Paper LBO

Sometimes you are given all the relevant information up front, and sometimes you need to ask the right questions (and perhaps be told to make logical assumptions). The following is the minimal information needed:

  • Capital structure (% debt versus equity)
  • Duration of investment for IRR estimation
  • Projected EBITDA for FCF (may be given in the form of revenue, growth rate and margins)
  • D&A for tax calculation
  • Cost of debt
  • Tax rate for taxes
  • Cash flow components: working capital, capex
  • Exit multiple for ending EV

On paper, your answer will consist of the calculations to get to FCF. Then you calculate the ending equity value. Some will ask you to estimate the IRR (see Returns (IRR) & Rule of 72)

Paper LBO Example

You buy a retail company for 5x forward EV/EBITDA. You raised 40/60 debt to equity; the debt costs 10%. Next year, the company is projected to generate $100 million in revenue with a 40% EBITDA margin. Revenue is expected to increase by $50 million every year and margins are estimated to stay flat. Working capital stays the same every year. Capex are 20% of sales. Depreciation is $20 million every year. Tax rate is 40%. You’d like to exit in 5 years. Does this look like a good investment?

FCF Projection

paper lbo mathReturns Math

IRR Math

This is a good investment, as the equity makes more than 5.5x (IRR is ~40%)