LBO Modeling Test from Blank Excel Sheet – 60 Minutes

You have 60 minutes to complete this LBO modelling test from scratch, starting with a blank
Excel sheet and using no outside resources or templates. Once you finish the model, respond to
the case study questions at the bottom.

A private equity firm plans to acquire a private, family-owned widget manufacturer (“Widget
Co.”) with annual sales of $500 million and EBITDA margins of 20% for 12x LTM EBITDA. The
transaction will be structured as a cash-free, debt-free deal, with a possible cash injection in the
beginning.

Total advisory and financing fees will equal 2% of the Purchase Enterprise Value. For simplicity,
assume no amortization of the financing fees.

The PE firm plans to fund the deal with the following:

• Term Loans: 3x EBITDA with a floating cash coupon rate of Benchmark Rate + 300 bps,
mandatory principal repayments of 5%, 10%, 10%, 15%, and 20% in Years 1 – 5, and a
50% cash flow sweep. The Benchmark Rate is expected to increase from 1.5% to 3.0%
over 5 years.

• Senior Notes: 1x EBITDA with a 3% fixed cash coupon rate, 5% PIK interest, and no
principal repayments (mandatory or optional).

• Subordinated Notes: 1x EBITDA with 10% PIK interest and no principal repayments
(mandatory or optional).

Management will also receive a 5% options pool, with an exercise price equal to the PE firm’s
per-share offer price to acquire this company.

The company’s operational profile and forecasts are described below:

• Annual Widget Sales: 4 million units; expected to grow at 10% in Year 1, declining to 6%
growth by Year 5. Average prices will initially increase by 5% per year, falling to 3%.

• Widget Factories and CapEx: 8 current factories; $2 million in Maintenance CapEx per
factory and $25 million to build each new factory.

• Expenses: 50% Gross Margin on widgets declining to 45% by Year 5; fixed expenses
should rise in-line with average widget pricing.

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 • Depreciation: $20 million in the most recent historical year. Use your judgment to
forecast this.

• Minimum Cash: 5% of the previous year’s sales (use Year 0 sales in the Sources & Uses
schedule).

• Working Capital: Inventory represents 20% of sales, Receivables are 10% of sales, and
Payables are 15% of sales.

• Taxes: Assume a 25% effective tax rate.

Case Study Questions:

1) What are the IRR and multiple of invested capital (MOIC) at reasonable exit multiples in
Years 4 and 5? Based on these results, would you recommend the deal?

2) Are this company’s financial projections plausible? Why or why not?

3) What is the best way for the PE firm to increase returns in this deal without changing
the company’s financial projections?

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 Leverage Buyout Model Case Study for PE Firm
Amount in millions

LTM Revenue 500

EBITDA Margin 20.0%
LTM EBITDA 100
Purchase TEV 1200
Fees 24
Purchase Mulitple 12.0x
Management Options Pool 5.0%
EBITDA Exit Multiple 10.0x
Tax Rate 25.0%

Exit Year Year 4 Interest

xEBITDA Cash Fixed PIK Fixed Spread Sweep

Term Loans 3.0x 3.0% 50.0%

Senior Notes 1.0x 3.0% 5.0%
Suboridnated Notes 1.0x 10.0%

Minimum Cash % Sales 5.0%

Inventory % Sales 20.0%
Receivables % Sales 10.0%
Payables % Sales 15.0%

Sources Uses

Term Loans 300 Purchase TEV 1200

Senior Notes 100 Fees 24
Subordinated Notes 100 Initial Cash injection 25
Equity 749 Total Sources 1249
Total Sources 1249

Drivers Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Widgets unit sales 4.0 4.4 4.8 5.2 5.5 5.9
Growth Rate 10.0% 9.0% 8.0% 7.0% 6.0%

Average Price Per Widget 125 131 137 143 148 152
Growth Rate 5.0% 4.5% 4.0% 3.5% 3.0%

Factories 8.0 8.8 9.6 10.4 11.1 11.7

Widgets per Factory 0.5 0.5 0.5 0.5 0.5 0.5

2.0
Maintenance CapEx per Factory (millions)
Growth CapEx per Factory (millions) 25.0

Total CapEx 36 37 38 39 39
% Sales 7.2% 7.5% 7.7% 7.8% 7.8%

Gross Margin % 50.0% 49.0% 48.0% 47.0% 46.0% 45.0%

COGS 250 295 342 392 442 491
Fixed Expenses 150 158 165 171 177 182

Depreciation 20 23 24 25 25 25
% Sales 4.0% 4.0% 3.7% 3.4% 3.1% 2.8%
Cash Flow Projections Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Sales 500 578 658 739 818 893
Growth 15.5% 13.9% 12.3% 10.7% 9.2%

