Beginner LBO Modeling questions
(Baboon, 156
Points)
on 4/10/12 at 8:59pm
I'm trying to create an LBO for a case.
1. This might be a very stupid question, but why does a DCF model add back depreciation, but the lbo model does not in the calculation of free cash flow? (Would it be wrong to add depreciation in an LBO?)
2. What are typical IRRs? I'm getting 19% but I added depreciation into the calculation of FCF
3. What are typical financial buyer acquisition control premiums? I assumed 10% if there even is one...
4. I don't know if this is some standard, but from what I can tell blue=hard coded and black=not hard coded.. what is red?
5. What is the usual % paydown (of debt) by year 5 (exit year)? I am getting 100% by year 6, but the model goes until year 10.
Thanks!
-Learning Student
2. I believe usually
2. I believe usually 20-30%
3. usually ~15%
In the past funds have aimed
In the past funds have aimed for 20+%, but these margins have been squeezed since the financial crisis (and increase in industry competitiveness).
Not bad questions
Not bad questions actually.
1) In a DCF adding back D&A is because it's a non-cash expense (unless it's non deductible amort.) and you
want to value the firm and it's operation of it's assets. Depreciation is subject to it's depreciation schedule
and for simplicity sake, outside of the control of the firms management. In a DCF you want to know PV of the
forecast-ed cash flows that are generated by your assets and firm operations and the the terminal value in
perpetuity.
I see this so many times, an LBO is not really a valuation (although you can argue it's a "floor" value), it's a
scenario analysis were you're saying "what type of return can I get given X return with Y amount of debt and Z
amount of equity." You're correct in that you don't add back D&A, but then again if you're doing your LBO right
it should not be included to begin with because you start with EBITDA; were is in a DCF you start at EBITDA
and deduct to EBIT(A) and adjust by your tax rate taking into account any non deductible amortization.
4) We use red to show initial investment on NPV and IRR calc's and only rare cases if something needs to
stand out on the model. Have noticed that PE shops like using it a lot more some reason.
5) Really the ideal % payed down is the amount that (sans any mandatory or revolver payments) A) get's the
sponsor their desired return the quickest or B) whenever you hit a specified hurdle rate. That's at least in
my experience.
Not sure I understand your
Not sure I understand your Q#1. D&A is non cash, hence it is added back for the FCF calc in both a DCF and an LBO.
The only real difference between the FCF in a DCF and the FCF (pre debt service) in an LBO is that the LBO FCF is levered (includes interest payments, as well as a respective tax shield) whereas the DCF FCF is unlevered (pre interest payments).
To better answer your question, can you please walk me through how you are calcing FCF? Are you starting with EBITDA or Net Income?
ihatebanking wrote: Not sure
Not sure I understand your Q#1. D&A is non cash, hence it is added back for the FCF calc in both a DCF and an LBO.
The only real difference between the FCF in a DCF and the FCF (pre debt service) in an LBO is that the LBO FCF is levered (includes interest payments, as well as a respective tax shield) whereas the DCF FCF is unlevered (pre interest payments).
To better answer your question, can you please walk me through how you are calcing FCF? Are you starting with EBITDA or Net Income?
So I am starting off with EBITDA. Then subtracting interest expense, tax, increase in NWC and Capex for the FCF available for debt.
I am working with a very basic model but I am also referencing a full blown model so I can see what the differences are. I have worked with DCF models so I know that you add depreciation in, but as I mentioned, I'm not quite clear why you don't add it back in on the LBO model.
When you say "don't add it
When you say "don't add it back", where exactly are you referring to? Are you referring to the DCF FCF when you go:
EBITDA
-D&A
=EBIT
*(1-Tax)
+D&A <-----Is this whats confusing you? That you don't add back D&A in a similar fashion in an LBO model?
ihatebanking wrote: When you
When you say "don't add it back", where exactly are you referring to? Are you referring to the DCF FCF when you go:
EBITDA
-D&A
=EBIT
*(1-Tax)
+D&A <-----Is this whats confusing you? That you don't add back D&A in a similar fashion in an LBO model?
Ohhh, that was one of them retard moments i just had. I never paid attention to the fact that FCF in a dcf starts from the EBIT and not the EBITDA, but now I get it. dcf: unlevered fcf lbo: levered fcf
and thats why you subtract and add it back in. Thanks!
Haha, cool. Hopefully you got
Haha, cool. Hopefully you got it.
What you just said is correct, since in a DCF, the FCF is unlevered so you need to take into account the tax shield of the D&A only (and not interest). Hence why you subtract D&A to get EBIT, do your tax calc, and then add back D&A again.
In an LBO, you can pretty much just start with the net income line (D&A, interest and taxes have already netted out) and just add your D&A from there.
As you can see, the key difference is how you account for interest (and subsequently, taxes), while D&A is accounted for the same way in both FCF calcs.