Investment Banking Interview Questions / Questions
Easy

Walk me through an LBO model

How to answer it in an investment banking interview: what is being tested, a step-by-step framework, a sample answer and the mistakes to avoid.

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What the interviewer is testing

Whether you can describe the model in order, explain where returns come from, and connect the mechanics to what makes a company a good LBO candidate.

Answer framework

  1. Purchase price and sources and uses: debt and sponsor equity versus purchase price and fees.
  2. Project the company's cash flows.
  3. Use free cash flow to pay interest and repay debt.
  4. Assume an exit after about 3 to 7 years at an exit multiple; subtract remaining net debt to get exit equity value.
  5. Calculate IRR and MOIC on the sponsor's equity.

Sample answer

A private equity firm buys a company using a large amount of debt and some equity. I set the purchase price and the sources and uses: debt and sponsor equity on one side, purchase price and fees on the other. Then I project the company's cash flows and use free cash flow to pay interest and repay debt.

I assume an exit after about 3 to 7 years at an exit multiple, subtract the remaining net debt to get exit equity value, and calculate IRR and MOIC on the sponsor's equity.

Returns come from three places: EBITDA growth, multiple expansion and debt paydown. Leverage magnifies all three.

Likely follow-ups

What makes a good LBO candidate? Stable, predictable cash flows to service debt, limited capex needs, a strong market position, room to improve, a reasonable price, assets that support borrowing, capable management and a clear exit path.
How do IRR and MOIC relate? For a single entry and exit, IRR = MOIC^(1/years) - 1, so the same MOIC over a shorter hold means a higher IRR.

Common mistakes

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Related questions

Based on questions #71, #72, #73, #75 in the full question bank.