Financial Modelling & Investment Assessment
LBO Valuation Scenario
Contained herein is a typical financial modelling and investment assessment (as part of the interview) for aspiring investment bankers or analysts who intend to join the finance industry. A time-constraint is normally being applied, i.e. 60-120 minutes, to complete the assessment. No prior templates or files will be provided or allowed to be downloaded, and you are required to build the model from scratch.
However, as this is an assignment, you are encouraged to use any materials provided in the weekly session and/or any resources available to you. Please ensure the model and respective calculations are constructed in a logical manner. Presentation and formatting is not critical but you are encouraged to make your model readable and presentable – it is a good modelling habit to have. You are not required to build a balance sheet for the exercise but other proformas will be required to derive the results for analysis.
Once you have finished constructing the model, please respond to the investment assessment questions at the bottom based on the results generated by your model.
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Case Materials and Assumptions
A private equity firm plans to acquire a private, family-owned gadget manufacturing company (“Target”) with annual sales of $550 million and EBITDA margins of 18% for 15x LTM EBITDA. The transaction will be structured as a cash-free, debt-free deal, with a possible cash injection on Day 1.
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%, & 20% in Yr 1 – 5 • 50% cashflow sweep • Benchmark Rate to increase from 1.5% to 3.0% over 5 yrs |
| 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
• No principal repayments during the term of the investment |
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.
Target’s profile and cashflow forecasts assumptions are described below
| Annual Sales | • 4m units; expected to grow at 10% in Yr 1, declining to 6% growth by Yr 5
• Average prices will initially increase by 5% per year, falling to 3% |
| No. of Factories and Capital Expenditure | • 8 current factories; $2 million in Maintenance Capex per factory
• $25 million to build each new factory |
| Other Expenses | • 50% Gross Margin on widgets declining to 45% by Year 5
• Fixed expenses should rise in-line with average widget pricing |
| Depreciation | $20 million in the most recent historical year. Use judgment to forecast |
| 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 |
| Tax Rate | 25% |
Case Study Questions
- What are the IRR and multiple of invested capital (MOIC) at reasonable exit multiples in Years 4 and 5? Please generate a sensitivity and scenario table like the ones used in the weekly lesson. Based on these results, would you recommend investing in this transaction and what are the rationale (considering a typical PE IRR target ranging from 12-20%)?
- Is the Target’s financial projections plausible? Why or why not?
- What is the best way for the PE firm to increase returns in this transaction without changing the Target’s financial projections?
- Are there any other financing option that the PE fund should consider?
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