## What is an LBO Model Test?

The **LBO Model Test** refers to a common interview exercise given to prospective candidates during the private equity recruiting process.

Usually, the interviewee will receive a “prompt,” which contains a description containing a situational overview and certain financial data for a hypothetical company contemplating a leveraged buyout.

Upon receipt of the prompt, the candidate will build an LBO model using the assumptions provided to calculate the return metrics, i.e. the internal rate of return (IRR) and the multiple on invested capital (“MOIC”).

Table of Contents

- Basic LBO Model Test: Practice Tutorial Guide
- LBO Modeling Test Interview Grading Criteria
- LBO Model Test Example: Illustrative Prompt
- LBO Model Test – Excel Template
- Step 1. Model Assumptions
- Step 2. Sources & Uses Table
- Step 3. Free Cash Flow Projection
- Step 4. Debt Schedule
- Step 5. Returns Calculation
- Basic LBO Modeling Test: Interview Answers

## Basic LBO Model Test: Practice Tutorial Guide

The following LBO model test is an appropriate place to start to ensure you understand the modeling mechanics, particularly for those starting to prepare for private equity interviews.

But for investment banking analysts interviewing for PE, expect more challenging LBO modeling tests like our standard LBO modeling test or even an advanced LBO modeling test.

The format for the basic LBO model is as follows.

**Excel Usage:**Unlike the paper LBO, which is a pen-and-paper exercise given in earlier stages of the PE recruiting process, in an LBO Modeling Test, candidates are given access to Excel and expected to construct an operating and cash flow forecast, financing sources & uses and ultimately determine the implied investment returns and other key metrics based on the information provided in the prompt.**Time Limit:**The various LBO Excel modeling tests you encounter throughout the recruitment process will most commonly be either 30 minutes, 1 hour or 3 hours, depending on the firm and how near you are to the final stage before offers are made. The one covered in this post should take approximately one hour at most, assuming that you’re starting from a blank spreadsheet.**Prompt Format:**In some cases, you will be provided a brief prompt consisting of a few paragraphs on a fictitious scenario and be asked to build a quick model from scratch – whereas, in others, you may be given the confidential information memorandum (CIM) of a real acquisition opportunity to put together an investment memo alongside an LBO model to support your thesis. For the latter, the prompt is usually left vague intentionally, and asked in the form of a “share your thoughts” open-ended context.

## LBO Modeling Test Interview Grading Criteria

Every firm has a slightly different grading rubric for the LBO modeling test, yet at its core, most boil down to two criteria:

**Accuracy:**How well do you understand the underlying mechanics of an LBO model?**Speed:**How quickly can you complete the task without a loss in accuracy?

For more complex case studies, where you will be given more than three hours, your ability to interpret the output of the model and make an informed investment recommendation will be just as important as your model flowing correctly with the right linkages.

^{In-Person LBO Modeling Test Spectrum}

Thanks for this post – it is very useful! A question on the calculation of IRR and MOIC, what did you do to make the functions applied to all the cells on the right and give out correct answer? i tried to use apply the formulas to the right use… Read more »

Hi, Rohit, Good question. This is hard to do because each exit year calculation is in a different row, so you cannot simply copy to the right. You could put the calculation of IRR and MOIC off to the right, and copy the formula down, and then you could copy… Read more »

why is the amount under the revolver a dash (-) and not 50million?

Hi Danielle – the revolver is assumed to be left undrawn on the initial date of purchase, and the formatting is set to display zero as a dash.

Hi. If in a CFDF txn, the minimum cash stays on the balance sheet and is not taken by the seller, why do we need to show it in the Uses ? Doesnt showing the min cash in the uses imply that the buyer will fund the min cash using… Read more »

Hi, SK,

If the minimum cash is kept in the company as it is turned over to the buyer, then you are correct, there is no need to show cash to B/S as a use of funds. But that also means it is not strictly a CFDF transaction.

