CFM CFM M&A Modeling & Deal Structuring 2 — Questions and Answers
Question 1: In an LBO model, which metric do private equity sponsors primarily use to measure investment returns?
- Return on Assets (ROA)
- Internal Rate of Return (IRR) and Money-on-Money (MoM) multiple (Correct answer)
- Net Present Value (NPV) of equity cash flows
- Dividend yield at exit
Correct answer: Internal Rate of Return (IRR) and Money-on-Money (MoM) multiple
PE sponsors evaluate LBO returns using IRR (time-weighted return) and MoM (total return multiple), targeting IRRs of 20%+ over a 3–7 year hold period.
Question 2: What is the purpose of a 'sources and uses' table in an LBO or M&A model?
- To reconcile the income statement with the balance sheet
- To show how the deal is financed (sources) and how the funds are applied (uses) (Correct answer)
- To track the amortization schedule of acquisition-related debt
- To project post-deal synergies over a five-year period
Correct answer: To show how the deal is financed (sources) and how the funds are applied (uses)
The sources and uses table ensures that total financing raised exactly equals total transaction costs, confirming the deal is fully funded.
Question 3: In M&A deal structuring, what is a 'collar' agreement?
- A cap on management retention bonuses post-close
- A mechanism that adjusts the exchange ratio if the acquirer's stock price moves outside a set range (Correct answer)
- A regulatory approval condition imposed by the DOJ
- A floor on the minimum cash consideration paid to target shareholders
Correct answer: A mechanism that adjusts the exchange ratio if the acquirer's stock price moves outside a set range
A collar protects target shareholders in stock deals by adjusting the exchange ratio to keep deal value within a defined range if the acquirer's stock fluctuates.
Question 4: When modeling an LBO, 'debt paydown' improves equity returns primarily by:
- Increasing the EBITDA of the combined company
- Reducing net debt at exit, which increases equity value for the same EV (Correct answer)
- Lowering the entry multiple paid by the sponsor
- Extending the hold period to allow more operational improvements
Correct answer: Reducing net debt at exit, which increases equity value for the same EV
As the LBO company pays down debt over the hold period, a greater share of enterprise value at exit flows to equity holders, boosting IRR and MoM.
Question 5: What distinguishes a 'merger of equals' from a typical acquisition?
- No premium is paid to either party's shareholders
- Both companies combine at roughly equal valuations with shared governance and no control premium (Correct answer)
- The deal must be financed entirely with debt
- Synergies are excluded from deal modeling
Correct answer: Both companies combine at roughly equal valuations with shared governance and no control premium
In a merger of equals, both companies have similar size and negotiate a combination where leadership, board seats, and ownership are shared rather than one party paying a premium for control.
Question 6: In M&A modeling, how is goodwill calculated?
- Revenue of the target minus its total liabilities
- Purchase equity value minus the fair value of net identifiable assets acquired (Correct answer)
- Total enterprise value minus total debt at acquisition date
- EBITDA × entry multiple minus book equity
Correct answer: Purchase equity value minus the fair value of net identifiable assets acquired
Goodwill equals the equity purchase price less the fair value of identifiable net assets (assets minus liabilities) obtained in the acquisition.
CFM CFM M&A Modeling & Deal Structuring 2
In an LBO model, which metric do private equity sponsors primarily use to measure investment returns?