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10. LBO MODELING TEST EXAMPLE

of Privat e Equit y Training

When int erviewing for a junior privat e equit y posit ion, a candidat e must prepare for in-office

modeling t est s on pot ent ial privat e equit y invest ment opport unit ies—especially LBO
scenarios. In t his module, we will walk t hrough an example of an in-office LBO modeling t est .

In-office case st udies and modeling t est s can occur at various st ages of an int erview
process, and addit ional int erviews wit h ot her members of t he privat e equit y t eam could

occur on t he same day. Therefore, you should st rive t o be able t o do t hese st udies
effect ively and efficient ly wit hout draining yourself so much t hat you can’t quickly rebound
and move on t o t he next int erview. Make sure t o t ake your t ime and build every formula

correct ly, since t his process is not a race. There are many complex formulas in t his t est , so

make sure you underst and every calculat ion.

This t ype of LBO t est will not be mast ered in a day or even a week. You must t herefore begin

pract icing t his t echnique in advance of meet ing wit h headhunt ers. Repeat ed pract ice,
checking for errors and difficult ies and learning how t o correct t hem, all t he while enhancing

your underst anding of how an LBO works, is t he key t o success.

In t he following LBO Case St udy module, we will cover t he following key areas:

Invest ment Scenario Overview

Given Informat ion (Paramet ers and Assumpt ions)

Exercises

St ep 1: Income St at ement Project ions

St ep 2: Transact ion Summary

 St ep 3: Pro Forma Balance Sheet

St ep 4: Full Income St at ement Project ions

St ep 5: Balance Sheet Project ions

St ep 6: Cash Flow St at ement Project ions

St ep 7: Depreciat ion Schedule

St ep 8: Debt Schedule

St ep 9: Ret urns Calculat ions

GIVEN INFORMATION (PARAMETERS AND ASSUMPTIONS)

Below we provide t he given informat ion from a real-life LBO t est t hat was given t o a pre-MBA

associat e candidat e at a large PE firm. We will use it as an example of how t o build an LBO

model from scrat ch during t he int erview. Remember t hat candidat es will receive a lapt op and
a print out wit h key informat ion regarding t he t ransact ion t o complet e t his assignment .

ABC Co mpany, Inc.

SCENARIO OVERVIEW AND REVENUE ASSUMPTIONS:

ABC Company, Inc. is a developer of soft ware applicat ions for smart phone devices. The
company sells t wo product s for t he various smart phones. The first is a soft ware applicat ion

called Cloud t hat t racks weat her dat a. The second applicat ion, Time, act s as a calendar t hat
keeps t rack of a user’s schedule. ABC Company prices Cloud at $16.00 and Time at $36.00
per soft ware license. ABC Company sold 1.5 million copies of Cloud and 3 million copies of

Time in 2010. That was t he first year ABC Company generat ed any revenue.

Each soft ware applicat ion requires t he payment of a $5.00 renewal fee every year. ABC

Company renews approximat ely 25% of t he licenses it sold in t he prior year; t his renewal fee
act s as a source of recurring revenue. To simplify, assume t hat renewals happen for only one

addit ional year and t hat t he recurring revenue st ream is based on t he prior year’s new
licenses. Not e t hat ABC Company does not incur any addit ional cost s for renewals.

COGS ASSUMPT IONS (ASSUME CONST ANT T HROUGHOUT T HE PROJECT ION PERIOD):

Packaging cost s = $1.50 per unit

Royalt ies t o t echnology pat ent owners = $3.00 per unit

Market ing expense = $3.00 per unit
Fulfillment expense = $4.00 per unit
 Fees t o smart phone companies = 15% of sale price (does not include renewal fees)
ABC Company incurs a 15% bad debt allowance on t ot al revenues (consider t his as part
of cost of sales, wherein ABC Company is unable t o collect from cust omers’ credit card

companies).

