I was recently in an interview and asked to calculate the PF free cash flow in the following scenario.

### Acquisition Scenario and Assumptions

• EBIT: \$40mm
• D&A: \$10mm
• CapEx: \$10mm
• Change in Working Capital: \$0
• Tax Rate: 40%
• Transaction Multiple: 5.0x EBITDA (assuming no cash or debt transaction)
• Debt: \$150mm (based on transaction multiple and 40% equity check), 100% bank debt, split between Term Loan A and Term Loan B
• Term Loan A: \$75mm, 8% cost of debt, amortizes over 10 years
• Term Loan B: \$75mm, 10% cost of debt
• Financing Fees: 2.5%, amortized over 10 years

### Calculate Pro Forma Free Cash Flow with Term Loan A and Term Loan B

There are a couple of ways to approach this scenario, from an operational or investor perspective. In an interview, be sure to explain which the rationale for your approach as you are walking the interviewer through your response. The answer below uses an operational approach.

Calculate Net Income:

EBITDA: 50 mm
- D&A: 10 mm
- Financing Fees Amort: .375 mm
= EBIT: 39.625 mm
- IntExp Term Loan A: 6 mm
- IntExp Term Loan B: 7.5 mm
= EBT: 26.125 mm
- Taxes: 10.45 mm
= Net Income: 15.675 mm

Calculate FCF:

Net Income: 15.675 mm
+ D&A: 10 mm
+ FinFeeAmort: 0.375 mm
+ NWC: 0 mm
- Capex: 10 mm
- TLA Amort: 7.5 mm
- TLB Amort: 0 mm
= FCF: 8.55 mm

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I caught one thing: the financing fee would be \$6.25mm (2.5% x \$250mm purchase price), or \$0.625mm per year amortizataion. (PP calc = \$50mm EBITDA * 5x multiple = \$250mm)

Cash Flow From Operations (Operating Cash)

## - Capital Expenditures

= Free Cash Flow

broken down more is

Net Income
+ D& A
+/- Change in WC

## - Capital Expenditures

= Free Cash Flow

EBIT - \$40.0mm
- Interest Expense from Term Loan A - \$6.0mm
- Interest Expense from Term Loan B - \$7.5mm
EBT - \$26.5mm
- Taxes \$10.6
Net Income \$15.9
+ D&A - \$10.0mm
+ Amortization from Financing Fees - \$0.625mm
- Amortization of Term Loan A - \$7.5mm
- Capex - \$10.0mm

## - Change in WC - \$0.0mm

FCF = \$7.775mm

Actually, you don't add the TLA amortization to EBIT to get EBITDA. Amortization in the non-cash sense is quite different form Debt amortization, which is mandatory and must be paid in cash.

EBITDA: 50 mm
-D&A: 10 mm
-Financing Fees Amort: .375 mm
EBIT: 39.625 mm
-IntExp A: 6 mm
-IntExp B: 7.5 mm
EBT: 26.125 mm
-Taxes: 10.45 mm
Net Income: 15.675 mm

FCF Calc

Net Income: 15.675 mm
+D&A: 10 mm
+FinFeeAmort: 0.375 mm
+NWC: 0 mm
-Capex: 10 mm
-TLA Amort: 7.5 mm

# -TLB Amort: 0 mm

8.55 = FCF

why is TLA amortization not just added to TLA Interest (ie making it \$13.5m)? I'm sure you're right I'm just curious about this.

Also for ibanker26 and welldawg08 how can you guys (apparently) work in IBD and Private Equity and get this stuff so wrong?

because i wrote my answer in 10 seconds without much thought. I have real work to do then troll ws oasis forums all day commenting on peep's mistakes

small point... i woulld start with EBIT to calculate FCF in an LBO as you sometimes have PIK interest which NI includes as well

EBITDA: 50
- D&A: 10
- Amortized Financing Fee: 150*2.5%/100 = 0.375
EBIT: 39.625
- Interest:75*8% + 75*10% = 13.5
Pretax Income:26.125
Net Income:26.125*(1-0.4)=15.675
+D&A+Amortized Finance Fee: 10.375
+ NWC: 0
- CAPEX: 10
- Mandatory Debt Repayment A: 7.5
FCF: 8.55

Envision, create and believe in your own universe, and the universe will form around you. -- Tony Hsieh

I'm shocked at the above answers. So much so, that I actually took the time out below to calculate it.

