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PAPER LBO MODEL EXAMPLE

of Private Equity Training

An illustrative example of a paper LBO is provided below in 5 simple steps. In a paper LBO exercise,

you will be expected to complete the important components of a working LBO model with the use of
paper and pencil and without the use of a computer.

Given LBO Parameters and Assumptions

XYZ Private Equity Partners purchases ABC Target Company for 5.0x Forward 12 months (FTM)
EBITDA at the end of Year 0.
The debt-to-equity ratio for the LBO acquisition will be 60:40.
Assume the weighted average interest rate on debt to be 10%.
ABC expects to reach $100 million in sales revenue with an EBITDA margin of 40% in Year 1.

Revenue is expected to increase by 10% year-over-year (y-o-y).

EBITDA margins are expected to remain flat during the term of the investment.
Capital expenditures are expected to equal 15% of sales each year.
Operating working capital is expected to increase by $5 million each year.
Depreciation is expected to equal $20 million each year.
Assume a constant tax rate of 40%.
XYZ exits the target investment after Year 5 at the same EBITDA multiple used at entry (5.0x
FTM EBITDA).
Assume all debt pay-down occurs at the moment of sale at the end of Year 5 (this eliminates the
iterative/circular dependency between debt pay-down/cash balances and interest expense in a
computer-based LBO model).

1. CALCULATE THE PURCHASE PRICE OF ABC.

Usinga5.0xentrymultiple,calculatethepricepaidbymultiplyingbyYear1EBITDA.$40millionin
EBITDA(whichrepresentsa40%EBITDAmarginon$100millioninrevenue)multipliedby5.The
purchasepriceis$200million.

2. CALCULATE THE DEBT AND EQUITY FUNDING AMOUNTS USED FOR THE PURCHASE PRICE.

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Thegiveninformationassumesdebttoequityratioof60:40forthepurchaseprice.
Debtportion=60%$200million,or$120million.
Equityportion=40%$200million,or$80million.

3. BUILD THE INCOME STATEMENT.

(Noticethat,becausetheexitvalueattheendofYear5willbebasedonaforwardEBITDAmultiple,

wemustcalculatesixyearsworthofincomestatement,not5.Alsonotethatthenumbersmightnot
agreeperfectlybecauseofrounding.Itisreasonabletoroundyourintermediatecalculationstothe

nearestintegerincarryingovercalculationstothenextstep.)

1. Project revenue: Revenue is expected to grow 10% annually.

$100millionYear1sales(1+10%growthrate)=$110millionsalesinYear2.

$110millionYear2sales(1+10%growthrate)=$121millionsalesinYear3.
$121millionYear3sales(1+10%growthrate)=$133.1millionsalesinYear4.

$133millionYear4sales(1+10%growthrate)=$146.3millionsalesinYear5.
$146millionYear5sales(1+10%growthrate)=$160.6millionsalesinYear6.

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2. Use EBITDA margin to calculate EBITDA.

$100millionYear1sales40%EBITDAmargin=$40millionYear1EBITDA.

$110millionYear2sales40%EBITDAmargin=$44millionYear2EBITDA.
$121millionYear3sales40%EBITDAmargin=$48millionYear3EBITDA.

$133millionYear4sales40%EBITDAmargin=$53millionYear4EBITDA.
$146millionYear5sales40%EBITDAmargin=$59millionYear5EBITDA.

$161millionYear6sales40%EBITDAmargin=$64millionYear6EBITDA.
3. Subtract Depreciation & Amortization (D&A) to get EBIT.

$40millionYear1EBITDA$20millionD&A=$20millionYear1EBIT.(etc.forYears26)
4. Calculate interest expense using the debt amount used for purchase multiplied by the interest

rate to calculate the yearly interest expense line item.

$120millionofdebt10%interestrate=$12millioninterestexpenseperyear.

5. Calculate Earnings Before Tax (EBT).

$20millionYear1EBIT$12millionint.exp.=$8millionYear1EBT.(etc.forYears26)

6. Subtract taxes using the tax rate to get to tax-effected EBT (a proxy for Net Income).

$8millionYear1EBT40%taxrate=$3milliontaxes,so$5millionYear1t/eEBT.
$12millionYear2EBT40%taxrate=$5milliontaxes,so$7millionYear2t/eEBT.

$16millionYear3EBT40%taxrate=$6milliontaxes,so$10millionYear3t/eEBT.
$21millionYear4EBT40%taxrate=$8milliontaxes,so$13millionYear4t/eEBT.

