How to Solve a Paper LBO (Private Equity Interview Guide)

A paper LBO is a leveraged buyout model solved on paper in five to ten minutes, with no Excel and no calculator. It is the single most common technical test in private equity interviews. This guide walks the exact structure interviewers expect - sources and uses, a five-year operating build, a debt schedule, and the exit returns - using one fully worked $1.0bn deal, plus the mental-math shortcuts that get you to an IRR in under a minute.

The paper LBO exists because it strips away the spreadsheet. Anyone can plug numbers into a template; the paper LBO tests whether you actually understand where returns come from in a buyout. An interviewer will read out six or seven assumptions, hand you a sheet of paper, and expect a clean IRR and MOIC at the end. The arithmetic is deliberately easy. The structure is what they are grading.

Most candidates fail for one of three reasons: they lose the thread between EBITDA and free cash flow, they forget that interest falls as debt is repaid, or they get to an exit equity value and cannot convert it to an IRR without a calculator. All three are fixable with a repeatable process.

The paper LBO in eight steps. Every interview version of this test follows the same path.

The Prompt You Will Actually Get

A typical paper LBO prompt sounds like this:

A sponsor acquires a business with $500M of revenue and a 20% EBITDA margin for 10.0x LTM EBITDA. The deal is funded with 6.0x EBITDA of debt at an 8% blended rate, plus sponsor equity. Transaction fees are 2% of enterprise value. Revenue grows $50M per year and margins hold flat. D&A and CapEx are each $25M per year. Working capital consumes $5M of cash per year. The tax rate is 25%. All free cash flow sweeps to debt. The sponsor exits in year 5 at the entry multiple. What is the IRR and MOIC?

Seven assumptions, one question. Write them down in a column on the left of your page before you calculate anything - you will need to reference them repeatedly, and re-asking the interviewer for an input you already heard costs you.

Step 1: Entry Valuation and Sources & Uses

Start with entry enterprise value. Everything else keys off it.

Entry EBITDA = $500M revenue x 20% margin = $100M
Purchase Enterprise Value = $100M x 10.0x = $1,000M

Now build sources and uses. Uses are everything the sponsor has to pay for; sources are where the money comes from. They must tie exactly - this is the first thing an interviewer checks.

Sponsor equity is the plug: total uses less the debt raised. That $420M is the number your MOIC divides into at the end, so circle it.

The fee trap. Fees are a use of cash but they buy no enterprise value. The sponsor writes a $420M cheque, yet only $400M of equity value sits inside the $1,000M enterprise value ($1,000M EV less $600M debt). That $20M gap is a permanent drag on returns, and forgetting it is the most common sources-and-uses error in interviews.

Step 2: The Five-Year Operating Build

Revenue grows $50M per year off a $500M base, with the EBITDA margin flat at 20%. Deliberately clean numbers - paper LBO prompts almost always are.

EBITDA grows from $100M to $150M - a 50% increase over five years. Hold on to that number; it drives most of the value creation.

Step 3: The Debt Schedule and Free Cash Flow

This is where candidates break down. The loop is circular in spirit but sequential in practice: interest is charged on the opening debt balance, free cash flow pays down debt, and next year's opening balance is lower. Do it one year at a time and it stays manageable.

Free cash flow available for debt paydown is:

FCF = EBIT - Interest - Tax + D&A - CapEx - Increase in Working Capital

Because D&A and CapEx are both $25M here, they cancel - a simplification interviewers use constantly to save you arithmetic. So FCF collapses to net income less the $5M working capital build.

Year 1, worked line by line:

Opening debt                          600.0
Interest at 8% of opening balance      48.0
EBIT                                   85.0
Less interest                         (48.0)
Pre-tax income                         37.0
Tax at 25%                             (9.2)
Net income                             27.8
Plus D&A                                25.0
Less CapEx                            (25.0)
Less working capital build             (5.0)
Free cash flow                          22.8
Closing debt = 600.0 - 22.8           577.3

Repeat for five years. Note how interest falls every year as the sweep chews through the debt:

Total debt repaid over the hold: $600.0M − $392.1M = $207.9M, which ties exactly to the sum of the five free cash flow lines (22.8 + 31.6 + 41.0 + 51.0 + 61.5 = 207.9). If those two numbers do not tie, you have made an arithmetic error - say so and fix it rather than plough on.

In Excel the same schedule is four formulas:

// Interest on opening balance (row 10 = opening debt)
= B10 * $B$4

// Free cash flow
= B_EBIT - B_Interest - B_Tax + B_DA - B_CapEx - B_WC

// Cash sweep, floored so debt never goes negative
= MIN(B_FCF, B10)

// Closing debt
= B10 - B_Sweep

Step 4: Exit and Returns

The sponsor exits at the end of year 5 at the entry multiple - no multiple expansion, which is the honest base case and what interviewers usually specify.

Exit Enterprise Value = $150M EBITDA x 10.0x = $1,500M
Less: net debt at exit                          ($392.1M)
Equity proceeds to sponsor                     $1,107.9M

Against a $420M cheque:

MOIC = $1,107.9M / $420M = 2.64x
IRR  = 2.64^(1/5) - 1 = 21.4%

A 2.6x MOIC and a 21.4% IRR over five years. That is a real answer to give: solid, but just short of the 25% IRR most funds underwrite to - and saying that out loud is exactly the kind of commercial judgement the interviewer is listening for.

