Hi, just saw this question for practice and was wondering how one would approach this paper LBO question:
Exit multiple of 10x, EBITDA cagr of 15% for 5 years. Cash conversion 100% (ie EBITDA= FCF)
What should my entry multiple be to hit 2x MOIC?
What should my entry multiple be to hit 15% IRR?
What if I fund this deal with 50% debt? What would be the answer to the above 2 questions?
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Question doesn't sound complete, can you double check?
Also if helpful 15% CAGR (or IRR) in 5 years is 2x MOIC - you should memorize that.
Have kept in mind 2x in 5 years is equivalent to 15% CAGR.
Also double checked and the question is complete.
1. Is this assuming a 100% equity purchase? Let's use $10 as your starting EBITDA. Next five years, you should generate $12, $13, $15, $17, and $20 of EBITDA (and FCF). You sell for 10x off the $20, or $200. Cumulative FCF would be $77. So you have $200 + $77 = $277 of total proceeds. $277 / 2 = $138.5 so entry multiple would be 13.85x.
2. 2x MOIC is roughly a 15% IRR. If the FCF isn't being paid out in the interim in the form of a dividend to shareholders and isn't effectively paid out until sale, then the multiple above should be the entry multiple.
3. You need an interest rate for the debt. If you completely ignored the interest, then you'd do $277 - X (starting debt) = 2 * X (starting debt since equity is the same as debt in a 50/50 deal). 3X = $277. X = $92.3. Double that and you're at ~$185, or an 18.5x entry off 10x. We would expect to be able to pay significantly more upfront and still achieve the same return if we are using leverage. That said, your FCF here is overstated. Now let's assume interest here is $8 annually. Your cumulative FCF will be $40 lower so same equation as earlier but instead of $277, use $237. X = $79. That would imply an interest rate of ~10%. Double X to get the TEV and you get $158, or 15.8x.
Note that this is all pretty bare bones. Excludes some considerations like fees.
With such suspicious choice of numbers, i.e., that 2x MOIC on 5 year period, I suspect that we shouldn't take into account the CF during the years.
Therefore, the answer to the question 1 & 2 is, that the entry level multiple can be the same as exit multiple (given that EBITDA = FCF).
Regarding Q3, my reasoning is as follows:
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