$27millionYear5EBT40%taxrate=$11milliontaxes,so$16millionYear5t/eEBT.
$32millionYear6EBT40%taxrate=$13milliontaxes,so$19millionYear6t/eEBT.

4. CALCULATE CUMULATIVE LEVERED FREE CASH FLOW (FCF).

1. Start with EBT (Tax-effected) and then add back non-cash expenses (D&A).

$5millionYear1taxeffectedEBT+$20millionD&A.
2. Subtract capital expenditures (Capex).
(NOTE:WedonotneedYear6capitalexpenditures,orFreeCashFlowforthatmatter,because
EBITDAdoesnotincorporatecapexandbecauseonlyFCFinYears15canbeusedtopaydown

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debt.)
$100millionYear1sales15%capex/sales=$15millionYear1capitalexpenditures.

$110millionYear2sales15%capex/sales=$17millionYear2capitalexpenditures.
$121millionYear3sales15%capex/sales=$18millionYear3capitalexpenditures.
$133millionYear4sales15%capex/sales=$20millionYear4capitalexpenditures.
$146millionYear5sales15%capex/sales=$22millionYear5capitalexpenditures.

3. Subtract the annual increase in operating working capital to get to Free Cash Flow (FCF).
$5mmY1t/aEBT+$20mmD&A$15mmY1capex$5mmNWC=$5mmYear1FCF.
$7mmY1t/aEBT+$20mmD&A$17mmY2capex$5mmNWC=$6mmYear2FCF.
$10mmY1t/aEBT+$20mmD&A$18mmY3capex$5mmNWC=$7mmYear3FCF.

$13mmY1t/aEBT+$20mmD&A$20mmY4capex$5mmNWC=$8mmYear4FCF.
$16mmY1t/aEBT+$20mmD&A$22mmY5capex$5mmNWC=$9mmYear5FCF.
4. Calculate Cumulative Free Cash Flow during the life of the LBO.
CumulativeFCFuntilexitequalstotaldebtpaydown,ifitisassumedthat100%ofFCFisused

topaydowndebt.(ThisisastandardassumptionforabasicLBOmodel.)
$5mmYear1FCF+$5mmYear2FCF+$7mmYear3FCF+$8mmYear4FCF+
$9mmYear5FCF=$34mmCumulativeFCF.

5. CALCULATE ENDING PURCHASE PRICE (EXIT VALUE) AND RETURNS

1. Calculate Total Enterprise Value (TEV) at Exit.

TakeForwardEBITDAatexit(Year6EBITDA)alongwitha5.0xexitmultipletocalculateExit

TEV.$64millionYear6EBITDA5.0xmultiple=$320millionEnterpriseValueatExit.
2. Calculate Net Debt at Exit (also known as Ending Debt).
BeginningDebtDebtPaydown=EndingDebt.
$120millioninBeginningDebt$34millioninCumulativeFCF=$86millioninEndingDebt.

3. Calculate ending Equity Value (EV) by subtracting Ending Debt from Exit TEV.
$320ExitTEV$86millionEndingDebt=$234millionEndingEV.
4. Calculate the Multiple-of-Money (MoM) EV return (Ending EV Beginning EV).
$234millionEndingEV$80BeginningEV=2.93xMoM.

5. Estimate IRR based on the MoM multiple.

ThefollowingtableisusefulforestimatingIRRbasedupon5yearMoMmultiples:
2.0xMoMover5years~15%IRR

2.5xMoMover5years~20%IRR
3.0xMoMover5years~25%IRR

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3.7xMoMover5years~30%IRR
Therefore,wecanassumethattheimpliedIRRforthepaperLBOcasestudyisapproximately

25%,orslightlybelow.(Itisactuallyverycloseto24%.)

The following is the full paper LBO case study exhibit, calculated using Excel rather than pen and
paper. As a result, some of the numbers might be slightly different, as rounding has been eliminated:

FINAL STEPS

Make sure to take your time and calculate every formula correctly since this is not a race, and any error
that you make will flow through the model youre building. If you catch a mistake part-way through, you

will have to go back and correct itsometimes causing you to have to recalculate nearly everything, and
possibly leading to compounding mistakes on top of the original one.

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In addition, the interviewer will ask you to walk through your thought process and calculations. Thus it

is important to be able to build the proper paper LBO in simple, accurate steps, and make sure you can
walk through the reasoning regarding the process and each calculation. This takes practice, so be sure
to practice at least one more paper LBO before your next private equity interview.

Good luck on the case!

Basics of an LBO Model LBO Modeling Test Example

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