EBIT 40
D&A 10
Capex 10
Tax 40%

TEV Multiple 5x
EV \$250
Amort/yr \$.375

Levered FCF:

EBIT 40
- Taxes (24)
+D&A 10
-Capex (10)
-WC 0
- Int Exp - TL A (6)
- Int Exp - TL B (7.5)
+ Amort Fin Fees 0.375
= Lev FCF 2.9

You add back amort of financing fees, as this an expense.

Not sure I would add back the Amort of Fin Fees. You add back the 10 of D&A because its baked into the EBIT number but is a non cash expense. The .375 of financing fees is a non-cash expense, but I don't think it is incorporated into that EBIT number. I guess there is a tax shield component here, so you could add back the .375 * 40%.

Also, if I'm looking at levered free cash flow shouldn't I be including the tax shield from the Debt? So subtract the tax-effected net interest expenses instead of the total number?

In general, if I was asked to calculate Free Cash Flow, I would stick to unlevered. From there, you can make any adjustments you need (Tax-effected Interest Expense, Mandatory Debt Amort) to get a "Capacity for Optional Debt Amortization" figure, which essentially is your PF LFCF

Amort of financing fees is not included in the D&A number calculation - this is why capex and D&A are identical.

I don't know what the hell you mean by tax shield from debt...did you mean D&A? If so, I am recognizing my tax shield.

We're looking at levered FCF because we are trying to determine after-debt cash flows. IRR is based off these type of cash flows.

My calculation above is correct. Once again, I'm shocked by the responses above and the misinformation on this website.

Loan amort should *not* be subtracted from FCF. This is cash that is creating equity, same as a dividend.

@"johnny_quest" is remarkably incorrect for somebody who is so "shocked by the above answers".
The 8.55 figure that @"Jeremystory" and @"curiousmonkey" arrived at seems correct to me.

Johnny_quest, the financing fees are separate from the \$10 of D&A so ebit needs to be recalculated. The taxes are wrong - incorrect tax rate first of all as pointed out already, and then you didn't use the int exp as a tax shield. Also, the amortization of TLA affects levered FCF and you don't account for that.

“Success means having the courage, the determination, and the will to become the person you believe you were meant to be”

I don't think that is correct. If it is a mandatory debt payment, whether or not its "creating equity", it is nonetheless a required cash out flow. If the company was unable to make that payment it'd be likely subject to default. Optional debt repayments would be a different story.

What?! Yes I flipped the Tax incorrectly in my post which was flagged earlier. This was a copy and paste error while I was transferring my numbers from my quick excel workbook - not a conceptual misunderstanding.

Taxes are based on EBIT. To get to FCF, you subtract int expense. "Your comment about int expense as a tax shield" is invalid here - this applies when we're trying to compute Net Income (e.g. we apply taxes to PBT).

The firm would be receiving the tax benefits and thus its tax burden on an cash outflow basis would be reduced. The actual cash leaving the firm would be the tax adjusted interest expense and therefore fcf calculation needs to take that into consideration. Under you scenario that firm would have ~2.5mm in extra cash that you aren't accounting for.

taxes should be based off of EBT to get to net income.

then start from net income to add back taxes. then add back d&a, amort of fin., subtract mandatory debt repayments, etc. to get LFCF.

a minor but small distinction. if you take taxes off of EBIT you overstate taxes.

Sigh. I'm not going to start a monkey s**t throwing contest as you guys tried to (although I'm realizing I've definitely got enough credits to make it interesting), but this is insane.

The implication that mandatory debt repayments should not be accounted for in levered FCF is absurd. Mandatory debt repayments are, by their nature, outflows of cash that the equity investor will therefore not see. Yes, of course it increases the equity stake, but that value will be realized when they cash out a larger portion at the sale. To not realize that the PE firm will get less cash during their holding period based on mandatory debt repayments is not looking at this from "an investor's perspective" - it is just ignoring multi million dollar cash outflows.

As for the distressed perspective brought up by mrb87, I can see how maybe you wouldn't account for mandatory debt repayments, if you feel that you'll be restructuring the debt or something like that. But this seems like a cut and dry LBO interview question. When non-distressed PE firms have to pay out millions of dollars to creditors instead of pocketing it, they tend to care and throw it in their models....

