Impact of Debt Financing on LBO Valuation

Hard Private Equity Valuation Leveraged Buyouts

In a Leveraged Buyout (LBO), the acquiring firm often relies on significant debt financing, and the valuation of the target company plays a critical role in determining the success of the deal. Campbell Capital is evaluating a potential LBO of Verde Technologies, which has an established revenue stream and a stable cash flow. The proposed acquisition would involve a debt-to-equity ratio of 70:30 and aim for an exit multiple of 8x EBITDA after a holding period of 5 years.

To finance this transaction, Campbell Capital needs to estimate Verde's enterprise value (EV) at the time of exit accurately. Which of the following statements is most likely true regarding the impact of debt financing on the valuation in the context of this LBO?

Higher levels of debt increase the expected return on equity, but the overall enterprise value of Verde Technologies remains unchanged during the holding period.

Higher levels of debt could potentially increase the enterprise value of Verde Technologies at exit by allowing for increased operational improvements funded by the debt.

The debt assumption in the LBO will inevitably decrease the equity value, not affecting the overall enterprise value due to the financing structure.

Hint

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