A leveraged buyout is an acquisition of a company using a significant amount of debt to meet the cost of the acquisition.
A leveraged buyout analysis helps determine the annualized returns (IRRs) of an investor's equity investment in a business after a specific time horizon.
In order to determine the IRR of a particular investment after a certain number of years, one first needs to establish the purchase price of the business. After estimating purchase price, one needs to determine the entire uses of funds (purchase price, net debt, and transaction fees) and the sources used to fund the acquisition (some combination of term loans, high yield debts, mezzanine, and equity). One can then construct a simple unlevered free cash flow analysis that will provide a projected EBITDA for estimating an exit and total cash produced for paying down debt. The projected EBITDA is multiplied by a multiple to get an estimated exit value. Often the purchase multiple is used as an estimated exit multiple. In order to establish return, one needs to calculate the final debt. The original debt raised to fund the acquisition plus the total interest incurred is calculated. One can estimate total interest by taking each annual interest expense multiplied by the number of years and multiplied by 1 – tax%. The sum of the original debt raised and the total interest expense less the sum of the unlevered free cash flow is the final debt balance. The return is the exit value (from the EBITDA times the multiple) less this final debt number. One can then compare the return with the equity originally invested in the business to calculate the IRR.
There are many differences between a basic and full-scale LBO model. One major difference is that simple analysis would just contain a simple cash flow build-up, whereas a full-scale model would contain complete projections. This would include the income statement, cash flow statement, balance sheet, as well as the supporting schedules. A full-scale analysis would also include balance sheet adjustments—a more detailed look at the balance sheet post-transaction adjustments. Another major difference to highlight is the simple analysis estimates interest in one year and multiplies by the number of transaction years to estimate total interest obligations. In reality, if a company is paying down debt each year, the interest expense should also be reducing. Because a full-scale model contains a debt schedule, it will more properly associate declining interest in line with debt paydown.
Although there is a vast range of possible securities utilized in funding a particular LBO transaction, they can come in several major categories: bank debt, high yield debt, and mezzanine debt. Bank debt, or a term loan, is the most fundamental type of debt. It usually carries 5 percent to 12 percent interest and can be backed by the core assets of the business. Such debt can be a revolving line of credit, a term loan, and other subordinated loans or notes.
High yield debt is a more aggressive type of debt borrowed at much higher interest rates to compensate for additional risk of defaulting on such debts. Interest in such debt can be upwards of 15 percent, but it varies depending on the situation at hand.
Mezzanine (or convertible) lending is a hybrid between debt and equity. The general concept of a mezzanine security is that it is initially considered debt that will convert to equity after a certain amount of time or after certain hurdles are met.
Often, one can conservatively assume the purchase multiple will be the exit multiple.
IRR can be calculated as: (Exit Equity Value/Equity Invested) ^ (1/Years) − 1
The more leverage used to fund an acquisition, the less equity needed. Less equity invested will maximize your return.
One can use debt multiples as comparable metrics to other similar leveraged buyouts.
You would rather have the extra dollar of EBITDA because of the multiple. At exit, the sale price is dependent on the EBITDA times the exit multiple. So, an extra dollar of debt paydown increases your equity value by only one dollar; an extra dollar of EBITDA is multiplied by the exit multiple.
In a dividend recap, the company re-levers (raises debt on) the balance sheet. The new money raised is often paid out as a dividend.
A dividend recap could have several advantages in maximizing returns. One common advantage is to extend the holding period of the company while still raising cash to expend for the fund's needs. If the market environment is not the best for target company exit, a dividend recap would allow the fund more time to look for the right exit opportunity.
You would often use a rate that reflects the expected equity return of the fund. If the fund is expecting a 25% return, this could be the rate to use.
A PIK security is a paid-in-kind security. The periodic interest obligations are satisfied “in kind,” meaning in something other than currency. Typically, when the interest obligation comes due, more debt is raised to meet that obligation. This results in interest-on-interest, which can get costly. On the other hand, it reserves cash for other beneficial uses.
A seller note is a loan to the purchased business from the seller. If a certain purchase price is negotiated in an acquisition, a certain amount is of course paid immediately, and the rest can be deferred as a seller note payable in certain terms. This can be used to prevent the seller from starting a competing business or can incentivize the seller to continue to support the business.
Use the space available to answer the following examples. The answers are at the end of the chapter.
These next few examples are designed to be 45-minute cases and answered on paper. I have provided blank pages to work out answers on your own. The solutions are provided at the end of the chapter.
