Key Rule 2

Question 1

Key rule 2
- how to make basic model assumptions

Answer 1

1. Assume a purchase price and the amount of debt and equity you’ll be using
2. Figure out the debt terms, including interest rates and annual repayment
3. Create a sources & uses schedule that tracks where your funds are coming from and where they’re going to go.

Question 2

How to work out purchase price

Answer 2

Use all standard methodologies, and look at premium if it’s a public company. You focus on equity value as you need to acquire all the outstanding shares of a public company.

Question 3

How to choose amount of debt and equity

Answer 3

This will be based on recent similar deals, as well as what lenders will go for, as if you propose that which is too high, that might be too aggressive and risky for them.

Question 4

Interest rates and annual payments depend on

Answer 4

The type of debt you want to use as well as what’s going on in the market

Question 5

What is the difference between bank debt and high yield debt?

Answer 5

• Bank debt tend to have lower interest rates as well as 10-15% annual principle repayment because it is less risky as it is secured by collateral
• High yield debt by contrast tend to have higher interest rate and no annual payment because it is unsecured so it’s riskier and therefore investors will demand higher returns
• Another difference is bank debt has maintenance covenants, while high yield debt has incurrence covenants

Question 6

What is a sources and uses schedule used for?

Answer 6

It shows where the transaction funding is coming from, and where it’s going to

Question 7

What are some common sources of funding?

Answer 7

Debt
Investor equity - cash from PE firm
Debt assumed

Question 8

What are some common uses of funding?

Answer 8

Equity value of company
Advisory, legal financing, and other fees
Debt assumed
Refinanced debt

Question 9

Do you pay the equity value or enterprise value to acquire a company in a leveraged buyout?

Answer 9

Neither one, at least it’s not exactly either one. It depends on what you do with a company’s existing debt
- Assume existing debt: the effective purchase price will be closer to the companies equity value
- Replay existing debt: the effective purchase price will be closer to the companies enterprise value