Case 024LBO modelling testsHard

Timed modelling test: build a three-year debt schedule for a castings company with a term loan under a 75% cash sweep, a PIK note and a revolver, where year 1 capex spikes. Show when the revolver is drawn and when it is repaid.

Carlyle GroupNew York · 2023

The situation

Ambrit Castings makes iron castings for tractor and pump makers. EBITDA is Rs 120 crore, growing 5% a year; depreciation Rs 30 crore; tax 25% on profit after all interest, including the PIK accrual. Capex is Rs 110 crore in year 1 for a new foundry line, then Rs 30 crore a year. The company holds Rs 20 crore of cash and must keep at least Rs 20 crore.

Debt at close: a Rs 400 crore term loan at 9% with 1% a year of scheduled amortisation and a 75% excess cash sweep; a Rs 150 crore PIK note at 13% that pays no cash; and an undrawn Rs 100 crore revolver at 8% with a 0.5% fee on the undrawn amount. Interest is on opening balances. Order of cash: scheduled amortisation, then revolver, then the sweep. The template is given with every line blank.

Your task

Build the three-year schedule: interest by tranche, tax, cash flow available, revolver draws and repayments, the sweep, and closing balances. Explain the order of the cash and what the PIK does.

Quick check

In year 1 EBITDA is Rs 120 crore and capex is Rs 110 crore. What happens to the revolver?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Year 1 is Rs 39.0 crore short after interest, tax, Rs 110 crore of capex and amortisation, so the revolver is drawn to Rs 39 crore; year 2 generates Rs 48.2 crore, repays the revolver in full, then sweeps Rs 3.9 crore to the term loan; year 3 sweeps Rs 40.3 crore. The term loan ends at Rs 343.8 crore. The PIK note never touches cash and grows from Rs 150 crore to Rs 216.4 crore, so total debt only falls from Rs 550 crore to Rs 560 crore, 4.2x EBITDA.

Step 1What is the order of the cash, and why does it matter?

Think of a household with a home loan EMI, a credit card and a savings target. The EMI is paid whatever happens; a bad month goes on the card; a good month clears the card first, and only then does extra go to prepaying the home loan. Here the scheduled Rs 4 crore of amortisation is the EMI, the revolver is the card, and the 75% cash sweepA loan term under which a fixed share of excess cash flow each year must be used to prepay the loan, on top of scheduled repayments. is the prepayment. Get the order wrong and the model sweeps cash into the term loan while the revolver is still drawn at a higher rate, which a reviewer spots in the first minute.

Step 2How does year 1 go, line by line?

EBITDA Rs 120 crore. Cash interest: 9% of Rs 400 crore is Rs 36 crore, plus the undrawn fee of 0.5% on Rs 100 crore, Rs 0.5 crore. The PIK accrues 13% of Rs 150 crore, Rs 19.5 crore, which is deducted for tax but paid by nobody. Tax is 25% of 120 less 30 less all interest, Rs 8.5 crore. Cash after interest, tax and Rs 110 crore of capex is minus Rs 35.0 crore; after Rs 4 crore of amortisation the company is Rs 39.0 crore short, with no cash above its Rs 20 crore minimum, so the revolver is drawn by exactly that. No sweep, because there is no excess.