Key Assumptions:
The fund expects to hold the company for five years.
Comparable analysis puts the company value at 5× EBITDA.
We have been able to negotiate a Term A loan at 3.0× LTM EBITDA (5 percent interest rate).
We have also been able to negotiate a high-yield loan for 0.5× LTM EBITDA at a 10 percent interest rate.
Assume no transaction fees.
Company Assumptions:
The company has an LTM EBITDA of $5 million.
Management expects the company to grow at 5 percent per year.
The company has a $20 million asset that will be evenly depreciated over 20 years.
The company's working capital is steadily increasing at $100k per year (resulting in a $100k cash flow decrease).
The company will maintain CAPEX spend at $1MM per year and will be depreciated over 20 years.
The tax rate is 40 percent.
Key Assumptions:
Company Assumptions:
The company has an LTM EBITDA of $7 million.
The company has 100k of existing net debt on its balance sheet.
Management expects the EBITDA to grow at 10 percent per year.
The company has a $20 million asset that will be evenly depreciated over 20 years.
The company will maintain CAPEX spend at $1.25MM per year, and it will be depreciated over 20 years.
Assume the company's working capital is projected at 30 days on EBITDA.
The tax rate is 40 percent.
Key Assumptions:
Company Assumptions:
Key Assumptions:
Company Assumptions:
Key Assumptions:
Company Assumptions:
I will go through this one step by step. Remember the first important task is to calculate the purchase price. A 5MM EBITDA at a 5× multiple gives us a $25MM purchase price. Next, we need to calculate sources and uses of funds. The uses are made up of the purchase price, target net debt, and transaction fees. No fees were assumed, so we can leave that at $0. There was also no mention of target net debt, but it's important to remember that even if the company did have target net debt, it is assumed in the purchase price, as the purchase price of $25MM is effectively an enterprise value. So the total uses of funds are simply $25MM. Now the sources are made up of debt and some equity investment. It is mentioned there will be a Term A loan raised at 3× EBITDA, or $15MM (3 × $5MM). And there will also be a high yield loan at 0.5× EBITDA, or $2.5M. Since there are no more debt assumptions, we assume the remainder is equity, or $25MM − $15MM − $2.5MM = $7.5MM.
Uses | Sources | ||
Purchase Price | $25,000,000 | Term A | $15,000,000 |
Net Debt | $0 | High Yield | $2,500,000 |
Transaction Fees | $0 | Equity | $7,500,000 |
Total Uses | $25,000,000 | Total Sources | $25,000,000 |
Now that we have the purchase price, sources, and uses of funds, we can proceed to the transaction at hand. The two key items needed are exit value (based on final year EBITDA) and the final debt determined to calculate our return. Both of these items depend on a simple cash flow analysis. So we first have to build an unlevered free cash flow for the estimated five years. Starting with the given EBITDA of 5MM at Year 0, we can use the 5% EBITDA growth assumption to project out five years.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 5,000,000 | 5,250,000 | 5,512,500 | 5,788,125 | 6,077,531 | 6,381,408 |
D&A | ||||||
EBIT | ||||||
Deferred Tax | ||||||
WC | ||||||
CAPEX | ||||||
Taxes | ||||||
Total UFCF |
We now need to fill out the rest of this UFCF table starting with D&A. As with any standard D&A table, we have PP&E and CAPEX to depreciate. The assumptions suggest 20MM in PP&E and 1MM in CAPEX, both with depreciation on a straight-line basis over 20 years.
