer -->> 1) Refinance 2) don't believe returns are too sensitive to interest payments. 3)Don't plan for major expansion 4) don't plan on selling off the company's assets
Why might you use bank debt rather than high-yield debt in an LBO? -correct answer -->> 1) Worried about meeting interest payments and wants a lower-cost option. 2) plan major
income and therefore, increases cash flow as a result of having debt.
Cash flow is still lower than it would be without debt due to interest expense decrease Net Income
What is a dividend recapitalization ("dividend recap")? -correct answer -->> dividend recap is the company takes on new debt soley to pay a special dividend to the firm that bought it. Developed bad reputation although still commonly used.
Why would a PE firm choose to do a dividend recap of one of its portfolio companies? -correct answer -->> 1) Boost returns, all else equal more leverage means greater returns. 2) PE firm is "recovering" some of the equity investment. Lower equity investment is easier to earn a higher return on a smaller amount of capital
How would a dividend recap impact the 3 financial statements in an LBO? -correct answer -->> I/S: No change
CFS: additional debt would add cash to financing. subtract equal amount from investing being paid out. No net change
BS: Debt would go up and shareholder's equity would go down so they would cancel out
Tell me about the different kinds of debt you could use in an LBO? -correct answer -->> 1) Bank Debt 2) High-yield debt 3) Mezzanine debt 4) Revolver debt
What is tenor? -correct answer -->> Years the loan is outstanding
Seniority? -correct answer -->> Referes to the order of claims on a company's assets in a bankruptcy case. Goes senior secured, senior unsecured, senior subordinated, and then equity investors
Amortization, types and what they are? -correct answer -- >> Straight line: Pays off a bit every year.
Bullet: Pays off the entire principal at the end
How would an asset write-up or write-down affect an LBO model?/Walk me through how you adjust the Balance Sheet in an LBO mode? -correct answer -->> Similar to a merger model. Calculate Goodwill and other intangibles the rest is write-ups. Then adjust BS by subtracting cash, ading capitalized financing fees, writing up assets, wiping out goodwill, adjusting deferred tax assets/liabilites, add new debt.
- To raise the funds, the PE firm will use a small amount of its cash on-hand (almost always < 50% of the Cie's value) and then raise debt from investors to pay for the rest...
- ...And it can raise debt from investors because it says to them, "We're using the debt to buy an income-generating asset
- this company. And we'll repay everything because we'll sell this company in the future and use the proceeds to pay you back."
- The PE firm raises the debt from investors, and then it combines it with its own cash to acquire the company.
- The PE firm operates the company for years into the future, and uses its cash flow to pay the interest and repay the principal on the debt that it borrowed to buy the Cie
- Then at the end of 3-5 years, the PE firm sells the company or takes it public via an IPO and realizes a return like that.
What Makes for a Good LBO Candidate? -correct answer -->> · Have stable and predictable cash flows (so they can repay debt) = most important
· Be undervalued relative to peers in the industry (lower purchase price);
· Be low-risk businesses (debt repayments)
· Not have much need for ongoing investments such as CapEx;
· Have an opportunity to cut costs and increase margins;
· Have a strong management team;
· Have a solid base of assets to use as collateral for debt.
How to make basic model assumptions -correct answer -->> 1. Assume a purchase price and the amount of debt and equity you'll be using.
- Figure out the debt terms, including interest rates and annual repayment.
- Create a Sources & Uses schedule that tracks where your funds are coming from, and where they're going to.
How to Project the Statements and Pay Off Debt? - excel - correct answer -->> · Revenue Growth: You generally want this to decline over time (e.g. 10% initially down to 5% in Year 5).
· EBIT / EBITDA Margins: These should stay in the same range each year.
· Balance Sheet Items: can be % of revenue, COGS, or Opex historical averages.
· D&A and Other Non-Cash Charges: Historical averages and percentages of revenue.
· Capital Expenditures: Make it a % of revenue, use a historical average, or assume a fixed $ amount growth each year. Sample LBO model:
they can sell it for 8 - 10x EV / EBITDA and show a range of different outcomes based on those numbers.
Once you calculate the Enterprise Value, you work backwards to calculate the Equity Value based on the company's Cash, Debt, Preferred Stock, and other Balance Sheet items that factor into the calculation.
Famous IRR -correct answer -->> · If a PE firm doubles its money in 5 years, that's a 15% IRR.
· If a PE firm triples its money in 5 years, that's a 25% IRR.
· If a PE firm doubles its money in 3 years, that's a 26% IRR.
· If a PE firm triples its money in 3 years, that's a 44% IRR.
What Affects the IRR in an LBO?
What increases / decreases an IRR? -correct answer -->> 1. Purchase Price
- % Debt and % Equity Used
- Exit Price
· Changes That Increase IRR: Lower Purchase Price, Less Equity, Higher Revenue Growth, Higher EBITDA Margins, Lower Interest Rates, Lower CapEx
· Changes That Reduce IRR: Higher Purchase Price, More Equity, Lower Revenue Growth, Lower EBITDA Margins, Higher Interest Rates, Higher CapEx
- Walk me through a basic LBO model. -correct answer -- >> Step 1 : "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 : Create a Sources & Uses section, which shows how the transaction is financed and what the capital is used for; it also tells you how much Investor Equity (cash) is required.
Step 3 : adjust the company's BS for the new Debt and Equity figures, allocate the purchase price, add in Goodwill & Other Intangibles on the Assets side to make everything balance.
