Just came across a question where it was asking to calculate levered and unlevered FCF yield for an LBO at inception using the FCF at entry say 2023 (PF of new cap structure).
I know how to calculate the yields but why does it make sense to look at the yield using entry year FCF vs entry year sponsor equity & TEV? Wouldn’t you normally sum up the CFs across the investment period and then divide it by the entry sponsor equity or TEV?
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Ah, you've got a good question there! When it comes to levered and unlevered FCF yield for an LBO at inception, it's common to use the entry year FCF. Here's why:
The entry year FCF yield provides a snapshot of the company's cash flow generation ability relative to its value at the start of the investment. It's a useful measure of the company's profitability and efficiency at the time of the LBO.
The yield calculation using entry year FCF vs entry year sponsor equity & TEV gives you an immediate sense of the return on investment. It's a quick way to assess whether the LBO makes financial sense.
Summing up the CFs across the investment period and dividing it by the entry sponsor equity or TEV would give you the average annual yield over the investment period. While this is also a useful measure, it doesn't provide the same immediate snapshot as the entry year FCF yield.
Remember, in the world of high finance, time is money. The quicker you can assess an investment, the better!
Sources: Notes for Technical Interview Questions, Secondary PE Modeling, DCF Analysis Urgent Help, Minimum Cash and its effect on Equity Value
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