G&A AND OT HER ASSUMPT IONS (ASSUME CONST ANT T HROUGHOUT T HE PROJECT ION PERIOD):

Rent of development propert y and warehouse facilit ies = $350,000 annually

License fee t o t elecom int ernet providers = $1.5 million annually

Salaries and benefit s = $1.75 million annually

Sales commissions = 5% of all sales including renewals
Offices and ot her administ rat ive cost s = $750,000 annually

CEO salary and bonus = $1.25 million annually + 3% of all sales including renewals
Federal t ax rat e = 35% and st at e t ax rat e = 5% on EBT

ST ART ING BALANCE SHEET :

INVEST MENT ASSUMPT IONS:

Due t o t he depressed macroeconomic and invest ing environment , t he PE fund is able t o

acquire ABC Company for t he inexpensive purchase price of 5.0x 2011 EBITDA (assuming a
cash-free debt -free deal), which will be paid in cash. The t ransact ion is expect ed t o close at
t he end of 2011.

Assumpt ions include t he following:

Senior Revolving Credit Facilit y: 3.0x (2.0x funded at close) 2011 EBITDA, LIBOR +
400bps, 2017 mat urit y, commit ment fee of 0.50% for any available revolver capacit y.
RCF is available t o help fund operat ing cash requirement s of t he business (only as
needed).
Subordinat ed Debt : 1.5x 2011 EBITDA, 12% annual int erest (8% cash, 4% PIK int erest ),
2017 mat urit y, $1 million required amort izat ion per year. (Hint : add t he PIK int erest once

you have a fully funct ioning model t hat balances.)

Assume t hat exist ing management expect s t o roll-over 50% of it s pre-t ax exit
proceeds from t he t ransact ion. Exist ing management ’s ownership pre-LBO is 10%.
Assume a minimum cash balance (Day 1 Cash) of $5 million (t his needs t o be funded by
t he financial sponsor as t he t ransact ion is a cash-free / debt -free deal).

Assume t hat all remaining funding comes from t he financial sponsor.

Assume t hat all cash beyond t he minimum cash balance of $5 million and t he required
amort izat ion of each t ranche is swept by credit ors in order of priorit y (i.e. 100% cash
flow sweep).
Assume t hat LIBOR for 2012 is 3.00% and is expect ed t o increase by 25bps each year.
The M&A fee for t he t ransact ion is $1.5 million. Assume t hat t he M&A fee cannot be

expensed (amort ized) by ABC and will be paid out of t he sponsor equit y cont ribut ion
upon close.
In addit ion, t here is a financing syndicat ion fee of 1% on all debt inst rument s used. This
fee will be amort ized on a five-year, st raight -line schedule.
Assume New Goodwill equals Purchase Equit y Value less Book Value of Equit y.

Assume Int erest Income on average cash balances is 1%.

Hint: The first forecast year for the model will be 2012. However, you will need to build out
the income statement for 2010 and 2011 to forecast the financial statements for years
2012 through 2016.

EXERCISES:

As part of t he in-person LBO t est , pre-MBA and post -MBA candidat es are expect ed t o
complet e t he following exercises in t heir ent iret y. Please not e t he assumpt ions given here
apply for mult iple scenarios:
 Build an int egrat ed t hree-st at ement LBO model including all necessary schedules (see

below).
Build a Sources and Uses t able.
Make adjust ment s t o t he closing balance sheet of ABC Company post -acquisit ion.
Build an annual operat ing forecast for ABC Company wit h t he following scenarios (using
2010 as t he first year for t he revenue forecast ; not e t hat 2010 EBITDA should be

approximat ely $25 million). Assume t hat in 2011 t here is 5% growt h in unit s sold (bot h
Cloud and Time unit s).
2012-2016 assumpt ions include:
Upside Case: 5% annual growt h in unit s sold (bot h Cloud and Time unit s)
Conservat ive Case: 0% annual growt h in unit s sold (bot h Cloud and Time unit s)
Downside Case: 5% annual decline in unit s sold (bot h Cloud and Time unit s)

Build a Working Capit al schedule using Account s Receivable Days, Account s Payable
Days, Invent ory Days, and ot her asset s and liabilit ies as a percent age of Revenue.
Assume working capit al met rics st ay const ant t hroughout t he project ion period and
assume 365 days per year.
Build a Depreciat ion Schedule t hat assumes t hat exist ing PP&E depreciat es by $1

million per year, and t hat new capit al expendit ures of $1.5 million per year depreciat e on
a five-year, st raight -line basis.
Build a Debt schedule showing t he capit al st ruct ure described earlier. Use average
balances for calculat ing Int erest Expense (except for PIK int erest —assume t hat PIK
int erest is calculat ed based on t he beginning year Subordinat ed Debt balance and not
t he average over t he year).

