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  1. 023Two businesses each earn EBITDA of 100 on revenue of 500. A has fixed costs of 50; B has fixed costs of 300. Revenue falls 10% at both. What is each one's EBITDA, and what happens to 4x leverage?Operating levers and margin mathsHardOaktree Capital ManagementLos Angeles · 2024

    Try it first

    After the 10% revenue fall, B's EBITDA is

    Show the worked solution

    A keeps 85 and B keeps 60; leverage goes to 4.7x and 6.7x. A's variable costs are 350, or 70% of revenue, so at 450 they are 315 and EBITDA is 450 less 315 less 50, which is 85. B's variable costs are 100, or 20%, so at 450 they are 90 and EBITDA is 450 less 90 less 300, which is 60. Debt of 400 was 4.0x at both; it is now 4.7x at A and 6.7x at B.

    Why does the same revenue fall hit the two businesses so differently?

    Think of two auto drivers. One rents his vehicle by the day and pays a fixed 300 whatever happens; the other owns his and pays mostly for fuel. On a slow day the owner-driver still goes home with something, while the renter may go home with nothing. Fixed costs do not shrink when revenue shrinks, so the whole of a revenue fall lands on profit after only the variable costs have been saved. At A, 70 of every 100 of lost revenue was variable cost that disappears with it, so profit falls by 30 on 50 of lost revenue. At B only 20 of every 100 was variable, so profit falls by 40 on the same 50.

    The same 10% revenue fall: fixed costs decide how much EBITDA survivesfixed 50variable 350EBITDA 100revenue 500debt 400 = 4.0xbeforefixed 50variable 315EBITDA 85revenue 450debt 400 = 4.7xafterfixed 300variable 100EBITDA 100revenue 500debt 400 = 4.0xbeforefixed 300variable 90EBITDA 60revenue 450debt 400 = 6.7xafterBusiness A: fixed costs 10% of revenueBusiness B: fixed costs 60% of revenueA loses 15% of EBITDA; B loses 40%. Same revenue fall, same debt.
    A 10% revenue fall from 500 to 450 cuts A's EBITDA from 100 to 85 because its fixed costs are only 50, but cuts B's from 100 to 60 because 300 of its costs do not move, so 400 of debt goes from 4.0x to 4.7x at A and 6.7x at B.

    What are the numbers, and what do they do to the lenders?

    A: revenue 450, variable costs 70% of that is 315, fixed 50, EBITDA 85, down 15%. B: revenue 450, variable 20% of that is 90, fixed 300, EBITDA 60, down 40%. Debt of 400 was 4.0x EBITDA at both companies, and after one bad year it is 4.7x at A and 6.7x at B, which is the difference between a conversation with the lender and a covenant breach. The operating leverageThe ratio of the percentage change in profit to the percentage change in revenue. High fixed costs mean high operating leverage. here is 1.5 at A and 4.0 at B: each 1% of revenue lost costs B 4% of EBITDA. Lenders feel it first because their claim is fixed and sits ahead of the equity; the equity feels it hardest because it is what is left.

    The relationship
    EBITDA1=R1(1−v)−FB:450×(1−0.20)−300=6040060=6.7x\text{EBITDA}_1 = R_1(1 - v) - F \qquad B: 450 \times (1 - 0.20) - 300 = 60 \qquad \frac{400}{60} = 6.7x
    R_1revenue after the fall, 450
    vvariable costs as a share of revenue, 0.70 at A and 0.20 at B
    Ffixed costs, 50 at A and 300 at B
    What it says in wordsProfit after the fall is the new revenue less the costs that move with it, less the costs that do not.

    How should a lender and a sponsor use this?

    By sizing the debt to the cost structure, not to the EBITDA alone. Two businesses with identical EBITDA can carry very different debt safely, because the one with high fixed costs needs far less of a downturn to stop covering its interest. B breaks even at revenue of 375, a fall of only 25%, while A breaks even at 167. A lender to B wants lower leverage, a wider cushion in the covenant and a close look at whether any of the 300 can be made variable. The limits: the split of costs into fixed and variable is never clean, fixed costs do move over a long enough horizon, and the same leverage cuts the other way in an upswing, where B's EBITDA would rise 40% on a 10% revenue gain.

