Impact of Leverage on LBO Valuation

Hard Private Equity Valuation Leveraged Buyouts

In the context of leveraged buyouts (LBOs), a private equity firm is considering acquiring a target company, XYZ Corp. The firm anticipates financing the buyout with a combination of debt and equity, projecting a 25% internal rate of return (IRR) over a five-year holding period. During the exit strategy, the firm expects to either sell XYZ Corp. to a strategic buyer or take the company public through an initial public offering (IPO).

Which of the following statements best describes the impact of financing structure on the valuation of XYZ Corp. in an LBO scenario?

Higher leverage increases equity returns but also increases the risk of financial distress.

Lower leverage reduces the equity returns due to lower debt interest payments.

The proportion of equity financing does not impact the overall valuation of the target company.

Hint

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