Converting MOIC to IRR Without a Calculator

You will not be handed a calculator, so memorise the MOIC-to-IRR grid. These are the only combinations that come up:

Our 2.64x over five years sits between the 2.5x (20.1%) and 3.0x (24.6%) rows, closer to the bottom - interpolating gives roughly 21%, against the exact 21.4%. Close enough to state confidently in the room.

Two shortcuts worth knowing:

• The 2x-in-5-years anchor. Doubling your money in five years is ~15% IRR. Doubling in three is ~26%. Tripling in five is ~25%. Anchor off those three and interpolate.
• The Rule of 72 in reverse. If money doubles in n years, IRR is approximately 72/n. Doubling in five years gives 72/5 = 14.4%, against the true 14.9%.

If you are checking your work afterwards in Excel, any of these give the same answer:

// Direct from MOIC
= (1107.9 / 420) ^ (1/5) - 1        // 21.4%

// From a cash flow series
= IRR({-420, 0, 0, 0, 0, 1107.9})   // 21.4%

// Using RATE
= RATE(5, 0, -420, 1107.9)          // 21.4%

Where the Returns Actually Came From

The best candidates do not stop at the IRR. They decompose it. There are only three sources of equity value creation in an LBO, and an interviewer will often ask which one dominated.

Roughly 71% of the $707.9M of enterprise-level equity creation came from growing EBITDA, and 29% from deleveraging. Zero came from multiple expansion, because we assumed none. That is the sentence to say out loud: "Returns here are driven by operational growth and deleveraging, not by paying a lower multiple than we exit at."

Sensitivity: The Two Follow-Up Questions

Once you produce a number, expect the interviewer to move one variable. Both follow-ups are predictable.

"What if you exit at a different multiple?"

Exit EBITDA is $150M and exit debt is $392.1M in every case; only the enterprise value changes.

Each full turn of exit multiple moves the IRR by roughly 3 percentage points. Two turns of multiple compression - 10.0x down to 8.0x - cuts the IRR from 21.4% to 14.0% and takes the deal below almost any fund's hurdle. This is why sponsors underwrite to a flat or lower exit multiple: assuming expansion is assuming the market does your job for you.

"What if you lever it differently?"

Changing leverage changes both the equity cheque and the interest burden, so the whole schedule has to be rebuilt. The results:

More leverage, higher IRR - that is the whole point of a leveraged buyout, and it holds as long as the business comfortably services the debt. But add the coverage check: at 7.0x, year 1 interest is $56M against $110M of EBITDA, or 1.96x interest coverage. Most credit agreements would not tolerate that, and one bad year breaks the covenant. Flagging the constraint alongside the higher return is what separates a strong answer from a mechanical one.

The 60-Second Version

If the interviewer wants a ballpark rather than a full schedule, you can skip the year-by-year sweep entirely and hold interest flat at the opening balance:

Total EBIT over 5 years          = 85 + 95 + 105 + 115 + 125 = $525M
Total interest (8% x $600M x 5)                              = $240M
Total pre-tax income                                         = $285M
Total tax at 25%                                             = ($71M)
Total net income                                             = $214M
D&A and CapEx cancel; working capital = 5 x $5M              = ($25M)
Total free cash flow                                         = $189M
Exit debt = $600M - $189M                                    = $411M
Equity proceeds = $1,500M - $411M                            = $1,089M
MOIC = $1,089M / $420M                                       = 2.59x
IRR                                                          = ~21.0%

That is 21.0% against the exact 21.4% - a 0.4 point error, arrived at in under a minute. The shortcut always understates returns, because holding interest flat ignores the interest saved as debt is repaid. Say that when you give the number: "This is a floor; the true answer is a touch higher because interest falls with the sweep."

Common Mistakes to Avoid

1. Charging interest on the closing debt balance. Interest accrues on the debt you actually had during the year. Using the closing balance (already reduced by the sweep) understates interest, and in a full model creates a circular reference. Use the opening balance in a paper LBO - every interviewer accepts it.
2. Forgetting transaction fees in the equity cheque. The sponsor funds fees on top of the purchase price. Dividing exit proceeds by $400M instead of $420M inflates the MOIC from 2.64x to 2.77x and the IRR by roughly a point.
3. Subtracting gross debt instead of net debt at exit. If the model builds a cash balance rather than sweeping 100%, exit equity is enterprise value less debt plus cash. Sweeping everything, as here, keeps cash at zero and makes the two identical - but only because of that assumption.
4. Adding back D&A but ignoring CapEx. Net income already deducted D&A, so you add it back - and then you must deduct real cash CapEx. Candidates who add back D&A and stop overstate free cash flow badly.
5. Assuming multiple expansion without being told. Exiting at a higher multiple than entry is a return assumption, not a fact. Unless the prompt gives you an exit multiple, use the entry multiple and say why.
6. Treating EBITDA as cash flow. EBITDA is the starting point, not the answer. Interest, cash taxes, CapEx, and working capital sit between $150M of year 5 EBITDA and the $61.5M of free cash flow that actually paid down debt - a 59% haircut.
7. Giving the IRR without commentary. A number with no view is a half answer. Say whether the deal clears the hurdle, what drove the return, and what would break it.