Depreciation | |||||
St Line | |||||
Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
PP&E | $20,000,000 | ||||
CAPEX | $1,000,000 | $1,000,000 | $1,000,000 | $1,000,000 | $1,000,000 |
Years | 20 | 20 | 20 | 20 | 20 |
Year 0 | $1,000,000 | $1,000,000 | $1,000,000 | $1,000,000 | $1,000,000 |
Year 1 | $50,000 | $50,000 | $50,000 | $50,000 | $50,000 |
Year 2 | $50,000 | $50,000 | $50,000 | $50,000 | |
Year 3 | $50,000 | $50,000 | $50,000 | ||
Year 4 | $50,000 | $50,000 | |||
Year 5 | $50,000 | ||||
Total | $1,050,000 | $1,100,000 | $1,150,000 | $1,200,000 | $1,250,000 |
Notice we didn't bother with Year 0. We only need to know the cash flow from Years 1 to 5, as these are the years the business was actually held by the fund. We can now plug the depreciation into the UFCF and subtract to get EBIT. We need EBIT in order to calculate taxes. Remember, in an UFCF, taxes are EBIT × tax%.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 5,000,000 | 5,250,000 | 5,512,500 | 5,788,125 | 6,077,531 | 6,381,408 |
D&A | 1,050,000 | 1,100,000 | 1,150,000 | 1,200,000 | 1,250,000 | |
EBIT | 4,200,000 | 4,412,500 | 4,638,125 | 4,877,531 | 5,131,408 | |
Deferred Tax | ||||||
WC | ||||||
CAPEX | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | |
Taxes | (1,680,000) | (1,765,000) | (1,855,250) | (1,951,013) | (2,052,563) | |
Total UFCF |
There were no assumptions for deferred taxes. The example also mentions working capital is increasing at 100k per year. So a working capital increase results in a cash outflow. This completes our UFCF analysis.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 5,000,000 | 5,250,000 | 5,512,500 | 5,788,125 | 6,077,531 | 6,381,408 |
D&A | 1,050,000 | 1,100,000 | 1,150,000 | 1,200,000 | 1,250,000 | |
EBIT | 4,200,000 | 4,412,500 | 4,638,125 | 4,877,531 | 5,131,408 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
WC | (100,000) | (100,000) | (100,000) | (100,000) | (100,000) | |
CAPEX | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | |
Taxes | (1,680,000) | (1,765,000) | (1,855,250) | (1,951,013) | (2,052,563) | |
Total UFCF | 2,470,000 | 2,647,500 | 2,832,875 | 3,026,519 | 3,228,845 |
Now that we have UFCF, we can proceed with calculating our exit. Assuming no multiple expansion, we can apply the 5× purchase multiple to the Year 5 projected EBITDA to get our exit value, giving us $31,907,039 (5 × $6,381,308). This is our exit value but it's not the money the investor receives as a return. We need to figure out how much debt is left at Year 5 and subtract from the exit value to get our return. To calculate final debt, we take the debt raised to fund the acquisition and add in five years of after-tax interest. We then use all the cash generated during the five years to pay down as much debt and interest as possible. So based on our sources, we've raised 15MM in Term A loans and 2.5MM in high yield. We need to calculate the interest on each and multiply by 1 – tax% and the number of years to get the total interest incurred. So for Term A:
And for the high yield:
So there's a total of 3,000,000 in interest incurred (2,250,000 + 750,000).
We can add the total interest to the debt raised to get total obligations 15,000,000 + 2,500,000 + 3,000,000 = 20,500,000.
We can now add up the five years of cash calculated in the UFCF analysis, giving us $14,205,738. This cash will be used to pay down all obligations.
So, $20,500,000 – $14,205,738 = $6,294,262. This is the final debt. So, subtracting the final debt from the exit gives us our return:
We can now calculate our IRR:
The purchase price should be straightforward at $28,000,000 (4 × $7,000,000). Now for the sources and uses. Remember, although the example suggests 100k target company net debt, we do not add this net debt to the uses of cash. As the purchase price is an enterprise value, it already included the assumption of net debt. We do, however, need to take 1% of the purchase price for transaction fees.
Uses | |
PP | $28,000,000 |
Debt | 0 |
Fees | $280,000 |
Total | $28,280,000 |
Notice the Term B loan in the sources is estimated at 15% of the total uses of funds. The remainder is Equity (Total Uses less Term A less Term B).
Sources | |
Term A | $17,500,000 |
Term B | $4,242,000 |
Equity | $6,538,000 |
Total | $28,280,000 |
Next we can start to lay out the unlevered free cash flow. Most components are straightforward.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 7,000,000 | 7,700,000 | 8,470,000 | 9,317,000 | 10,248,700 | 11,273,570 |
D&A | 1,062,500 | 1,125,000 | 1,187,500 | 1,250,000 | 1,312,500 | |
EBIT | 6,637,500 | 7,345,000 | 8,129,500 | 8,998,700 | 9,961,070 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | ||||||
CAPEX | (1,250,000) | (1,250,000) | (1,250,000) | (1,250,000) | (1,250,000) | |
Taxes | (2,655,000) | (2,938,000) | (3,251,800) | (3,599,480) | (3,984,428) | |
Total UFCF |
The example suggests to estimate total working capital at 30 days on EBITDA. So we can use the working capital formula (30/360 × EBITDA) to make our annual working capital estimates. We then need to calculate the year-over-year changes for our cash flow.