    Where candidates lose it

    The common slip is to cut EBITDA by 10% along with revenue, giving 90 at both companies. That treats every cost as variable and misses the whole point of the question.

    The second loss is stopping at 85 and 60. The question says 4x leverage for a reason: convert both numbers into leverage and name which one has become a lender's problem, and say that it is the debt holders who feel operating leverage first because their claim does not shrink.

    What the interviewer asks next

    • What revenue fall would take B to zero EBITDA?
    • Revenue rises 10% instead. What is each EBITDA, and which company would you rather own the equity of?
    • How would you check what share of a target's costs is really fixed during diligence?

    Asked at Oaktree Capital Management, Credit, Los Angeles, 2024 (Wall Street Oasis): How does operating leverage affect debt vs. equity holders

  2. 064Revenue is 1,000 at a 25% EBITDA margin. Depreciation and amortisation are 40, interest is 60, tax is 25%, capex is 50, and working capital is 10% of the revenue growth of 100. Walk from revenue to levered free cash flow.Operating levers and margin mathsCoreVista Equity PartnersAustin · 2025

    Try it first

    What is levered free cash flow?

    Show the worked solution

    Levered free cash flow is 92.5. EBITDA is 250. Take off D&A of 40 and interest of 60 to get pre-tax profit of 150, tax of 37.5 and net income of 112.5. Add back the 40 of D&A because it is not cash, then subtract capex of 50 and the 10 of working capital the growth absorbs. What remains, 92.5, is cash the owners could take out.

    Why does depreciation come off and then go back on?

    Think of a delivery van bought last year. Each year the accounts charge a slice of its cost as depreciation, but no money leaves the business that year: the van was paid for already. Depreciation reduces taxable profit, which saves real tax, but it is not a cash payment, so it is subtracted to work out tax and then added back to reach cash. The cash cost of assets enters through capex instead, here 50, which is more than the 40 of depreciation because the business is growing.

    From EBITDA to levered free cash flow: lenders, taxman, reinvestment250EBITDA-60Interest-37.5Tax-50Capex-10Moreworking capital92.5Levered FCFTax is on profit after D&A:250 - 40 - 60 = 150 taxablex 25% = 37.5; D&A 40 is no cashRevenue 1,000 x 25% margin
    EBITDA of 250 loses 60 to interest, 37.5 to tax, 50 to capex and 10 to working capital, leaving levered free cash flow of 92.5; depreciation of 40 appears only inside the tax calculation.
    StepAmount
    Revenue1,000
    EBITDA at 25%250
    Less D&A(40)
    EBIT210
    Less interest(60)
    Pre-tax profit150
    Less tax at 25%(37.5)
    Net income112.5
    Add back D&A40
    Less capex(50)
    Less increase in working capital(10)
    Levered free cash flow92.5
    Net income of 112.5 plus D&A of 40, less capex of 50 and a working capital increase of 10, gives levered free cash flow of 92.5, the same answer the EBITDA route gives.

    What makes it levered, and why does a buyout investor want that version?

    Levered means after interest: the lenders have been paid. Levered free cash flow is the cash left for the equity holders after the lenders, the taxman and the business's own reinvestment, which is exactly the cash that repays debt in a buyout. Check it a second way from EBITDA: 250 less 60 less 37.5 less 50 less 10 is 92.5. The limit worth saying: working capital is modelled here as 10% of growth, and a real business can swing by far more in a single year.

    Where candidates lose it

    The most common slip is forgetting to add back depreciation, which gives 52.5 and treats the van as paid for twice, once through depreciation and again through capex.

    The second is using the whole working capital balance, 10% of revenue, instead of the increase, 10% of the growth. Only the change in working capital uses cash in the year.

    What the interviewer asks next

    • What is unlevered free cash flow here, and why is it higher?
    • Revenue falls instead of growing. What happens to the working capital line?
    • Capitalised software development of 30 sits inside capex. Should a software buyer treat it differently?

    Asked at Vista Equity Partners, Private Equity, Austin, 2025 (Wall Street Oasis): I got a question about getting from revenue to levered free cash flow