Creat e an Exit Ret urns schedule (including bot h cash-on-cash and IRR) showing t he
ret urns t o t he PE firm equit y based on all possible year-end exit point s from 2012 t o
2016, wit h exit EBITDA mult iples ranging from 4.0x t o 7.0x.
Display t he result s of all of t hese calculat ions using t he “Upside Case.”

Not e t hat t he above descript ion incorporat es all of t he informat ion, assumpt ions and
assignment s t hat were given in t his LBO in-person t est example.

STEP 1: INCOME STATEMENT PROJECTIONS

As part of t he first st ep, build out t he core operat ing Income St at ement line it ems for years
2010 t hrough 2016.
Based on t he provided assumpt ions, t he Upside Case est imat es an annual increase of 5.0%
for Revenue from 2012-2016. Next , you should build t he following exhibit in Excel in order t o
be able t o change t he case scenarios easily (wit h t he select ed case driving t he revenue
growt h numbers in t he operat ing model).

Make a dist inct ion bet ween 2011 assumpt ions and 2012-2016 assumpt ions

Take t he provided assumpt ions and make t he revenue and cost build based upon
t hem.

Not e t hat t he highlight ed “1” is t he input t o t he operat ing model, and t he “5.0%” in grey
background represent s t he formula t hat is built t o pick up t he appropriat e case. We use t he
=OFFSET() funct ion in Excel t o drive t his formula.

OFFSET is a simple Excel formula t hat is used commonly t o int erchange scenarios,
especially if t he model becomes very complex. It simply reads t he value in a cell t hat is

locat ed an appropriat e number of rows/columns away, based on t he paramet ers given

t o t he funct ion. Thus, for example, =OFFSET(A1, 3, 1) will read t he value in cell B4 (3
rows and 1 column aft er A1).

Next , build t he cost s relat ed t o Revenue based upon t he informat ion given in t he case.
Then, build t he G&A expenses from t he given informat ion.

Finally, build a simple summary schedule for t he above project ions.

STEP 2: TRANSACTION SUMMARY

As part of t he second st ep, build out t he t ransact ion summary sect ion which will consist of
t he Purchase Price Calculat ion, Sources and Uses, and t he Goodwill calculat ion.

Using t his graphic, you should be able t o underst and and build all t he formulas. Be sure t o
t hink t hrough each number and how it is calculat ed, as t his is t he main summary of t he LBO
t ransact ion as a whole. A few point s wort h not ing:

This model assumes a debt -free/cash-free balance sheet pre-t ransact ion for
simplificat ion. Wit hout debt or cash, t he t ransact ion value is simply equal t o t he offer
price for t he equit y (before fees and minimum cash—discussed below).
The funding for t his model is fairly simple: t he funded credit facilit y is 2.0x 2011E
EBITDA, t he subordinat ed debt is 1.5x, and t he remaining port ion is t he equit y funding,
which is a combinat ion of management rollover equit y and sponsor (PE firm) equit y.
(Not e t hat t he 5.0x 2011E EBITDA is t he offer value for t he equit y before t he M&A and

financing fees and t he minimum cash balance, not aft er. Aft er fees/cash, it ends up
being 5.25x.)
The management rollover is simply half of t he management t eam’s proceeds from
selling t he company. Since management owned 10% of t he company before t he
t ransact ion, it const it ut es 5% of t he offer price for t he original equit y.
The sponsor equit y is t he “plug” in t his calculat ion. In ot her words, it is t he amount t hat
is solved for once all ot her amount s are known (offer price + minimum cash + fees –
debt inst rument s – management rollover equit y).
The t ot al equit y (including management rollover) represent s about 30-35% of t he
funding for t he deal, which is about right for a t ypical LBO t ransact ion.
 Goodwill is simply t he excess paid for t he original equit y (offer price – book value of

equit y).

