Series 79 practice questionmediumLBOs and MBOs
In an LBO model, why is debt paydown capacity so important?
- AThe seller receives only stock
- BThe buyer is always the incumbent CEO
- CA significant portion of the purchase price is financed with debt that is expected to be serviced by the target’s cash flows✓ Correct answer
- DThe target must be in bankruptcy
Explanation
Why C — A significant portion of the purchase price is financed with debt that is expected to be serviced by the target’s cash flows
A significant portion of the purchase price is financed with debt that is expected to be serviced by the target’s cash flows LBOs use debt to amplify equity returns, with lenders looking to the target’s cash generation for repayment. That financing structure makes leverage capacity a central underwriting question.
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