Lease liabilities in LBO model

Based on the most helpful WSO content, here's how you should account for capitalized lease liabilities in an LBO model under IFRS:

(A) Entry EV/EBITDA Multiple

• EV Calculation: When calculating the Entry EV/EBITDA multiple, the Enterprise Value (EV) should indeed include lease liabilities. The formula would be:
  • EV = Equity + Debt - Cash + Lease Liabilities + Other Items (e.g., pension liabilities)

(B) Annual Free Cash Flow (FCF)

• FCF Calculation: For calculating the annual Free Cash Flow, the FCF should be post principal paydown of lease liabilities. The formula would be:
  • FCF = Net Income + D&A - Change in NWC - Capex - Principal Repayment of Lease Liabilities

(C) Forecasting Interest Expense

• Interest Expense Forecast: To forecast the interest expense associated with the lease liability during the forecast period, you need to:
  • Calculate the interest portion of the lease payments: This can be done by applying the interest rate implicit in the lease to the outstanding lease liability balance.
  • Amortize the lease liability: Over the lease term, the interest expense will decrease as the principal is paid down.

This approach ensures that lease liabilities are accurately reflected in both the valuation and cash flow projections of the LBO model.

Sources: Adjusting EV for Operating Lease Liabilities?, Net debt: The definite list, Beyond the guide: a list of real interview technical questions, Modeling ground lease payments into a pro forma, DCF Modeling Course ~ Pre-training text.pdf