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LBO Interview Questions With 100% Correct Answers!!
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LBO Interview Questions With 100% Correct Answers!!
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Name: Score:42 Multiple choice questions
Definition 1 of 42
If the PE firm is concerned about the company meeting interest payments and wants a lower cost
option they might use bank debt.
They might also use Bank Debt if they are planning on a major expansion or Capital Expenditures
and don't want to be restricted by incurrence covenants.
What if the company has existing debt? How does that affect the projections?
Why would a PE firm prefer High-Yield Debt instead?
Why might you use Bank debt rather than High Yield debt in an LBO?
What's the point of assuming a minimum cash balance in an LBO?
,Term 2 of 42
How do you project the financial statements and determine how much debt the company can pay
off each year?
There are mature, cash-flows table companies in almost every industry. Some goals might
be
-Industry Consolidation: buying competitors in a market and combining them to increase
efficiency and customers
Turnarounds- taking struggling companies and improving their operations
Divestitures - selling off divisions of a company or turning a division into a strong stand-
alone entity.
Issue of risk is more applicable in industries where companies truly have unstable cash
flows - anything commodities based
The same way you do it anywhere else; you look at what comparable companies are
trading at, and what multiples similar LBO transactions have been completed at. You show a
range of purchases and exit multiples using sensitivity tables.
Sometimes you set purchase and exit multiples based on a specific iRR target- this is just
for valuation purposes if you're using an LBO model to value the company.
The same way you project the financial statements anywhere else: assume a revenue
growth rate, make key expenses a percentage of revenue and then tie Balance Sheet and
Cash Flow Statement items to revenue and expenses on the Income Statement and to
historical trends.
To project the cash flow available to repay debt each year, you take Cash Flow from
Operations and subtract CapEx.
Just as in the DCF analysis you assume that other items in the Investing and Financing
sections are non-recurring and therefore do not impact future cash flows.
This only determines how much debt principal the company could repay - interest expense
has already been factored on the Income Statement and its impact is already reflected in
the Cash Flow from Operations number.
If the company has existing debt and the PE firm refinances it (pays it off) it's a non-factor
because it goes away. If the PE firm assumes the debt instead, you need to factor in interest
and principal repayments on that debt over future years.
, Normally you do this by assuming that existing debt principal is paid off first after you've
calculated Cash Flow from Operations minus CapEx. Then you can use any remaining cash
flow after that to pay off debt principal for new debt raised in the LBO.
Term 3 of 42
Don't you need to factor in interest payments and debt principal repayments somewhere in the
IRR calculations?
If a firm doubles its money in 5 years, thats a 15% IRR.
If they triple their money in 5 years thats a 25% IRR.
If they double their money in 3 years thats a 26% IRR.
IF they triple their money in 3 years thats a 44% IRR.
Look at recent, similar LBOs and assess the debt terms and tranches used in each
transactions.
Look at companies in a similar size range and industry, see how much debt outstanding they
have and base your own numbers on those.
Yes because they use debt to buy it in the beginning. if they raise $500 million of Debt and
only pay with $500M of cash then get back $1 billion in cash at the end thats a 15% IRR.
you ignore them because the company uses its own cash flow to pay interest and pay off
debt principal. Since the PE firm itself is not paying for these neither one affects its IRR.
, Definition 4 of 42
Ideal candidates should:
- Have stable and predictable cash flows (so they can repay debt)
- Be undervalued relative to peers in the industry (lower purchase price)
- Be low-risk businesses (debt repayments0
- 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
Stable cash flows are the most important
What IRR do private equity firms usually ai for?
What is meant by the "tax shield" in an LBO?
What is an "ideal" candidate for an LBO?
What is a dividend recapitalization "dividend recap?
Definition 5 of 42
Depends on the economy and fundraising climate but an IRR in the 20-25% range or higher would
be good.
Sometimes PE firms will go lower and accept a 15-20% IRR but usually they target at least 20%.
Private Equity is a riskier and less liquid asset class than equities or bonds so the investors in the
fund need to be compensated for that in the form of higher returns.
Why are Goodwill & Other Intangibles create in an LBO?
What's the point of assuming a minimum cash balance in an LBO?
What is meant by the "tax shield" in an LBO?
What IRR do private equity firms usually ai for?
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