Working Capital | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 7,000,000 | 7,700,000 | 8,470,000 | 9,317,000 | 10,248,700 | 11,273,570 |
Days | 30 | 30 | 30 | 30 | 30 | 30 |
Total Working Capital | 583,333 | 641,667 | 705,833 | 776,417 | 854,058 | 939,464 |
Changes in Working Capital | (58,333) | (64,167) | (70,583) | (77,642) | (85,406) |
We can now use these changes in our UCFC and calculate the total.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 7,000,000 | 7,700,000 | 8,470,000 | 9,317,000 | 10,248,700 | 11,273,570 |
D&A | 1,062,500 | 1,125,000 | 1,187,500 | 1,250,000 | 1,312,500 | |
EBIT | 6,637,500 | 7,345,000 | 8,129,500 | 8,998,700 | 9,961,070 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | (58,333) | (64,167) | (70,583) | (77,642) | (85,406) | |
CAPEX | (1,250,000) | (1,250,000) | (1,250,000) | (1,250,000) | (1,250,000) | |
Taxes | (2,655,000) | (2,938,000) | (3,251,800) | (3,599,480) | (3,984,428) | |
Total UFCF | 3,736,667 | 4,217,833 | 4,744,617 | 5,321,578 | 5,953,736 |
With this information we can calculate our exit and return. Final EBITDA times 4 gives us an exit of $45,094,280. Applying interest to the Term A and B loans multiplied by 5 years and then multiplied by (1 − tax%) give us:
Total obligations are $28,519,120 ($17,500,000 + $4,242,000 + $5,250,000 + $1,527,120).
The total cash generated is $23,974,431. Reducing the obligations with cash leaves us with $4,544,689 in final debt.
So the return is the exit less final debt, or $40,549,591. Applying the IRR formula (($40,549,591/$6,538,000) ^ (1/5) −1) gives a return of 44.05%.
The purchase price, sources, and uses should be straightforward.
Uses | Sources | ||
PP | $50,000,000 | Term A | $35,000,000 |
Debt | $0 | Term B | $5,000,000 |
Fees | $250,000 | Equity | $10,250,000 |
Total | $50,250,000 | Total | $50,250,000 |
Next we can start to lay out the unlevered free cash flow. Most components are straightforward.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 10,000,000 | 10,500,000 | 11,025,000 | 11,576,250 | 12,155,063 | 12,762,816 |
D&A | 4,110,000 | 4,220,000 | 4,330,000 | 4,440,000 | 4,550,000 | |
EBIT | 6,390,000 | 6,805,000 | 7,246,250 | 7,715,063 | 8,212,816 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | ||||||
CAPEX | (1,100,000) | (1,100,000) | (1,100,000) | (1,100,000) | (1,100,000) | |
Taxes | (2,556,000) | (2,722,000) | (2,898,500) | (3,086,025) | (3,285,126) | |
Total UFCF |
The example suggests to estimate total working capital at 15 days on EBITDA. So we can use the working capital formula (30/360 × EBITDA) to make our annual working capital estimates. We then need to calculate the year-over-year changes for our cash flow.
Working Capital | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 10,000,000 | 10,500,000 | 11,025,000 | 11,576,250 | 12,155,063 | 12,762,816 |
Days | 15 | 15 | 15 | 15 | 15 | 15 |
Total Working Capital | 416,667 | 437,500 | 459,375 | 482,344 | 506,461 | 531,784 |
Changes in Working Capital | (20,833) | (21,875) | (22,969) | (24,117) | (25,323) |
We can now use these changes in our UCFC and calculate the total.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
EBITDA | 10,000,000 | 10,500,000 | 11,025,000 | 11,576,250 | 12,155,063 | 12,762,816 |
D&A | 4,110,000 | 4,220,000 | 4,330,000 | 4,440,000 | 4,550,000 | |
EBIT | 6,390,000 | 6,805,000 | 7,246,250 | 7,715,063 | 8,212,816 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | (20,833) | (21,875) | (22,969) | (24,117) | (25,323) | |
CAPEX | (1,100,000) | (1,100,000) | (1,100,000) | (1,100,000) | (1,100,000) | |
Taxes | (2,556,000) | (2,722,000) | (2,898,500) | (3,086,025) | (3,285,126) | |
Total UFCF | 6,823,167 | 7,181,125 | 7,554,781 | 7,944,920 | 8,352,366 |
With this information we can calculate our exit and return. Final EBITDA times 5 gives us an exit of $63,814,078. Applying interest to the Term A and B loans multiplied by 5 years and then multiplied by (1 − tax%) give us:
Total obligations are $52,750,000 ($10,500,000 + $2,250,000 + $35,000,000 + $5,000,000).