STEP 3: PRO FORMA BALANCE SHEET

As a next st ep, build out t he Pro Forma Balance Sheet using t he given 2011 balance sheet .
To do t his, you need t o incorporat e all t he t ransact ion and financing-relat ed adjust ment s
needed t o produce t he Pro Forma Balance Sheet . Each adjust ment is discussed in det ail
below.

Since t his is a cash-free and debt -free deal t o st art , t here are no Pro Forma
adjust ment s for t he cancelling or refinancing of debt .
Cash increases by $5 million upon close because t he sponsor is funding t he minimum
cash balance (minimum cash t hat is assumed t o be needed t o run t he business).
The New Goodwill is simply t he purchase value of t he equit y (not including fees) less
t he original book value of t he equit y.
The adjust ment for Debt Financing Fees reflect s t he cost of issuing t he new debt
inst rument s t o buy t he company. This fee is considered an asset , and is capit alized and
amort ized over 5 years.

The Debt -relat ed adjust ment s reflect t he new debt inst rument s for t he new capit al
st ruct ure.
The Equit y adjust ment reflect s t he fact t hat t he original equit y is effect ively wiped out
in t he t ransact ion—t he “adjust ment ” amount shown here is simply t he difference
bet ween t he new equit y value and t he old one. The new equit y value will equal t he
amount of t he t ot al equit y funding for t he t ransact ion (sponsor plus management ’s
rollover) less t he M&A fee, which is account ed for as an off balance-sheet cost .
 VERY IMPORTANT: This st age of t he LBO model development (once Pro Forma
adjust ment s have been made t o reflect t he impact of t he t ransact ion on t he balance
sheet ) is a very good t ime t o check t o make sure t hat everyt hing in t he model so far
balances and reflect s t he given assumpt ions. This includes old and new asset s equaling

old and new liabilit ies plus equit y; new sources of capit al equaling t he t ransact ion value,
which equals t he offer price for t he original equit y (adjust ing for cash, old debt and
fees), et c.

STEP 4: FULL INCOME STATEMENT

Next , build t he full Income St at ement project ions all t he way down t o Net Income. Not e t hat
a few line it ems (especially Int erest Expense!) will be calculat ed in lat er st eps. Once t he Cash
Flow sect ion and ot her schedules are built , link all t he final line it ems t o complet e t he
int egrat ed financials.

You can link t he Revenue, COGS and SG&A calculat ions t o t he operat ing model (built in
St ep 1) t o get t o EBITDA.
To get from EBITDA t o Net Income, set up t he framework first (include line it ems t o
subt ract D&A, and t o subt ract Int erest and fees, t o get t o EBT. Then subt ract t axes
t o get Net Income—but keep in mind for now t hat calculat ing D&A and Int erest will
come a bit lat er, from ot her schedules you have not yet creat ed).

D&A will be linked t o t he Depreciat ion Schedule t hat you will need t o build
(schedule of t he Depreciat ion of t he exist ing PP&E and new Capit al Expendit ures
made over t he project ion period).
Int erest Expense and Int erest Income will be linked t o t he Debt Schedule t hat you
will need t o build. There will be a nat ural circular reference because of t he cash
 flow sweep feat ure of t he LBO model, combined wit h t he fact t hat Int erest
Expense is dependent upon Cash balances. This is usually one of the last things
you should build in an LBO model.
The amort izat ion of Deferred Financing Fees is fairly st raight forward: it uses a
st raight -line, 5 year amort izat ion of t he fees described in t he case writ e-up and
comput ed in St ep 2.

The t ax rat es apply t o EBT aft er all of t hese expenses have been subt ract ed out .
They are given in t he case writ e-up.

STEP 5: BALANCE SHEET PROJECTIONS

Next , forecast t he Balance Sheet from 2011 t o 2016. Not e t hat we st art wit h t he 2011 Pro
Forma Balance Sheet from Step 3, not t he original Balance Sheet .

