Chapter 14 - Highly leveraged transactions: leveraged buyout valuation and modeling basics

Abstract

This chapter addresses the basics of valuing and modeling highly leveraged transactions, including a discussion of how investors evaluate leveraged buyout (LBO) investment opportunities and typical formats used in building LBO financial models. Such models serve to determine the maximum amount of leverage that can be supported by the target firm consistent with the investor’s desired financial returns. The cost of capital and adjusted present value methods are described in detail along with the strengths and weaknesses of each approach. In an LBO, borrowed funds, often secured by assets of the target firm, are used to pay for most of the purchase price, with the remainder provided by a financial sponsor, such as a private equity investor group or hedge fund. LBOs can be of an entire company or divisions of a company. LBO targets can be private or public firms. As in prior chapters, the terms buyout firm and financial sponsor are used interchangeably throughout this chapter to include the variety of investor groups that commonly engage in LBO transactions.