BB

Hi Brad, Thank you for all of your responses here. They are very helpful. I understand that the CFDF article conventionally means the seller takes all the cash regardless of whether it is necessary for the operation or it is excess cash. However, we cannot read as so from the… Read more »

Hi, S U, That is a good catch of a slight inconsistency. But it could go either way: It could be totally CFDF where the seller keeps all cash, then the buyer provides an injection of cash in uses of funds to run the business, in which case they probably… Read more »

Hi,

In Step 3. could you please explain why amortization of financing fees is included as part of net income but mandatory amortization of term loan isn’t? Shouldn’t net income include all debt related repayments? Thanks.

Hi, Krishna, Amortization of financing fees is an accrual expense that reduces net income but is added back on the cash flow statement. It is treated like non-cash interest expense, part of the cost of the loan. Amortization of loan principle is not a cost of the loan, it is… Read more »

How long should it take to build this model from scratch (blank excel) and complete the exercise? thanks

If starting from scratch, the basic modeling test should take approximately 45 minutes to complete (and an hour at most).

thank you!

Yes, thank you, Justin!

Hi Brad,

Does IRR and MOIC generally move in opposite directions? What is the intuition behind this?

Hi, Mohit, They do not typically move in opposite directions, but in the same direction. However, they can move in opposite directions when the amount of the total return is larger but the time period is longer; in other words, when there is a change in overall cash returns plus… Read more »

Hi – The revolver wasn’t drawn upon, therefore we didn’t have to reflect a dollar amount on the Sources section, but how come we don’t apply the 2% financing fee to it like we did for the TLB and Senior Notes? If there was a financing fee on the revolver,… Read more »

Hi, Leo,

Yes, the revolver would come with a commitment fee based on unused capacity, not a financing fee based on the amount drawn (especially in this case, zero).

BB

Hi, thanks a lot for the post, very helpful. I have a question regarding the circularity. Even if I look at the tab “Complete” (which includes the circularity toggle), it still gives a circularity error. So, if I switch the toggle from 1 to 0, and then to 1 again,… Read more »

Hi, Emilie,

Make sure in your calculation settings (Alt F T F) you have checked ‘enable iterative calculation’.

BB

Hi Brad,

Thank you for this post.

In the exercice can you explain how LABOR (%) grows by +0,2 PP each year? E.g. from 1,5% in Y1 to 1,7% in Y2.

How are we supposed to know LABOR basis point in the exercise?

I think I missed smt there 🙂

Hi, Dalongeville,

The LIBOR is a projection of what the rates are expected to be in the futures market. LIBOR is now discontinued, so you would want the SOFR rate, and you can find a projection of that here: https://www.chathamfinancial.com/technology/us-forward-curves

BB

Hi WSP team, I have an odd question – if the sponsor is to buy the target company on a CFDF basis, then shouldn’t the use of fund side begin with purchased equity value rather than the purchased enterprise value? If it is due to the use of entry EV/EBITDA… Read more »

Hi, Aries, No, the use of funds in a CFDF transaction is enterprise value plus fees (possibly plus cash to the B/S). EV is cash free debt free, that is the point; it is the value of the core operations of the business, independently of how it is financed and… Read more »

Why is the cash flow not used to pay off the TLB and senior notes? (i.e. why do we not use the min(max) formula instead of assuming only the mandatory amortization amount to be paid off every year?)

Hi, Jimmy,

Good question. Our standard LBO test does use excess cash flows to pay down the TLB. Unlikely we will pay the senior notes early, as bonds usually have call protection to prevent early repayment.

BB

The model is really very helpful …I have learned from basic to advanced about LBO modelling just from these few pages of wall street prep.

Glad to hear, Sushant!

Nvm, saw an earlier screenshot.

Thanks for the article – I have a question about transactions that occur on a cash free debt free basis. in a CFDF basis, does the seller take ALL of the cash (including cash needed for daily operations)? OR does the seller just take the excess cash (and you assume… Read more »

Hi, Andrew, Yes, typically the seller takes all the cash, which is why the buyer needs to inject some cash as a use of funds. And yes, technically the value of core operations should include some minimum cash, and in that sense, enterprise value is not exactly the same as… Read more »

For the equity value calculation at the end, shouldn’t we exclude the 5m in cash if it is not excess cash and necessary to run the business

Hi, Cynthia, Here is the answer I just gave Andrew above about the cash that is needed to run the business, which should answer your question a well. The exit enterprise value should not include the value of the cash to run the business, we just assume it is done… Read more »