Laying out t he Balance Sheet is similar t o laying out t he Income St at ement —you’ll have
t o set up t he framework for some line it ems and leave t he formulas blank at first , as
t hey will be calculat ed in t he ot her schedules you will creat e.
Cash remains at $5 million t hroughout t he life of t he model, as we’re assuming a 100%
cash flow sweep and t hat t he minimum cash balance is $5 million. (Cash would only st art
t o increase if we project out long enough t hat all out st anding Debt is paid off.)
You’ll need t o build out t he Operat ing Working Capit al line it ems (Account s Receivable,
Invent ory, Ot her Current Asset s, Account s Payable, Ot her Current Liabilit ies) according
 t o t he assumpt ions st at ed in t he case writ e-up.
Account s Receivable (AR): Calculat e AR days (AR ÷ Tot al Revenue × 365) for
2011 and keep it const ant t hroughout t he project ion period.
Invent ory: Calculat e Invent ory days (Invent ory ÷ COGS × 365) for 2011 and keep
it const ant t hroughout t he project ion period.
Ot her Current Asset s: Keep t his line it em as a const ant percent age of revenue
t hroughout t he project ion period.
Account s Payable (AP): Calculat e AP days (AP ÷ COGS × 365) for 2011 and keep
it const ant t hroughout t he project ion period.
Ot her Current Liabilit ies: Keep t his line it em as a const ant percent age of revenue

t hroughout t he project ion period.

Tot al Deferred Financing Fees are comput ed based upon t he Debt balances and
percent age assumpt ions given in t he model. Deferred financing fees are t hen
amort ized, st raight -line, over 5 years.
The Credit Facilit y and Subordinat ed Debt line it ems will link t o your Debt schedule.
Their balances will decrease over t ime as a funct ion of t he cash available for Debt
paydown (since t he case writ e-up specifies a 100% cash sweep funct ion).
Equit y (specifically Ret ained Earnings) will increase each year by t he same amount as
Net Income, because t here are no dividends being declared. If dividends were t o be
added int o t he model, you would calculat e ending Ret ained Earnings as Beginning
Ret ained Earnings + Net Income – Dividends Declared.
As discussed earlier, t he balance sheet has t he pleasing feat ure t hat if it balances, t he
model is probably operat ing correct ly! Now is another good time to make sure
everything balances before proceeding.

STEP 6: CASH FLOW STATEMENT PROJECTIONS

Next , forecast t he Cash Flow St at ement as request ed in t he Exercises sect ion.

The primary purpose of t he Cash Flow St at ement in t he int egrat ed financial model is t o
calculat e t he Levered Free Cash Flow (LFCF) being generat ed by t he business. This is for
obvious reasons: cash generat ion is very import ant in t he eyes of PE invest ors, as it is used
t o pay down debt and t hereby increase equit y value (and t hereby decrease fut ure int erest
burdens on t he business, which helps t o decrease risk over t ime).

St art wit h Net Income and add back non-cash expenses from t he Income St at ement ,
such as D&A, Non-Cash Int erest (PIK), and Deferred Financing Fees.
Next , subt ract uses of Cash t hat are not reflect ed in t he Income St at ement . These
include t he increase in Operat ing Working Capit al (which you calculat ed using your
balance sheet ) and Capit al Expendit ures (which is calculat ed here or, alt ernat ively, could
be calculat ed in t he Depreciat ion Schedule t o be built short ly).
Next , calculat e t he change in cash, which will be int erconnect ed wit h t he Debt
schedule. In t his case, t he model is assuming a 100% cash flow sweep (aft er
mandat ory debt amort izat ion payment s), so cash should not change aft er t he 2011PF
Balance Sheet amount of $5 million.
Even t hough t he amount is not changing, t he Cash line it em should link back t o t he
Balance Sheet . This is because t he model could lat er be used t o relax t he assumpt ion
t hat 100% of excess cash is swept t o pay down Debt . If it ’s less t han 100%, Cash
would accumulat e, and t hat would need t o t ie in t o t he ot her financial st at ement s.

