Modeling Test: Option Pool Question

CEEBanker's picture
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Rank: Senior Baboon | banana points 217

Hi All-

I've been working through some of the WSO LBO modeling tests from the PE guide. My question relates to the Basic LBO 2 model and the option pool. There is a dividend recap at the end of year 3 and the sponsor exits in year 7. A management option pool is exercised on exit. The formula for the cash generated from the management option pool is as follows:

=IF(exit equity > (entry equity - div payment ), option pool % * (entry equity - div payment),0)

My question is why is the dividend payment even coming into consideration? If the dividend is in year three, the sponsor is the only equity holder at the time. The options are executed in year 7, so I would think only entry equity and exit equity values would come into consideration - not what the sponsor earned along the way during the hold period. The way the formula is laid out reduces the amount of cash generated when management exercises the options. I modeled the cash proceeds from the options as:

=IF(exit equity > entry equity, option pool % * entry equity, 0)

Is this correct? Can anyone help explain this?

Thanks!

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Comments (3)

 
Jan 23, 2019

Hey CEEBanker, the following topics might be helpful:

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  • More suggestions...

Fingers crossed that one of those helps you.

Hedge Fund Interview Sample Pitches - Long and Short
 
Jan 26, 2019

When a dividend recap occurs in reality, you typically adjust down the strike price of the options by the dividend amount per share in order to make the option holders whole and no worse off than if you didn't do the dividend. That's what that original formula in the template is reflecting.

Vice President - Certified Professional Certified Private Equity Pro
 
Feb 2, 2019

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