LBO · WORKED EXAMPLE
LBO returns: separate debt paydown from multiple expansion
A clean five-year example of equity value, MOIC and IRR.
The original scenario
A sponsor buys a business with $40 million EBITDA at 8× enterprise value. Entry debt is $200 million; ignore fees and excess cash. Five years later EBITDA is $50 million, the exit multiple is still 8× and debt is $140 million. There are no interim distributions.
Calculate the equity investment
Entry enterprise value is $40 million × 8 = $320 million. Initial equity is $320 million − $200 million = $120 million.
Calculate exit proceeds
Exit enterprise value is $50 million × 8 = $400 million. Exit equity proceeds are $400 million − $140 million = $260 million. Equity value increases by $140 million: $80 million from operating growth at a constant multiple and $60 million from debt reduction.
Calculate the return
MOIC is $260 million ÷ $120 million = 2.17×. With a single investment and exit five years apart, IRR is (260 ÷ 120)^(1/5) − 1 = approximately 16.72%. Interim distributions would require a cash-flow-based IRR calculation.
Test the downside
At a 7× exit multiple, enterprise value is $350 million and equity is $210 million. MOIC falls to 1.75× and five-year IRR to approximately 11.84%. A one-turn change removes $50 million of exit equity value.
Explain what the model has not proved
The example assumes debt really falls to $140 million. A full model must show that cash generation supports debt service and repayment after taxes, capex and working capital. More leverage can magnify losses as well as gains.
Written by Accretive Thinking. Fictional companies and illustrative assumptions. Educational material, not investment advice. Expert editorial review pending.