STEP 7: DEPRECIATION SCHEDULE

Next , forecast t he Depreciat ion schedule as request ed in t he Exercises sect ion.

The Depreciat ion schedule is broken int o t wo part s:

The original PP&E is depreciat ed $1 million annually, as st at ed in t he assumpt ions.

New Depreciat ion is calculat ed based on t he annual invest ment in Capit al Expendit ures
over t he project ion period. This new Depreciat ion is creat ed using a wat erfall (see
 above): each year new Capit al Expendit ures occur and need t o be depreciat ed; each
year, Capit al Expendit ures from previous project ion years in t he model may have t o be
part ially depreciat ed in t hat year. The sum of all of t he component Depreciat ion line
it ems (one row for each year, plus t he Depreciat ion on t he original PP&E) gives t he t ot al
Depreciat ion Expense for t he year.

Not e t hat t his model is less complex t han it could be. Given t hat Capit al Expendit ures do not

change each year, and t hat each new Capit al Expendit ure is depreciat ed according t o t he
same simple schedule, t he numbers and calculat ions are fairly st raight forward. Here, we’re
simply assuming t hat new Capit al Expendit ures are expensed evenly over a 5 year period
(using st raight -line depreciat ion), as specified in t he case writ e-up.

STEP 8: DEBT SCHEDULE

Next , forecast t he Debt Paydown and Int erest Expenses for each year via t he Debt
Schedule, as request ed in t he Exercises sect ion.

We need to build this schedule correctly! The Debt Schedule is probably t he t rickiest
part of t he LBO model t o build—especially for anyone who has not built an LBO model
before. The Debt Schedule will creat e t he circular (it erat ive) reference t hat is t he
defining charact erist ic of a t rue LBO model. Before linking t he Debt , Cash, and Int erest
calculat ions t o one anot her in t he Debt schedule, be sure t o t urn “It erat ions” on in t he
Formulas sect ion of Microsoft Excel’s Opt ions menu.
 WARNING: Be very careful about changing formulas once you have built t he
it erat ive calculat ion. If you do so and int roduce an error, it could bust your ent ire
model if you’re not careful. This is because t he error will t ravel all t he way t hrough
t he it erat ive calculat ions and end up everywhere! If you run int o t his problem,
break t he circular reference ent irely (by delet ing it ), reconst ruct t he calculat ions

for t he first forecast year (2012), and t hen copy and past e t hem across t he
columns, one year at a t ime (2013, t hen 2014, et c.). Many PE professionals have
spent late nights in the office trying to recover from an accidental error
introduced into a circular LBO model formula!
To comput e t he changes in Debt balances, calculat e LFCF (t he framework for t his
st art ed already on t he St at ement of Cash Flows). This det ermines how much debt is
going t o be paid down (bot h discret ionary and non-discret ionary).
The non-discret ionary port ion is t he required amort izat ion payment s made on
debt (in t his case, t here is only required pay-down for subordinat ed debt ).
The discret ionary port ion is t he sweep port ion of t he remaining LFCF less required
amort izat ion. Since we’re assuming a 100% cash flow sweep, all of t he LFCF is
used t o pay down debt —first t he Senior Credit Facilit y, t hen t he Subordinat ed
Debt . The cash flow sweep and required payment s will help you calculat e t he
beginning and ending balances of bot h of t he debt t ranches.
The Senior/Revolving Credit Facilit y (S/RCF) is t he first priorit y t o get paid off via
t he cash flow sweep. It should be complet ely paid off before lat er t ranches
receive any discret ionary principal repayment in t he Debt Schedule.
Also not e t hat we need t o include a fee for t he availabilit y of t he unused
port ion of t he RCF, even if t he business never uses it —t his is a t ypical,
annual commit ment fee arrangement for revolving credit facilit ies.
The int erest rat e on t he debt is a float ing rat e (t his means an int erest rat e
t hat is dependent on LIBOR, according t o t he assumpt ions provided). We
need t o calculat e int erest based on t his rat e t imes t he average S/RCF

balance over t he year.

