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Q1-What is the process by which goodwill is generated?
A. The amount of money paid for each share of a company's stock.
B. Synergies generated as a result of a merger and acquisition transaction
C. The excess of the purchase price paid for a target over the target's net identifiable assets
Correct Answer is C
Explanation: In the acquisition of a target, goodwill is created by paying more than the target's net identifiable assets is worth. In order to avoid being written off, the goodwill created must remain on the balance sheet (unamortized) for the duration of the investment, but it must be evaluated for impairment on an annual basis.
Q2-What is the significance of capital expenditure projections in an LBO analysis?
A. Assists prospective buyers in determining their investment time horizon.
B. Capital expenditures represent a use of cash that reduces free cash flow.
C. Buyers prefer companies that have a high level of maintenance capital expenditure.
Correct Answer is B
Explanation: Typically, capital expenditures (capex) are the most important line item under investing activities. The target's projected net PP&E must take into account both capital expenditure projections (which are added to PP&E) and depreciation projections (subtracted from PP&E.) Taking the sum of annual cash flows generated by operating activities and investing activities, we can calculate annual cash flow available for debt repayment, which is referred to as free cash flow in the financial industry.
Q3-What is the typical process for developing capital expenditure projections?
A. This information was obtained from the CIM.
B. Analysis of comparable companies
C. In-depth inventory inspection
Correct answer is A
Explanation: The CIM is typically used to generate projected capital expenditure assumptions. For situations where capital expenditure projections are not provided or not available, the banker typically projects capital expenditure as fixed percentage of sales at historical levels, with appropriate adjustments for cyclical or non-recurring items.
Q4-Deferred financing fees are charged on an annual basis.
A. This is only found in LBO transactions.
B. Excluded from consideration in the post-LBO model
C. Expenses other than cash
Correct answer is C
Explanation: The amortization of deferred financing fees is a non-cash expense that is reclassified as a non-cash expense in the cash flow statement prepared after the LBO.
Q5- What exactly is a cash flow sweep in the context of an LBO?
A. Following the completion of mandatory debt repayments, all cash generated by the target is applied to the optional repayment of outstanding prepayable debt.
B. Following the payment of mandatory debt repayments, the target uses all of the cash generated to pay dividends.
C. Three financial statements that are linked together
Correct Answer is A
Explanation: A typical LBO model makes use of a "100 percent cash flow sweep," which assumes that all cash generated by the target after making mandatory debt repayments is applied to the optional repayment of outstanding prepayable debt after the target has made mandatory debt repayments (typically bank debt). The following order is generally followed for modelling purposes when it comes to bank debt repayment: revolver balance, term loan A, term loan B, and so on.
Q6- What is the most common assumption made in LBO analysis when it comes to the exit multiple, and why?
A. Make the number equal to, or lower than, the entry multiple.
B. Increase the entry multiple by a factor greater than one.
C. Set the bar higher than the nearest competitor.
Correct Answer is A
Explanation: For conservatism, the exit multiple is typically set to be equal to, or lower than, the entry multiple.
Q7-What is the typical variation in IRR based on the year of exit?
A. Maintains its value throughout the investment horizon
B. Decreases as a result of slowing growth rates as well as the time value of money
C. Continues to grow indefinitely
Correct Answer is B
Explanation: The internal rate of return (IRR) typically decreases in tandem with declining growth rates and the time value of money.
Q8- What is the treatment of a PIK in an LBO?
A. Is treated as a cash interest expense.
B. Considered cash interest expense, but not included in the average interest expense convention if that methodology is used.
C. Added back to cash flow from operating activities on the cash flow statement as a non-cash interest expense.
Correct Answer is C
Explanation: During periods of strong credit markets, companies have been able to issue bonds with atypical "issuer-friendly" provisions, such as a payment-in-kind (PIK) toggle, without incurring significant financial penalties. The PIK toggle allows an issuer to choose whether to pay interest "in-kind" (i.e., in the form of additional notes) or in cash, depending on the circumstances. PIK instruments are included in the total interest expense on the cash flow statement, and the non-cash interest portion is added back to cash flow from operating activities on the cash flow statement.
Q9-Which of the following typically has the least likely impact on IRR?
A. Interest rates
B. Purchase price
C. Projected financial performance
Correct Answer is A
Explanation: The projected financial performance of the target, the purchase price, and the financing structure (particularly the size of the equity contribution), as well as the exit multiple and year, are the primary IRR drivers. An expected goal of an investor is to minimise the price paid and equity contribution while gaining an increased level of confidence in the target's future financial performance and ability to exit at a reasonable valuation.
Q10-As part of the deal, how do transaction fees get paid?
A. Amortized like financing fees
B. Expensed as incurred
C. Paid in stock
Correct Answer Is B
Explanation: Typical other fees and expenses include payments for services such as M&A advisory, legal, accounting, and consulting, as well as payments for other miscellaneous deal-related expenses. With respect to the sources and uses of LBO funds, this amount is deducted from the equity contribution at the time of closing.
Q11-In an LBO model, how does the senior notes balance change over the course of a projected period of time?
A. Decreases
C. Increases
C. Stays constant
Correct Answer Is C
Explanation: High yield bonds, in contrast to traditional bank debt, are not redeemable prior to maturity without incurring a penalty, nor do they have a mandatory repayment schedule prior to the bullet payment at maturity. Consequently, LBO models do not assume repayment of high yield bonds prior to maturity, and the beginning and ending balances for each year during the projection period are equal.
Q12-Which of the following are the two main marketing documents for an auction's first round?
A. Teaser & confidentiality agreement
B. Teaser & confidential information memorandum
C. Teaser & bid procedures letter
Correct Answer is B
Explanation: The teaser and the corporate identity manual (CIM) are the two most important marketing documents for the first round. It is the first marketing document that prospective buyers see, and it is a brief 1-2 page synopsis of what the target is looking for.
Q13-When does the marketing process for financing a transaction typically begin for an acquirer who requires access to the capital markets in order to complete the transaction?
A. Before the first round
B. Before the end of the second round
C. After signing of the definitive agreement
Correct Answer Is C
Explanation: Following the signing of the definitive agreement, the acquirer begins the marketing process for the financing in order to be prepared to fund as soon as all of the conditions to closing are satisfied.
Q14-What is the most important legal document that establishes a formal agreement between a buyer and a seller to purchase the object of their affection?
A. Confidentiality agreement
B. Indenture
C. Definitive purchase/sale agreement
Correct Answer Is C
Explanation: The definitive agreement is a legally binding contract between a buyer and a seller that details the terms and conditions of the purchase and sale transaction between the two parties. Despite the fact that the content of definitive agreements involving public and private companies differs, their basic format is the same, and it includes an overview of the transaction structure and deal mechanics, representations and warranties, pre-closing commitments (including covenants), closing conditions, termination provisions, and indemnities (if applicable), as well as associated disclosure schedules and exhibits.
Q15- When the pro forma earnings per share of two combined companies exceeds the earnings per share of the acquirer on a standalone basis, the transaction is said to be profitable.
A. Accretive
B. Dilutive
C. Consensus
Correct Answer is A
Explanation: The accretion/(dilution) analysis is used by public strategic buyers to determine the pro forma effects of a transaction on earnings, assuming a specific purchase price and financing structure are followed. The pro forma earnings per share (EPS) of the acquirer for the transaction is compared to its standalone earnings per share. It is said to be accretive if the pro forma earnings per share (EPS) is higher than the standalone earnings per share; conversely, it is said to be dilutive if the pro forma earnings per share is lower than the standalone earnings per share.