Hello, just two questions regarding the IRR. 1) What do we calculate FCF (post revolver) if at the end we use a multiple of EBITDA and exit value for the calculation of IRR? 2) In the table above IRR increases as the exit years get delayed. I’ve seen some models… Read more »

Hi, Leo, EBITDA is just a way to estimate the enterprise value that we will sell the business for, whereas FCF post revolver helps us to measure how much excess cash we have to pay down debt, and that will increase what is left over for equity value at the… Read more »

Hi, For the revolver, in this scenario it seems that it is set to draw only if pre-revolver fcf is negative but shouldn’t we need to adjust it to reflect the 5mn in minimum cash each year? I realize that because the CFs are all positive that this doesn’t impact… Read more »

Hi, Avery, Great question, and yes, it should account for the $5mm minimum cash. But that is why we base the revolver draw not only on the pre-revolver FCF from that year, but on the cash available which takes into account the beginning cash balance, the minimum cash balance, and… Read more »

Hi, I was wondering if the formula of the UFCF is missing something.

If we start with NI, isn’t it UFCF = NI + D&A + I (1-t) – CAPEX – Change in NWK?

I don’t see I (1-t) being added back.

Can we also start with NOPAT?

Hi, Anthony, That would be the correct formula for Unlevered FCF, and yes, for UFCF, we would preferably start with NOPAT (which is EBIT * (1-tr). However, in this LBO model, what we mean by FCF is not UFCF, but the FCF available to pay down the revolver, and after… Read more »

Hi,

For the calculation of unlevered FCF, aren’t we supposed to add back interest expense x (1-t) ?

Unlevered FCF = Net income + depreciation and amortization + interest expense (1-t) – capital expenditures – change in net working capitalHi, Leo, That would be the correct formula for Unlevered FCF. However, in this LBO model, what we mean by FCF is not UFCF, but the FCF available to pay down the revolver, and after the revolver is paid, the increase in the cash balance. So, it needs to incorporate… Read more »

Great thanks !

You’re welcome!

Why didn’t we add the $50mm under “$ amount” for revolver in “Debt Assumptions”? Why are we just including it in the debt schedule?

Hi Lily – the revolving credit facility is assumed to be undrawn on the date of initial purchase. The $50 million is the revolver’s predefined capacity, i.e. the maximum amount that can be drawn if the borrower experienced a cash shortfall. If left undrawn, the revolver is a source of… Read more »

Hi, how would you account for the transaction fee in the final returns calculation?

Thanks a lot for your help and great tutorial!

Hi, Lisa, As long as the transaction and financing fees are included in uses of funds, then the amount of equity that the sponsor has to inject in order to come up with the total sources of funds will be impacted by those fees, and therefore the final return calculation… Read more »

Got it, thanks a lot Brad, great tutorials!

You’re welcome, Lisa!

Hi, in case I have a lot of unused cash and no debt to pay off before the purchase, can I use it as a source of funding? If so, how can I add this step to the model?

Thanks a lot!

D.

Hi, Diana,

Yes, if a company has excess cash and no debt to pay off, that cash is netted against the purchase price as a ‘source of funds’ in the LBO model.

BB

Hi, in the FCF pre revolver, why do we subtract “mandatory amortization? Is it a real cash out flow?

Hi, Alexandre,

Yes, they are real cash outflows. Mandatory amortization (or principal payments) must be made before any revolver payments are made, so we need to include them in pre-revolver FCF.

BB

So that means we can possibly use the revolver to pay the mandatory amortization of other debts?

Hi, Anqi,

Yes, we could use the revolver to make a mandatory amortization payment if we had no other source of funds.

BB

Why are we adding back the amortization of financing fees? I understand that it’s a form of amortization, but it seems to me that it’s a cash expense?

Hi, Chris,

It is a non-cash expense. The fees are paid up front in cash out of the proceeds from the debt issuance, like a prepaid expense. But they are expensed over the life of the debt as a non-cash expense.

Brad

This makes sense. Thank you for the clarification!

You’re welcome!

In step 3 there is already interest expense, how is that possible?

because it is stated that for a while we leave it as a blank

Jonibek:

That’s only because we are using screenshots from the completed model.

Best,

Jeff