LBO questions Flashcards
1
Q
walk me through basic LBO model
A
- make assumptions about purchase price, Debt/equity ratio, interest rate on debt. Assumptions on company operations such as revenue growth and margins
- create a sources and uses section: how you finance the acquisition. how much investor equity
- adjust company’s balance sheet for new debt and equity .
- project company 3 statements and determine how much debt paid off each year, based on available cash flow and interest payments
- make assumption on EBITDA exit multuple, and calculate IRR and MoM based on how much equity is returned to firm
2
Q
Definition of IRR, and MoM
A
IRR: internal rate of return annualized on equity investments initially (20-25%)
MoM: overall and tital return on equity initially invested (2-3x)
3
Q
Definition of LBO
A
- use of leverage to buy a company
- with the aim to boost returns by improving operational efficiencies for revenue growth
4
Q
why would you use leverage to buy a company
A
- to boost returns
- Debt is not your money, so its easier to get higher returns from borrowed money than from partly borrowed and partly own cash
- for example, if I borrow 4Bill and put in 1B of own cash, and I make 2.5Bill return, my ROI = 2.5x, if all 5Bill are my money then even if i maken 2.5Bil its only 0.5.
- cash can a;so just be used elsewhere
5
Q
What variables impact an LBO model the most?
A
- entrance and exit multiples
- how much leverage
- revenue growth
6
Q
Why are Goodwill & Other Intangibles created in an LBO?
A
- premium payment, and anything acquired over fair market value
7
Q
Can you explain how the Balance Sheet is adjusted in an LBO model?
A
- first on the liabilities side: new debt added, and no shareholders equity –> replaced by equity invested by firm
- on asset side: cash is adjusted for uses on cash to finance acquisition, goodwill is used as a plug to balance
8
Q
We saw that a strategic acquirer will usually prefer to pay for another company in cash – if that’s the case, why would a PE firm want to use debt in an LBO?
A
- PE firm plans to sell off and exit the company
- so less concerned about the cost of cash vs debt
- it wants to use debt to leverage return rates, and reducing amount of cashb and equity invested
9
Q
difference between bank debt and high yield debt
A
- high yield debt - higher interest rates but fixed
- high yield debt required incurrence covenant - prevents you from doing things like selling assets
- bank debt has maintenance covenant: requir9e a minimum financial performance
- bank debt is paid off over time
- high yield debt paid off at the end altogether
10
Q
How could a private equity firm boost its return in an LBO?
A
- lower purchase price
- raise exit multiple
- increase leverage
- increase company growth rate organically or inorganically
- decrease expenses: cutting employees
11
Q
What is meant by the “tax shield” in an LBO?
A
- interest payment is tax deductible
- but doesnt matter too much, because the interest payment still reduces net income over what it would be for a debt free company
12
Q
please describe and explain to me what is an LBO
A
- when during an acquistion, the buyer like PE firm uses high leverage acquire a company
- with the intent to boost their returns
- the aim is to improve operation al efficiency and more growth to then sell business at higher valuation or IPO
- this is because when using more debt to finance acquisition, your return on invested equity will be much higher than using equity
- and the equity not used for this can be invested elsewhere, leading to a more amplified affect of having higher IRR and return on investments.
- for eg you acquire a company with 100 million, where 80Mill is debt, and you make 20 million. then your return on equity is 100%, as you only invested in 20Mill of your own money (minus interest payments). Whereas if you use 100Mill of own equity, the return is only 20%. and with debt, the equity your not using can be invested elsewhere to generated more returns.
