Posted:

What is Leveraged Buyout and its Example

Purchase of another company or its assets using a huge amount of borrowed money, bonds, shares, and loans to meet the charge of possession in Leveraged buyout. Typically, the properties of company being purchased are used as collateral for the loans in addition to the assets. A single asset is purchased by combination of equity or borrowed money in leveraged buyouts. A leveraged buyout model shows what actually takes place when private equity firms acquire a company using the combination. Stock in company with huge amount of debt is leverage equity.  

What is Leveraged Buyout and its Example

This concept is very similar to buying a car with the use of down payment and a mortgage. In both of the transactions, money is saved by putting tiny amount in cash and borrowing the remaining.   

Leveraged buyout can be explained with the use of an example.

Buying a company for $50 with 100% cash and selling it later for $100 and another condition of buying same company for $50 but only using 50% cash and sell it later for $100

For the first case:

Value of company= $50

Sale value= $100

 

Cash used= 100% ($50)

Debt used= -

Now,

 

Purchase value= $50

Sale value= $100

 

Return multiple = Sale value/Purchase value = $100/$50 = 2 times

Internal Rate Of Returns (IRR) = 15%

 

 

For the second case,

Value of company= $50

Sale value= $100

 

Cash used= 50% ($25)

Debt used= 50% ($25)

Total use= $50

Now,

 

Purchase value= $25

Sale value= $75

 

Return multiple = Sale value/Purchase value = $75/$25 = 3 times

Internal Rate Of Returns (IRR) = 25%

{Note: It is shown as $75 because the $25 (while buying) in debt must be repaid}

 

A huge difference can be seen in the example above; return multiple increases from 2 times to 3 times, and the IRR leap from 15% to 25%. This analysis presumes that the $25 of debt we use in the beginning to purchase the company stays constant and nothing is repaid.

Add a new Comment