Subordinat ed debt is t he second priorit y t o get paid off t hrough t he cash flow
sweep. Ot her t han required amort izat ion, none of t he Subordinat ed Debt get s
paid off before t he S/RCF is fully paid off.
The 8% cash int erest is calculat ed based upon t he average of t he debt
balance, just like wit h t he S/RCF.
However, t he 4% PIK (non-cash) int erest will accrue based upon t he
beginning debt balance, not t he average.
 Because of t his difference (and t he fact t hat one source of int erest uses
cash and t he ot her does not ), we need t o make sure we’re using separate
line items for t he t wo t ypes of Int erest Expense.
We also need t o be aware of t he mandat ory amort izat ion payment of $1
million per year, provided in t he assumpt ions. This amount will get paid down
out of LFCF no mat t er what .
Int erest Income on Cash is fairly easy t o calculat e—it is t he Cash int erest rat e
(1%) t imes t he average balance t hroughout t he year. This amount will increase
Cash.
When we’ve finished wit h t hese calculat ions, we need t o link t hese line it ems t o various
line it ems in t he int egrat ed financial st at ement .
Tot al Int erest needs t o be linked t o t he Income St at ement .
Non-Cash Int erest needs t o be added back t o Net Income in t he St at ement of
Cash Flows t o assist in deriving LFCF (it ’s a non-cash expense).

Any LFCF t hat is not used t o pay down Debt needs t o link t o t he Cash line it em of
t he Balance Sheet . (In t his model none will, but you should include t his measure in
case t he model is lat er used t o eit her relax t he 100% cash sweep assumpt ion, or
t o project financials beyond t he point at which all debt has been paid off).
All Debt balances paid down by LFCF need t o link t o t he Debt line it ems on t he
Balance Sheet .

STEP 9: RETURNS CALCULATIONS

In t he final st ep of t he LBO t est , build out t he Ret urns calculat ion required in t he Exercises
sect ion.
The last port ion of t he model t o complet e is t he Equit y Ret urns schedule. This is
essent ially a simple calculat ion based upon t he out put s generat ed by rest of t he
model.
For each year, we simply t ake EBITDA mult iplied by a range of purchase mult iples

t o get t o a t ot al Exit Value for t he company (Transact ion Ent erprise Value, or
TEV).
Next , we subt ract out Net Debt (which is dependent on t he 3-st at ement model
you just creat ed) t o get t o Equit y Value.
Next , we calculat e t he port ion of t he Equit y Value t hat belongs t o t he
management and t he sponsor by using t he init ial equit y breakdown for each
part y.
From t here it ’s import ant t o calculat e bot h t he int ernal rat e of ret urn (IRR) and t he
cash-on-cash ret urns (also known as t he Mult iple of Money or Mult iple of Invest ed
Capit al). The only t ricky part of t his calculat ion is t o make sure t hat you’re calculat ing
IRR correct ly, by using t he correct Net Present Value or IRR formula and t hat , very
import ant ly, you’re discount ing by t he right number of years! Aft er all t he ment al
energy you’ve expended t o get t o t his point , it ’s easy t o make t his mist ake.
Put simply, t he IRR is equal t o t he cash-on-cash ret urns compounded by t he
number of years, minus 1. Thus, for example, for t he 5-year, 5.0x Exit Mult iple
 scenario:

LBO CASE STUDY: CONCLUSION AND FINAL COMMENTS

We hope t hat t his case st udy provides some insight int o all of t he considerat ions t hat need
t o be made in building a realist ic LBO model based on a case st udy in a Privat e Equit y
int erview, and t hat t he 9-st ep breakdown helps you simplify t he t ask int o easy-t o-replicat e
and easy-t o-execut e st eps.

No one becomes an expert LBO modeler overnight , so t he key t o doing well in t his port ion of
t he process is pract ice, pract ice, and more pract ice. Wit h enough sample LBO cases, you
should be able t o mast er t he st eps needed t o confident ly build a fully funct ioning,
professional LBO model on int erview day.

Good luck wit h t he modeling case and wit h t he int erviews!

←9. Paper LBO Model Example

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