Case 051Leveraged buyoutsWarm up
Paper LBO over the phone: Neerbahini Pumps has EBITDA of Rs 100 crore growing 7% a year, bought at 8x with 5x debt at 10%, and all cash after interest repays debt. What are the money multiple and the IRR?
1The situation
A sponsor buys Neerbahini Pumps, a maker of agricultural pumps, for 8.0x its EBITDA of Rs 100 crore. It borrows 5.0x EBITDA at 10% interest and puts in the rest as equity. EBITDA grows 7% a year.
Free cash flow before interest is 50% of EBITDA every year, after tax, capex and working capital. Every rupee left after paying interest goes to repay debt. Interest is charged on the opening balance. The sponsor sells at the end of year 5 at the same 8.0x.
2Your task
What are the money multiple (MOIC) and the IRR, and which driver produces most of the gain? You have no spreadsheet.
Quick check
Before working the years: roughly what IRR do you expect?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
About 2.3x the money and an IRR of about 18%. Entry equity is Rs 300 crore. Exit EBITDA of Rs 140 crore at 8.0x is worth Rs 1,122 crore; five years of cash after interest repay about Rs 66 crore, leaving Rs 434 crore of debt. Equity is worth about Rs 688 crore. EBITDA growth supplies most of the gain; debt paydown is small because interest eats most of the cash.
Step 1What do you write down before any year-by-year maths?
Three numbers: what goes in, what comes out, and how long it takes. Entry equity is the price less the debt, so 800 less 500 leaves Rs 300 crore of sponsor money. Think of buying a flat for Rs 80 lakh with a Rs 50 lakh home loan: your own stake is Rs 30 lakh, and every rupee the flat gains in value belongs to you, not the bank. That is why a paper LBO starts with the sources and usesA two-column table at the start of a deal: what the money is spent on, and where each rupee comes from. before anything else.
Step 2How much debt does the cash actually repay?
Less than most candidates expect. Year 1 EBITDA is Rs 107 crore, so cash before interest is Rs 53.5 crore. Interest is 10% of Rs 500 crore, Rs 50 crore. Only Rs 3.5 crore is left to repay debt in year 1, because a 5x loan at 10% costs half of EBITDA, and half of EBITDA is all the cash there is. Repayment speeds up as EBITDA grows and the balance shrinks, but across five years it totals only about Rs 66 crore.
| Year | EBITDA | Cash before interest | Interest | Debt repaid | Debt at year end |
|---|---|---|---|---|---|
| 1 | 107.0 | 53.5 | 50.0 | 3.5 | 496.5 |
| 2 | 114.5 | 57.2 | 49.7 | 7.6 | 488.9 |
| 3 | 122.5 | 61.3 | 48.9 | 12.4 | 476.5 |
| 4 | 131.1 | 65.5 | 47.7 | 17.9 | 458.7 |
| 5 | 140.3 | 70.1 | 45.9 | 24.3 | 434.4 |
| Total | 65.6 | 434.4 |
Step 3Where does the sponsor's gain come from?
Split it into the three engines, because the follow-up is always which one matters. EBITDA growth at a constant multiple adds Rs 322 crore of value, debt paydown adds Rs 66 crore, and the multiple adds nothing because it is 8.0x in and 8.0x out. Equity goes from 300 to about 688. Growth carries roughly 83% of the gain here, which tells the interviewer this deal is a bet on the pump market, not on financial engineering.
| 1,122 | exit enterprise value, 8.0x EBITDA of 140.3 |
| 434 | debt still owed at exit |
| 300 | sponsor equity at entry |
Step 4How do you get there out loud without a calculator?
Round hard and say you are rounding. 1.07 to the fifth is about 1.4, so exit EBITDA is about 140 and exit value about 1,120. Repayment is small: roughly 4, 8, 12, 18 and 24, about 65 in all, so debt is about 435. Equity is about 685 on 300, a little under 2.3x. Then use the ladder: 2x in five years is about 15%, 2.5x is about 20%, so 2.3x is about 18%. An answer within a point, reached in a clear sequence, is what a phone screen is grading.
Close with the limit. The answer is very sensitive to the exit multiple: at 7.0x instead of 8.0x, exit equity falls to about Rs 547 crore, 1.82x and an IRR of about 13%. One turn of multiple is worth more than all five years of debt paydown, which is the first thing to say when asked what could go wrong.
Where candidates lose it
The usual loss is assuming all of free cash flow repays debt and forgetting interest. That would repay about Rs 300 crore and give an IRR in the mid twenties; the interviewer has built the case so that interest consumes most of the cash.
The second is computing the IRR as total gain divided by years. A gain of 129% over five years is not 26% a year; compounding makes it about 18%. Use the ladder of multiples instead of dividing.
What the interviewer asks next
- The exit multiple falls to 7.0x. What is the IRR now, and how much EBITDA growth would offset it?
- What happens to the IRR if the sponsor uses 6x debt instead of 5x?
- Why does the debt paydown engine matter more in a low interest rate world?
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Company names and figures are illustrative.