Exit Valuation
What return metrics are most important for a private equity investor and how are they calculated?
MOIC = Ending Equity Value / Beginning Sponsor Equity
IRR = MOIC^(1/Holding Period) -1
How is FCFE calculated?
FCFE = Net Income + D&A - CapEx - Change in NWC - Repayments
What is a leveraged buyout and what are its characteristics?
An investor acquires a company using a large portion of debt financing. Debt and interest is paid back by the acquired company
Why do we need to calculate our net debt at the end of every year in order to compute our returns?
In order to calculate our equity values, which are the investors proceeds in case of sale
What is a "revolver" and why would we include such in our financial forecast?
Revolver refers to revolving credit line and can be used to offset years in which FCFE is negative, therefore not needing additional cash injection by the investor
How do we calculate our basic equity value for a listed company in an LBO?
Equity Value = Share Price x Shares Outstanding
Assume a MOIC of 2,3x over a 5 year period, what is the implied IRR on the investment?
18,13%
What is used to accurately forecast interest expenses in an LBO and why does it create a circular reference?
Debt Schedule
It creates a circular reference because interest expenses are calculated in the debt schedule, which impacts Net Income and therefore FCFE
What is working capital and net working capital and why do we need change in net working capital to calculate FCFE?
Working Capital = Assets - Liabilities
NWC = Inventories + Receivables - Payables
Because changes in NWC represent either cash inflows pr outflows and therefore impact FCFE
Please explain the idea of the J-Curve in connection with IRR returns for a private equity investment.
The J-Curve effect is more pronounced in PE funds than in single deals, because fund-level cash flows also include management fees and undrawn commitments that amplify the early dip.
What is a deferred tax account (DTA) and how does it impact our financial forecast?
Accounting item that carries forward losses in years where EBT is negative, increasing the DTA.
This reduces cash tax payments in profitable years until the DTA is used up.
What type of debt tranches do you know and what are the important debt characteristics to include in an LBO?
Term Loans = variable interest rate, floor, minimum amortisation, financing fee
Senior Notes = fixed coupon rate, financing fee
Revolver = variable interest rate, financing fee, not used for leverage
Please name three main drivers in an LBO that impact IRR returns the most.
Leverage -> higher ROE
Margin expansion -> FCFE increase
Multiple expansion (Delta) -> higher exit equity value
Why do we use FCFE for an LBO and not FCFF?
Free Cash Flow to the Firm (FCFF): Cash available to all providers of capital (debt + equity) before debt service.
Free Cash Flow to Equity (FCFE): Cash available only to equity holders, after debt service (interest + mandatory repayments).
FCFF is used in valuation methods like DCF, where you want the value of the whole firm (debt + equity).
But in an LBO, we already know the entry EV (purchase price).
Using FCFF would ignore leverage and therefore overstate cash available to equity in a debt-heavy structure.
Please explain what transaction and financing fees refer to and how to they differ from the financing fees amortisation period.
Transaction fees typically refer to costs for lawyers, bankers and advisors that help to structure the deal and support with due diligence, often expressed as a percentage of the purchase enterprise value. Additionally, there are two types of financing fees. Financing Fees are costs for arranging the debt packaging with banks or other lending institutions.
Amortization period refers to the second type of financing fee, which is paid upfront for each tranche of debt and are capitalized over the life of the loan, reducing interest expenses.