A model of leveraged buyout shows what all takes place when a company is acquired by a private equity firm by using a combination of equity or cash along with debt which is then sold off within a period of 3-5 years. By taking such a step, the aim of the private equity firm is to earn a return of 20 -25 percent which is far in excess of the “historical average annual return” in case of the stock markets. The leveraged buyouts are more or less same to the normal deals of merger and acquisitions; the only difference is that in a leveraged buyout, the assumption is that the buyer will be selling the target in future. Through this training you shall be learning about Leverage Buy-out deals and concepts and practically creating a LBO model for Siemens AG company.

There exists a similarity between purchasing a house and leveraged buyout as a combination of down payment as well as a mortgage can be made use of. In the case of both these transactions, there is saving of money as a small amount is put down in cash and the remaining is borrowed. In case of the leveraged buyout, the “down payment” is known as the equity or the cash whereas the “mortgage” is known as the debt. The debt is utilized by the private equity firms for boosting its returns. If everything else is equivalent, it means that if the private equity firm makes use of more leverage or debt, the firm is likely to earn a higher rate of return on the investment that has been made by it.

As far as the real LBO model is concerned, the repayment of debt is made by the companies over a period of time which boosts the returns of the private equity firm even more. The numbers show a significant improvement with leverage due to the following reasons:

• What money is worth today is higher than what it will be worth in future- This means that earning higher amount of money 5 years from now will be great, however, it is much better t=if that same amount of money is saved today because of money’s time value.

• Earning a higher amount of return on a money of a smaller amount is much more easy– It is difficult for the portfolio managers with thousands of crores under management to earn rates of return that are high, however for individual investors who have for example made investments of less than one crore, it is much easier to earn returns that are higher. This is the reason why leverage is used by the private equity firms. It goes on to boost their returns in a significant way by bringing reductions in the upfront investment.