Regarding private equity and the valuation of LBOs, select the correct statement:

Question

BlackTom AI · Accepted Answer

The question asks us to evaluate statements about private equity and LBO valuation, so we will assess each option in turn before isolating the one that accurately reflects standard LBO practice.
Option A: 'The leveraged acquisition of a publicly traded company that will then be delisted from the exchange is not considered a private equity transaction.' In reality, a public-to-private transaction via LBO is a classic PE activity; taking a company private through significant leverage is a hallmark of private equity deals. The claim that such an transaction isn't PE-related mischaracterizes common PE activity, making this option incorrect.
Option B: 'The usual plan in a LBO is to issue a large amount of risky debt to finance the acquisition of a target and then use the target’s free cash flow and sales of non-core or unproductive assets to repay debt quickly.' This description aligns with the conventional LBO playbook: leverage the acquisition heavily, rely on the target’s cash generation and asset sales to repay debt, and aim for a high internal rate of return. The emphasis on debt financing, operating cash flow, and asset divestitures as sources for debt repayment captures the core mechanics of many LBO structures, so this statement is accurate.
Option C: 'The practitioner approach to the valuation of LBO targets is based on a required rate of return or multiple of invested capital, but does not use multiples of comparables or free cash flow projections.' In LBO valuation, practitioners typically blend required return targets (or MIC/ROI) with forward-looking cash flow projections and often use precedent multiples (comparables) as a sanity check. Saying it does not use multiples of comparables or free cash flow projections contradicts standard practice, making this option incorrect.
Option D: 'Young firms with fast growing and highly volatile cash flows offer significant upside potential to private equity investors, so they make ideal LBO targets.' Private equity tends to favor mature, cash-generative, stable cash flows to support debt service, not highly volatile or very young firms. High volatility increases risk of debt repayment and often disqualifies such firms as ideal LBO targets, making this statement incorrect.
Thus, after evaluating each choice, the option that accurately reflects the conventional LBO financing and valuation approach is the one describing heavy debt financing paired with cash flow and asset-sale-driven debt reduction, i.e., the statement in Option B.

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Regarding private equity and the valuation of LBOs, select the correct statement:

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