Chapter 17 – LBO Financial Model
Please also refer to questions in the accompanying case study, “Toys R Us”
Q1. What does an LBO analysis include, what does it solve for and what question is
answered by the analysis?
A. An LBO analysis includes cash &ow projections, terminal value projections (the
price at which a financial buyer thinks the company can be sold in three to seven
years) and present value determination (the price that a financial buyer will pay
Q2. What are the three ways to create returns through an LBO transaction?
A. Deleveraging; improving margins; and multiple expansion.
Q3. What is the formula for determining cash &ow available for debt service?
A. Net income + depreciation and amortization +/- changes in deferred taxes +/-
other non-cash changes +/-changes in net working capital = cash &ow from
Q4. What are the key credit statistics in an LBO )nancing?
A. Total Debt/EBITDA; Senior Bank Debt/EBITDA; EBITDA/Interest Coverage; Band
Debt Payo=; and Equity Contribution.
Chapter 18 – Private Equity Impact on Corpora&ons
Q1. What are some measurable benefit from private equity ownership of corporations?
A. Be>er management practices; higher productivity and correspondingly higher
Q2. What were the World Economic Forum’s principal conclusions regarding private
equity firm?
A. The World Economic Forum’s conclusions are that private equity firm do more
than apply financial engineering to their target companies. Research has
demonstrated that private equity-owned companies have high scores on a wide
Q3. What were the principal perceived benefit for the PE consortium’s acquisition of
TXU?
A. Low-beta industry; solid historical returns; strong projected industry growth;
Q4. In hindsight, what were some of the errors commi>ed by the buyout group for TXU?
A. They bought TXU at a time when energy costs were at an all time high and
Q5. What were the principal risks faced by the PE consortium when they made their bid
to acquire HCA?
A. Whether the capital markets would allow $27 billion of new debt; whether the
targeted IRR was achievable, given the possibility of margin contraction due to
Q6. What aspect of Harrah’s business makes it not a good buyout target?
A. Large casino operators often grow by expanding their footprint, which requires
large amounts of capital spending. Under private equity ownership, however,
Q7. What is the impact of highly leveraged deals on the porKolio companies’ ability to
compete in their industries?
A. High leverage decreases the operating &exibility of a company. Cash &ow that
otherwise would have gone to maintenance or expansion CapEx is instead
Q8. Describe the three main areas where private equity investments may bring value to
corporations.
A. The three areas are:
i. Financial engineering: refers to effort to add value by improving a
company’s capital structure. Improvement means making the capital
ii. Operational engineering: refers to effort by private equity firm to
improve their porKolio companies through formal and informal
iii. Governance engineering: refers to initiatives by private equity firm to
create value in porKolio companies by improving incentives and creating
monitoring processes that focus on improvements in cash &ow through
Q9. Which of the three private equity value propositions for corporations has become
most problematic in recent years?
A. Financial engineering: while prudent debt can lower the overall cost of capital for
Q10. What is a bene)t of having a financial buyer versus a strategic buyer in an M&A
transaction?
A. No anti-trust issues (assuming the Target is not being merged with another
Q11. Describe the benefit of the private-equity ownership model versus public ownership
and family-ownership.
A. Private Equity owned companies are more likely to expose and recon)gure or sell
suboptimal business segments, compared to large public companies. Companies
owned by private equity firm avoid public scrutiny and quarterly earnings
Q12. Based on the description of the ideal buyout target in the beginning of the section
titled Corporate Rationale for Private Equity Transaction, which of the companies
described in the section “Private Equity PorKolio Companies Purchased During
2006-2007” were the most suitable buyout targets?
A. Univision, HCA and EOP: stable cash &ows, relatively low capital expenditures,
strong asset base, and leverageable balance sheets. TXU, Harrah’s and Freescale