Paper LBO: How to Ace the IB / PE Interview Question (Step-by-Step)

The paper LBO is a staple of private equity interviews and increasingly appears in IB interviews too. You're given a set of assumptions and asked to estimate returns in your head or on paper, without a spreadsheet. It tests whether you understand LBO mechanics and can think numerically under pressure.

The good news: once you've practised the structure a few times, it becomes mechanical. Here's the step-by-step approach.

The Typical Setup

You'll be given something like: 'A PE firm acquires a company for 8x EBITDA. EBITDA is £100m. The deal is funded with 5x leverage. EBITDA grows 5% per year. The company generates £50m of free cash flow annually for debt repayment. The PE firm exits after 5 years at 8x EBITDA. What's the return?'

Let's work through this.

Step 1: Calculate Purchase Price

Purchase Price = EBITDA × Multiple = £100m × 8x = £800m

Step 2: Determine Debt and Equity

Debt = 5x EBITDA = £500m

Equity = £800m - £500m = £300m

Step 3: Project EBITDA at Exit

EBITDA Y5 = £100m × (1.05)^5 = £127.6m

Quick mental math: 5% for 5 years ≈ 28% cumulative growth. £100m × 1.28 = £128m (close enough for a paper LBO).

Step 4: Calculate Debt Paydown

Debt Repayment = £50m × 5 = £250m

total debt repaid.

Remaining Debt = £500m - £250m = £250m

Step 5: Calculate Exit Value

Exit EV = £128m × 8x = £1,024m

Step 6: Calculate Equity Value at Exit

Exit Equity = £1,024m - £250m = £774m

Step 7: Calculate Returns

MOIC = £774m / £300m = 2.6x

IRR: 2.6x over 5 years. Using the rule of thumb: 2x in 5 years ≈ 15%, 3x in 5 years ≈ 25%. 2.6x sits around 21%. That's a solid PE return.

Where Did the Returns Come From?

This is the follow-up interviewers love:

EBITDA growth: EBITDA went from £100m to £128m. At an 8x multiple, that's £224m of value creation (£28m × 8x). This increases both EV and equity.

Multiple expansion: Zero in this example (entry and exit both at 8x). If the exit multiple were 9x instead, the exit EV would be £1,152m, pushing MOIC to 3.0x.

Debt paydown: £250m of debt was repaid. This amount flows directly to equity value, even though the company's overall value didn't change because of it. This is the leverage effect.

Mental Math Tips for Paper LBOs

Compounding shortcuts: 5% for 5 years ≈ 28%. 10% for 5 years ≈ 61%. 5% for 3 years ≈ 16%.

IRR approximations: 2x in 3 years = ~26%. 2x in 5 years = ~15%. 3x in 5 years = ~25%. 2.5x in 5 years = ~20%.

Round aggressively: Paper LBOs reward speed over precision. £127.6m becomes £128m. Interviewers care about your process, not decimal places.

Common Variations

What if the exit multiple compresses? Lower exit multiple = lower EV = lower returns. This is the biggest risk in an LBO. A 1x multiple compression on £128m EBITDA is £128m of value destroyed.

What if there's no EBITDA growth? Flat EBITDA means returns come entirely from debt paydown (and multiple expansion, if any). Returns will be lower.

What if FCF changes over time? In reality, FCF grows as EBITDA grows and interest expense falls (from debt paydown). For paper LBOs, using a constant FCF is usually acceptable unless told otherwise.