Private Equity puzzles, solved step by step

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  1. 012A company's enterprise value is 800. It has 500 of senior debt, 400 of subordinated notes and equity beneath both. In a restructuring, what does each class recover? What changes if enterprise value is 1,000 instead?Leverage and capital structureWarm upKKRNew York · 2025

    Try it first

    At an enterprise value of 800, what do the subordinated notes recover?

    Show the worked solution

    At 800, senior recovers 100%, the notes 75% and equity nothing. Value is paid strictly by priority. Senior takes its 500 first, leaving 300 for the 400 of notes, which is 75%. At 1,000, value covers all 900 of debt, so both classes recover in full and equity is left with 100. The 200 increase in value goes 100 to the notes and 100 to equity.

    In what order does the value get paid out?

    Think of a row of buckets under one tap, each bucket overflowing into the next. The first fills completely before a drop reaches the second. A capital structure works the same way: each class is paid in full before the class below it receives anything. With 800 of value, the senior bucket takes 500 and is full. The remaining 300 flows into the notes bucket, which holds 400, so it is 75% full. Nothing reaches equity.

    Value fills claims in order of priority; the line cuts one trancheEV of 800Senior 500Sub notes 400EquityEV 800EV of 1,000Senior 500Sub notes 400EquityEV 1,000RecoverySenior 500 (100%)Sub 300 (75%)Equity 0Each extra 1 ofEV goes to thenotes until 900Senior 100%, sub 100%, equity 100the notes are the tranche the line cuts
    At an enterprise value of 800 the senior debt of 500 is paid in full, the subordinated notes get the remaining 300 of their 400, a 75% recovery, and equity gets nothing; at 1,000 both debt classes are whole and equity keeps 100.

    Which security does the interviewer care about most?

    The one the value line cuts through. That tranche is the fulcrum securityThe most senior class of claims that is not repaid in full, and so typically ends up owning the restructured company., here the subordinated notes at an EV of 800. Every change in enterprise value between 500 and 900 lands entirely on the notes, so they are the class whose price moves with the valuation argument while senior sits at par and equity sits at zero. In a restructuring the fulcrum holders usually swap their claim for the new equity, which is why distressed investors spend their time on it.

    What changes if enterprise value is 1,000?

    The line clears the debt. Senior is still paid 500, the notes are now paid their full 400, and the 100 left over belongs to equity. The 200 of extra value is split 100 to the notes and 100 to equity, and none of it reaches senior, which was already whole. That asymmetry is the lesson: a senior lender's upside is capped at par, while the junior classes capture the swing. Say the limitations too: real cases add administrative claims ahead of senior debt, and negotiated outcomes sometimes give junior classes a little value to secure their agreement.

    Where candidates lose it

    The usual slip is sharing value pro rata, giving every creditor 800 over 900, about 89%. That ignores priority, which is the whole point of having senior and subordinated claims.

    The second miss is stopping at the recoveries. The follow-up about 1,000 is there to see whether you notice which tranche absorbs the change in value.

    What the interviewer asks next

    • At what enterprise value does equity start to recover anything?
    • If the senior debt were secured on assets worth only 400, how would the answer change?
    • Why might a distressed fund buy the notes at 60 when they recover 75?

    Asked at KKR, Distressed Debt, New York, 2025 (Wall Street Oasis): What are your weaknesses? A capital structure question with enterprise value.

  2. 020A sponsor buys a company at 10x EBITDA of 100, funded with 60% debt. EBITDA stays flat for five years and the exit is also at 10x. What is the MOIC if no debt is repaid, and what is it if 300 of debt is repaid over the five years?Leverage and capital structureWarm upMid-market buyout fund

    Try it first

    With 300 of debt repaid and nothing else changing, the MOIC is:

    Show the worked solution

    1.0x with no paydown and 1.75x with 300 repaid. The purchase price is 1,000, with 600 of debt and 400 of equity. With flat EBITDA and the same multiple, the exit value is again 1,000. If debt is still 600, equity is still 400: 1.0x. If 300 has been repaid, debt is 300 and equity is 700, which is 1.75x, an IRR of about 12% over five years.

    Where does the return come from if nothing grows?

    Think of buying a flat for 1 crore with a 60 lakh home loan, then renting it out and using the rent to pay down 30 lakh of the loan over five years. If the flat is still worth 1 crore, your share has gone from 40 lakh to 70 lakh, though the flat itself is unchanged. Debt paydown moves value from the lenders to the owner: the business is worth the same, but a larger slice of it belongs to the sponsor. The company's own cash flow is doing the repaying, so the sponsor's cheque never changes.

    Same 1,000 of value at entry and exit: paydown moves it to the sponsordebt 600equity 400Entrydebt 600equity 400: 1.0xExit, no paydowndebt 300Exit, 300 repaidEV 1,000 = 10x 100EV 1,000, flatEV 1,000, flatequity 700: 1.75x+300 from lendersFive years at 1.75x is an IRR of 11.8%, with no growth and no multiple expansion.
    The business is worth 1,000 at entry and at exit, but repaying 300 of debt cuts the lenders' claim from 600 to 300 and lifts the sponsor's equity from 400 to 700, a 1.75x multiple and a 11.8% IRR with no growth at all.

    What are the numbers, step by step?

    Entry: 10 x 100 is 1,000. Sixty per cent debt is 600, so equity is 400. Exit with nothing repaid: 1,000 less 600 is 400 of equity, 1.0x, a zero return over five years. Exit with 300 repaid: 1,000 less 300 is 700 of equity, and 700 over 400 is 1.75x. Over five years, 1.75x is about 11.8% a year: 1.12 to the fifth is 1.76, so a shade under 12%.

    The relationship
    MOIC=EVexit−DexitEentry=1000−300400=1.75x\text{MOIC} = \frac{EV_{\text{exit}} - D_{\text{exit}}}{E_{\text{entry}}} = \frac{1000 - 300}{400} = 1.75x
    EV_exitexit enterprise value, 10x EBITDA of 100
    D_exitdebt left at exit, 600 less 300 repaid
    E_entrythe sponsor's equity cheque, 400
    What it says in wordsThe sponsor's multiple is exit equity, enterprise value less remaining debt, over the equity it put in.

    Is 300 of paydown realistic, and what is left out?

    It means 60 a year of free cash flow after interest and tax on a business with EBITDA of 100, which is possible for a capital-light company and unlikely for a capital-hungry one. Paydown is the most reliable of the three return levers, alongside EBITDA growth and multiple change, because it depends on cash the business already generates rather than on the future. Say what the simple version ignores: transaction fees at entry and exit, any cash left on the balance sheet, and the risk that interest rates or a downturn absorb the cash meant for repayment.

    Where candidates lose it

    The common error is saying flat EBITDA and a flat multiple mean no return. That ignores the capital structure, which is exactly what the interviewer is testing.

    The second slip is computing the return on enterprise value, 1,000 to 1,000, rather than on equity. The sponsor owns the equity; say 400 in and 700 out.

    What the interviewer asks next

    • What exit multiple would give 2.0x with the same paydown?
    • If EBITDA grows to 120 as well, what is the MOIC?
    • Why do lenders accept higher leverage for businesses with stable cash flow?