The order of the cash: amortisation, then revolver, then the 75% sweepYear 1: capex yearEBITDA120.0less cash interest and fees(36.5)less tax(8.5)less capex(110.0)Cash after interest, tax, capex(35.0)less 1% amortisation(4.0)Shortfall: revolver draws39.0Sweep0.0Year 2: repair yearEBITDA126.0less cash interest and fees(39.1)less tax(8.7)less capex(30.0)Cash after interest, tax, capex48.2less 1% amortisation(4.0)Revolver repaid first(39.0)75% of the rest sweeps the term loan(3.9)Cash kept1.3
In year 1 the Rs 110 crore capex leaves a Rs 39.0 crore shortfall after amortisation that the revolver funds; in year 2 the Rs 48.2 crore of cash after interest, tax and capex repays the revolver first and then sweeps 75% of the remainder, Rs 3.9 crore, into the term loan.
Step 3What happens in years 2 and 3?
Rs croreYear 1Year 2Year 3
EBITDA120.0126.0132.3
Term loan interest, 9%(36.0)(35.6)(34.9)
Revolver interest and undrawn fee(0.5)(3.4)(0.5)
PIK accrual, 13%, non-cash19.522.024.9
Tax, 25%(8.5)(8.7)(10.5)
Capex(110)(30)(30)
Cash after interest, tax, capex(35.0)48.256.4
Scheduled amortisation(4)(4)(4)
Revolver draw / (repayment)39.0(39.0)(0.0)
Cash sweep, 75% of excess(0.0)(3.9)(40.3)
Term loan at year end396.0388.1343.8
Revolver at year end39.00.00.0
PIK note at year end169.5191.5216.4
Total debt and leverage604.5, 5.0x579.6, 4.6x560.3, 4.2x
The revolver is drawn to Rs 39 crore in year 1 and repaid in year 2 before any sweep; the term loan falls to Rs 343.8 crore; the PIK note climbs to Rs 216.4 crore; total leverage moves from 4.6x at close to 4.2x.

Year 2: EBITDA Rs 126 crore, capex back to Rs 30 crore, and the revolver now costs 8% on Rs 39 crore plus the fee on the undrawn part. Cash after interest, tax and capex is Rs 48.2 crore. After Rs 4 crore of amortisation, Rs 39.0 crore repays the revolver, and 75% of the Rs 5.2 crore left, Rs 3.9 crore, sweeps the term loan; the other quarter stays as cash. Year 3 has no revolver to repay, so Rs 40.3 crore sweeps and cash builds to Rs 33.4 crore.

Debt at each year end, Rs crore: the revolver comes and goes, the PIK only growsClose550396Term loan39Revolver170PIK note604, 5.0xYear 1388Term loan192PIK note580, 4.6xYear 2344Term loan216PIK note560, 4.2xYear 3Year 1:capex 110 drawsrevolver 39Year 2:repays 39, thensweeps 3.9Year 3:sweeps 40.3PIK accrues19.5, 22.0, 24.9Total debt 550 at close, 604 after year 1, 560 after year 3
Total debt rises to Rs 604 crore after year 1 as the revolver is drawn and the PIK accrues, then falls to Rs 560 crore by year 3 as the revolver is cleared and the sweep works on the term loan, while the PIK note grows from Rs 150 crore to Rs 216.4 crore whatever the cash does.
Step 4What does the PIK do, and what should the reviewer hear from you?

The PIK noteDebt whose interest is paid in kind: added to the principal rather than paid in cash. The balance compounds and the whole amount falls due at maturity. is the quiet line. It costs no cash, so it never affects the revolver or the sweep, but it compounds at 13%: Rs 150 crore becomes Rs 216.4 crore in three years and will keep growing until it is refinanced. The term loan fell by Rs 56.2 crore over three years and the PIK rose by Rs 66.4 crore, so the company's deleveraging is a little over half of what the term loan line alone suggests. Say three things when you hand the model in: the revolver is drawn only in the capex year and cleared the next; the sweep is applied after the revolver, not before; and the PIK's tax deduction is assumed, which should be confirmed against the current rules on interest deductibility. The limit is the 5% growth and flat Rs 30 crore capex; a second foundry line would redraw the revolver.

Where candidates lose it

The common loss is sweeping cash into the term loan in year 2 before repaying the revolver, or letting the sweep take cash below the minimum balance. The order is amortisation, revolver, then 75% of what remains; a model that breaks it fails the review even if every other number is right.

The second miss is treating the PIK as if it were cash interest, which overstates the year 1 shortfall and the revolver draw by Rs 19.5 crore, or forgetting it entirely, which understates debt at exit by Rs 66 crore.

What the interviewer asks next

  • Year 3 EBITDA falls 15% instead of rising 5%. Does the revolver get drawn again, and does the company breach a 4.5x leverage covenant?
  • Why would a sponsor accept a 13% PIK note rather than more term loan at 9%?
  • The sweep is 50% instead of 75%. How much more cash does the company hold at year 3, and who prefers that?

Asked at Carlyle Group, Credit, New York, 2023 (Wall Street Oasis): an LBO modeling test conducted remotely, 90min, with a revolver, cash sweep, and PIK note

Company names and figures are illustrative.