FYI - yes, as pointed out, I'm an incoming analyst. I've also had FO internship spanning IB, HF and PE (3 in PE).

“Success means having the courage, the determination, and the will to become the person you believe you were meant to be”

Things are getting heated up in herrr...

I think @"ayoayo" was correct based on the definition of LFCF. Johnny and mrb are looking at this from a different perspective, but in practice they aren't wrong. The way the original question/post was worded, each could be a valid answer IMO.

In an LBO, you have two lines that you care about:

1) cash flow available (needed) before principal payments
2) cash flow available (needed) after mandatory amort

I've never seen anyone use the UFCF or LFCF terms in the real world.

Spot on as usual @"peinvestor2012" with regards to the two CF lines. SB'ed.

When I think of true "levered free cash flow", I think of your '2)', as specified above, as it takes into account all aspects of the leverage. Labeling it LFCF if you are arriving at the 'cash flow available (needed) before principal payments' line doesn't seem fitting imo.

“Success means having the courage, the determination, and the will to become the person you believe you were meant to be”

It's funny how you say "spot on", when you repudiated everything I just said which is expressed in point #1, and told me to take anode long course.

Given that you're a novice, we use #1 from investors perspective if you're a sponsor as pricing and debt quantum will vary according to what Term Sheets we"ll receive from banks.

Also, you won't see TL A's often, unless it's a unitranche format. You perhaps don't know this, but the TL b won't amortize if there is a TL A senior to it.

One recommendation, I'd like to make as you begin your banking experience, is to stay humble and don't act like you know everything especially with the "dense" internship experience you had in HF and PE (which basically means you sourced deals and did monkey work).

I think you have a head on your shoulders, but just need to fix that attitude and stop trying to use your academic and pedantic approach to justify that others are wrong.

Bankers look at things a different than an investor does - academics won't teach you that; listening to what other folks are saying and reasons for them will go a long way for u.

At the end of the day there is no "right" answer. This thread has gotten a little out of hand. I'm sure JQ and MRB know what they are talking about and are approaching it from their filter and how they have been trained as investors. Also, NT and AY are correct if you are talking about the actual cash outflows and definition of LFCF. It's really just semantics.

I think it would be helpful for everyone to not just state your answer and that someone is wrong but rather state your rationale so people can learn something from one another.

Am I missing something, or shouldnt the debt be 120 and not 150? A 5x ebitda multiple means offer value of 200, and if equity is only 40%...

Edit: nvm, 40 was ebit

I have a question, isn't amortized financing cost added as part of interest expense? (that is, I thought EBIT does not include amortized finance cost)

This would only change whether you have to add back financing cost or not.

Dude - loan amortization is principal repayment (paying back the debt owed), not like D&A even though it's using the same word ("Amortization").

Debt repayment goes in the statement of cash flows.

Only piece of debt that shows up in the income statement is Net Interest Expense

Best Response

Exactly, there seems to be some confusion about the word "amortzation" here. Don't mix up
1) loan amortization = principal repayment = a cash outflow in the CFS and
2) amortization of capitalised financing fees (asset on the balance sheet that gets amortized in the normal way you know) = expense in I/S = add back in CFS

Rate of return on a Term Loan B (Originally Posted: 10/28/2013)

Can anyone shed some light on this process? New to this kind of debt. Say you hypothetically committ \$100MM on a 7-year \$500MM TLB issued at 99%. Annual amortization 100bps of face value, priced on a 350+450 LIBOR spread. How shouuld I be thinking about this? Any significant variables I'm excluding (besides risk)?

Risk is a pretty big one. Like LIBOR floor is one (don't really know what it is one of, since i'm not sure what we're looking for here.....). But thinking about what? If I'm thinking about putting \$100m out the door, risk is definitively going to be up there.

Be more specific in what you're looking at, then we'll be able to help you to a greater extent. Do you care about covenants, the law which the doc is written under, the White List, the intercreditor?

In reality everything in a loan doc is driven by the company itself, its operations and risk.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper

Not worried about the risk, covenants (covenant lite), etc. regarding this hypothetical security. LIBOR floor 100bps, initial cash flow sweep provision of 75%, 101% softcall year 1 (re-pricings). I really just want some color on calculating and thinking through the return. i.e. why do it, how much money is to be made? Much apprecaited. If I don't have enough info. than this thread can just be disregarded, like I said pretty new to this.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper