Technical Concepts

Question 1

FCF

Answer 1

• FCF determines how much debt a company can service which then determines how much leverage an LBO can use
• total amount of cash profits that a company can pay out to its owners, equity or debt holders

Question 2

Calculating FCF

Answer 2

EBIT(1-tax rate)+ D &A - Capex - change in working capital

Question 3

Why does PE use leverage? How does leverage increase PE retunes?

Answer 3

PE returns are calculated based on return of their invested equity

• using leverage to do deals allows you to use less equity which means the ultimate returns are larger in comparison to the amount of equity intiaally invested
• another way to look at this is that the cost od debt is lower than the cost of equity because equity is prices to an IRR of 20% whereas the annual interest expense on debt is usually below 10%

Question 4

How would you determine an appropriate exit multiple on a PE deal?

Answer 4

• comparable multiples analysis will tell you what multiples similar public companies are trading for on the stock market
• precedent transactions will tell you what the multiples were on deals involving similar targets
• LBO analysis will tell you what multiple a financial sponsor would be willing to pay in the future

Question 5

Walk me through an LBO model

Answer 5

1. calculate the total acquisition price, including acquisition of the target’s equity, repayment of an outstanding debt, and any transaction fees (fees paid to investment banks, deal lawyers, accountants, consultants)
2. Determine how the total price will be paid including : equity from PE firm, roll-over equity from target’s management, debt
3. Project the target’s operating performance over 5 years and determine how much of the debt principal used to acquire the target can be paid down using the target’s FCF over that time
4. Project how much the target could be sold for after 5 years and determine how much of the debt principal used to acquire the target can be paid down using the target’s FCF over that time
5. Calculate the projected IRR and MoM return on equity based on the amount of equity originally used to acquire the target and the projected equity returns upon exit