Leverage choice: the same business at 10x, financed with 3x or 6x debt at 10%. Work the base case IRR for each, then a downside where EBITDA falls 25% in year 2. Which structure do you choose?

Base case: 14% at 3x and 17% at 6x. Downside: 3% at 3x and -3% at 6x, a loss. Choose 3x. At a 10x price and 10% interest the business earns barely more than the debt costs, so extra leverage adds about 3 points in the plan and takes away about 6 in the downside, and at 6x cash does not cover interest even in the base year 1. Leverage raises the average and the chance of losing money together; here the first is small and the second is large.

Because leverage only adds what the asset earns above the cost of the debt. Think of borrowing at 10% to buy a shop earning 10% on its price: you gain only if the shop grows, and you lose on every rupee if it does not. At 10x the EBITDA yield is 10%, the same as the interest rate, so the spread leverage works on is the 8% growth and nothing else; doubling debt lifts the base IRR from 14.3% to 17.2%. At 6x the Rs 72 crore of year 1 interest exceeds Rs 64.8 crore of cash, so the revolver grows in year 1 even on plan.

The same hit to EBITDA, a very different hit to equity. Exit value falls to Rs 1,224 crore in both; at 3x that still covers Rs 233 crore of debt and returns 1.18x, while at 6x debt has compounded to Rs 813 crore and the sponsor gets back 0.86x. That is the equity cushionThe share of the purchase price funded by equity. The thicker it is, the further value can fall before lenders are at risk and the sponsor is wiped out. at work: at 3x equity is 70% of the price and absorbs a 25% fall; at 6x it is 40% and the interest keeps eating while EBITDA is down.

Put a probability on the downside and compare expected outcomes, then look at the worst case on its own. With a 70% chance of the plan, the expected IRR is about 11% at 3x and 11% at 6x, and the 6x structure also carries a revolver that grows in year 1 even on plan, which is a covenant conversation waiting to happen. A structure that cannot pay its interest from cash in a good year is not a structure; it is a bet that the exit multiple holds. The 3x structure earns less on paper and keeps the fund in control of the company in every case shown.

When the spread is wide and the cash is steady. At 7x entry the EBITDA yield is over 14%, the gap to a 10% coupon is wide, and the same 6x of debt would add far more to the base case; and a business with contracted revenue, not a lab that can lose accreditation, can carry interest close to its cash. So the answer the interviewer wants is conditional: leverage is a tool whose value depends on the entry yield against the cost of debt and on how much the cash can fall. Here both conditions argue for less. The limitation: the downside case is one path, and a real model would test a slower recovery and a lower exit multiple, both of which hurt 6x more.