EBITDA 100 125 151 176 199 220

Margin 20.0% 21.7% 23.0% 23.8% 24.3% 24.6%

(-) Depreciation (20) (23) (24) (25) (25) (25)

(-) Interest (32) (33) (33) (31) (28)

Pre-Tax Income 71 94 118 142 166

(-) Taxes (18) (24) (30) (36) (42)
Net Income 53 71 89 107 125

Net Income 53 71 89 107 125

(+) Depreciation 23 24 25 25 25
(+) Non-Cash Interest 15 16 18 19 21
(+/-) Change in Working Capital (12) (12) (12) (12) (11)
(-) CapEx (36) (37) (38) (39) (39)
Free CashFlow 44 62 81 101 120

(-) Mandatory Repayments (15) (30) (30) (45) (60)

(+) Beginning Cash Balance 25 39 50 67 80
(-) Minimum Cash (25) (29) (33) (37) (41)
(+) Free CashFlow 44 62 81 101 120
CF available for debt repayment 29 42 68 86 99

CF for debt repayment (14) (21) (34) (43) (8)

Ending Cash 39 50 67 80 132

Debt Balances
Term Loans 300 271 220 156 67.77 -
Senior Notes 100 105 110 116 122 128
Subordinated Notes 100 110 121 133 146 161

Term Loan Repayments in % 5.0% 10.0% 10.0% 15.0% 20.0%

Interest
Benchmark rate 1.5% 1.9% 2.3% 2.7% 3.0%
Term Loans - Cash 14 13 12 9 4.07
Senior Notes - Cash 3 3 3 3 4
Subordinated Notes - PIK 10 11 12 13 15
Senior Notes - PIK 5 5 6 6 6

Exit Enterprise Value - - - 1,992 -

(-) Debt - - - (336) -
(+) Cash - - - 80 -
Exit Equity Value - - - 1,736 -
(+) Cash from management options - - - 37 -
(-) Equity to management option holders - - - (84) -
Net Equity to Sponser (749) - - - 1,689 -

Sponser Multiple 2.3x

Sponser IRR 23%
Sensitivity - Sponsor IRR vs Exit Year and Exit Multiple Sensitivity - Sponsor IRR vs Exit Year and Exit Multiple %

2.3x Year 4 Year 5 0.2x Year 4 Year 5

13.0x 3.0x 3.5x 13.0x 32% 28%
12.5x 2.9x 3.3x 12.5x 30% 27%
12.0x 2.8x 3.2x Exit 12.0x 29% 26%
Exit Multiple
11.5x 2.6x 3.1x Multiple 11.5x 27% 25%
11.0x 2.5x 2.9x 11.0x 26% 24%
10.5x 2.4x 2.8x 10.5x 24% 23%
10.0x 2.3x 2.6x 10.0x 23% 21%
LBO Model Case Study Answers

Ans 1: At reasonable exit multiple (9- 13x vs 12x purchase multiple), the MOIC
is between 2x and 3x with a Year 4-5 exit and IRR between 20% and 30%. Since
these are the levels typically targeted by PE firms in 4-5 year leveraged layouts,
we recommend completing this deal.
Ans 2: Overall, the assumptions and forecasts are reasonable, as the company’s
growth rate slows down, its pricing power comes down and its margins
increase over time as it matures. The margin expansion maybe a little too high
in this specific time as the company goes from 20% EBITDA margin to
approximately 2.5%, but its hard to assess why this might be happening
without further information. CapEx and Depreciation both decrease over time
as percentages of revenue matching the company’s falling growth rate. The
most likely issue here is that fixed expenses may not be growing at a high
enough rate, which is main factor that explains why EBITDA margin is rising
rather than falling, despite the company’s falling gross margins.
Ans 3: The easiest method would be to use slightly more debt in the beginning
(6x EBITDA rather than 5x) or to implement a dividend recap in year3-5 or
simply distribute cash dividend in one of those years, as company replays loan
completely by years and builds up large cash balance. Increasing the initial
leverage to 6x would boost the IRR by approx. 2% and a dividend recap or
other dividend distribution near the end would be likely increase the IRR by
something in that range.