The total cash generated is $37,856,360. Reducing the obligations with cash leaves us with $14,893,640 in final debt.
So the return is the exit less final debt, or $48,920,438. Applying the IRR formula (($48,920,438/$10,250,000) ^ (1/5) − 1) gives a return of 36.7%.
The purchase price is based on EBITDA, which needs to be calculated from revenue and costs. Costs are projected at 30% of the $10MM revenue, so EBITDA is $7MM ($10MM − $3MM). This gives us a $42MM purchase price ($7MM × 6). From here, sources and uses should be straightforward. Note the Term A loan assumption at 25% of the total uses.
Uses | Sources | ||
Purchase Price | $42,000,000 | Term A | $10,605,000 |
Debt | 0 | Term B | $14,000,000 |
Fees | $420,000 | High Yield | $7,000,000 |
Total | $42,420,000 | Equity | $10,815,000 |
Total | $42,420,000 |
Next we can start to lay out the unlevered free cash flow.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue | 10,000,000 | 10,200,000 | 10,404,000 | 10,612,080 | 10,824,322 | 11,040,808 |
Operating Expenses | 3,000,000 | 3,060,000 | 3,121,200 | 3,183,624 | 3,247,296 | 3,312,242 |
EBITDA | 7,000,000 | 7,140,000 | 7,282,800 | 7,428,456 | 7,577,025 | 7,728,566 |
D&A | 2,600,000 | 2,700,000 | 2,800,000 | 2,900,000 | 3,000,000 | |
EBIT | 4,540,000 | 4,582,800 | 4,628,456 | 4,677,025 | 4,728,566 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | ||||||
CAPEX | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | |
Taxes | (1,816,000) | (1,833,120) | (1,851,382) | (1,870,810) | (1,891,426) | |
Total UFCF |
For working capital, the example provides guidance on accounts receivable and accrued expenses. These items should be based on revenue and operating expenses, respectively. So we can use the working capital formula, 30/360 × revenue, to make our annual accounts receivable estimates, and the formula, 10/360 × expenses, for the accrued expenses estimates. We then need to subtract assets less liabilities and calculate the year-over-year changes for our cash flow.
Working Capital | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Accounts Receivable | 833,333 | 850,000 | 867,000 | 884,340 | 902,027 | 920,067 |
Days | 30 | 30 | 30 | 30 | 30 | 30 |
Accrued Expenses | 83,333 | 85,000 | 86,700 | 88,434 | 90,203 | 92,007 |
Days | 10 | 10 | 10 | 10 | 10 | 10 |
Total Working Capital | 750,000 | 765,000 | 780,300 | 795,906 | 811,824 | 828,061 |
Changes in Working Capital | (15,000) | (15,300) | (15,606) | (15,918) | (16,236) |
We can now use these changes in our UCFC and calculate the total.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue | 10,000,000 | 10,200,000 | 10,404,000 | 10,612,080 | 10,824,322 | 11,040,808 |
Operating Expenses | 3,000,000 | 3,060,000 | 3,121,200 | 3,183,624 | 3,247,296 | 3,312,242 |
EBITDA | 7,000,000 | 7,140,000 | 7,282,800 | 7,428,456 | 7,577,025 | 7,728,566 |
D&A | 2,600,000 | 2,700,000 | 2,800,000 | 2,900,000 | 3,000,000 | |
EBIT | 4,540,000 | 4,582,800 | 4,628,456 | 4,677,025 | 4,728,566 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | (15,000) | (15,300) | (15,606) | (15,918) | (16,236) | |
CAPEX | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | (1,000,000) | |
Taxes | (1,816,000) | (1,833,120) | (1,851,382) | (1,870,810) | (1,891,426) | |
Total UFCF | 4,309,000 | 4,434,380 | 4,561,468 | 4,690,297 | 4,820,903 |
With this information we can calculate our exit and return. Final EBITDA times 6 gives us an exit of $46,371,394. Applying interest to the loans multiplied by 5 years and then multiplied by (1 − tax%) gives us:
Total obligations are $42,976,500 ($10,605,000 + $14,000,000 + $7,000,000 + $3,181,500 + $5,040,000 + $3,150,000).
The total cash generated is $22,816,047. Reducing the obligations with cash leaves us with $20,160,453 in final debt.
So the return is the exit less final debt, or $26,210,941. Applying the IRR formula (($26,210,941/$10,815,000) ^ (1/5) – 1) gives a return of 19.4%.
The purchase price is based on EBITDA, which needs to be calculated from revenue and costs. Costs are projected at 25% of the $12MM revenue, so EBITDA is $9MM ($12MM – $3MM). This gives us a $63MM purchase price ($9MM × 7). From here, sources and uses should be straightforward.
Uses | Sources | ||
PP | $63,000,000 | Term A | $31,500,000 |
Debt | 0 | Term B | $13,500,000 |
Fees | $1,260,000 | HY | $4,500,000 |
Total | $64,260,000 | Equity | $14,760,000 |
Total | $64,260,000 |
Next we can start to layout the unlevered free cash flow.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue | 12,000,000 | 12,840,000 | 13,738,800 | 14,700,516 | 15,729,552 | 16,830,621 |
Operating Expenses | 3,000,000 | 3,210,000 | 3,434,700 | 3,675,129 | 3,932,388 | 4,207,655 |
EBITDA | 9,000,000 | 9,630,000 | 10,304,100 | 11,025,387 | 11,797,164 | 12,622,966 |
D&A | 2,525,000 | 2,550,000 | 2,575,000 | 2,600,000 | 2,625,000 | |
EBIT | 7,105,000 | 7,754,100 | 8,450,387 | 9,197,164 | 9,997,966 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | ||||||
CAPEX | (500,000) | (500,000) | (500,000) | (500,000) | (500,000) | |
Taxes | (2,842,000) | (3,101,640) | (3,380,155) | (3,678,866) | (3,999,186) | |
Total UFCF |
For working capital, the example provides guidance on accounts receivable and accrued expenses. We then need to subtract assets less liabilities and calculate the year-over-year changes for our cash flow.
Working Capital | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Accounts Receivable | 1,166,667 | 1,248,333 | 1,335,717 | 1,429,217 | 1,529,262 | 1,636,310 |
Days | 35 | 35 | 35 | 35 | 35 | 35 |
Accrued Expenses | 125,000 | 133,750 | 143,113 | 153,130 | 163,850 | 175,319 |
Days | 15 | 15 | 15 | 15 | 15 | 15 |
Total Working Capital | 1,041,667 | 1,114,583 | 1,192,604 | 1,276,086 | 1,365,413 | 1,460,991 |
Changes in Working Capital | (72,917) | (78,021) | (83,482) | (89,326) | (95,579) |
We can now use these changes in our UCFC and calculate the total.
Unlevered Free Cash Flow | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue | 12,000,000 | 12,840,000 | 13,738,800 | 14,700,516 | 15,729,552 | 16,830,621 |
Operating Expenses | 3,000,000 | 3,210,000 | 3,434,700 | 3,675,129 | 3,932,388 | 4,207,655 |
EBITDA | 9,000,000 | 9,630,000 | 10,304,100 | 11,025,387 | 11,797,164 | 12,622,966 |
D&A | 2,525,000 | 2,550,000 | 2,575,000 | 2,600,000 | 2,625,000 | |
EBIT | 7,105,000 | 7,754,100 | 8,450,387 | 9,197,164 | 9,997,966 | |
Deferred Tax | 0 | 0 | 0 | 0 | 0 | |
Working Capital | (72,917) | (78,021) | (83,482) | (89,326) | (95,579) | |
CAPEX | (500,000) | (500,000) | (500,000) | (500,000) | (500,000) | |
Taxes | (2,842,000) | (3,101,640) | (3,380,155) | (3,678,866) | (3,999,186) | |
Total UFCF | 6,215,083 | 6,624,439 | 7,061,750 | 7,528,972 | 8,028,200 |
With this information we can calculate our exit and return. Final EBITDA times 7 gives us an exit of $88,360,759. Applying interest to the loans multiplied by 5 years and then multiplied by (1 – tax%) gives us:
Total obligations are $65,835,000.
The total cash generated is $35,458,445. Reducing the obligations with cash leaves us with $30,376,555 in final debt.
So the return is the exit less final debt, or $57,984,204. Applying the IRR formula (($57,984,204/$14,760,000) ^ (1/5) – 1) gives a return of 31.5%.
As mentioned in the beginning, this book was designed to allow practice of technical questions and exercises representing the knowledge one would require in an investment banking interview. Of course, the technical aspect is one of several required to be a strong interview candidate. The ability to communicate these questions effectively, to present oneself effectively, in addition to behavior and fit are among the attributes assessed in an interview. I hope this book proves to be one of many useful tools in helping achieve your investment banking career goals.