Paper LBO in 5 Minutes: A Step-by-Step Walkthrough With Worked Numbers

You're in a private equity interview or a late-round banking superday. The interviewer slides over a sheet of paper and says: "Walk me through a quick LBO. No calculator."

That's the paper LBO. It's a simplified leveraged buyout you do by hand in about 5 minutes. It tests whether you understand how PE returns are created and whether you can do clean mental math under pressure.

This post walks through a complete example with real numbers, the shortcuts that make it fast, and the follow-up questions interviewers usually ask.

What a Paper LBO Actually Tests

Interviewers don't care if you land on 20.4% or 20.1%. They care about three things:

• Structure: do you know the steps in the right order?
• Mechanics: can you get from EBITDA to free cash flow to debt paydown without getting lost?
• Judgment: can you sanity-check your answer and explain where the returns came from?

Get those right, and a small arithmetic slip won't sink you.

The 5-Step Framework

Every paper LBO follows the same skeleton:

1. Calculate the purchase price and split it into debt and equity
2. Project EBITDA over the holding period
3. Calculate free cash flow each year and use it to pay down debt
4. Calculate exit value and subtract remaining debt to get exit equity
5. Calculate returns (MOIC and IRR)

Memorize this order. If you blank mid-problem, it tells you exactly where to go next.

The Prompt

Here's a typical setup, with numbers chosen to be realistic but mental-math friendly:

• Entry EBITDA: $50M
• Purchase multiple: 10.0x EBITDA
• Leverage: 5.0x EBITDA of debt, at an 8% interest rate
• EBITDA growth: +$5M per year
• D&A: $10M per year
• Capex: $10M per year
• Change in net working capital: zero
• Tax rate: 25%
• Holding period: 5 years
• Exit multiple: 10.0x (same as entry)
• All free cash flow goes to paying down debt
• Ignore transaction fees and assume the target is acquired cash-free, debt-free

Write these down first. Seriously. Having the assumptions in one corner of the page saves you from re-asking later.

Step 1: Purchase Price and Sources of Funds

The purchase price is entry EBITDA times the multiple:

• Enterprise value = $50M × 10.0x = $500M

Now split it:

• Debt = $50M × 5.0x = $250M
• Equity (the sponsor's check) = $500M − $250M = $250M

So this is a 50/50 debt-to-equity deal. Quick note: in a real deal, fees would add to the uses of funds and increase the equity check. Interviewers often drop them in paper LBOs, but mention that you're ignoring them.

Step 2: Project EBITDA

With +$5M per year, this takes ten seconds:

If the prompt gives you revenue growth and a margin instead, calculate revenue first, then apply the margin. Same idea, one extra line.

Step 3: Free Cash Flow and Debt Paydown

This is where most candidates slow down. Here's the clean way to do it.

The Simplified FCF Formula

Free cash flow to equity in this setup is:

FCF = Net Income + D&A − Capex − Increase in NWC

Since D&A equals capex ($10M each) and NWC doesn't change, those cancel out. That leaves:

FCF = Net Income

That's a huge time saver. Always look for cancellations like this before you start crunching.

The Interest Shortcut

To stay fast, calculate interest on the initial debt balance every year:

• Interest = $250M × 8% = $20M per year

In reality interest falls as debt is paid down, so this slightly understates cash flow. That makes it a conservative shortcut. Tell the interviewer you're doing it. If they want declining-balance interest, they'll say so.

Net Income Each Year

The Averaging Trick

You don't need to add five numbers. Because EBITDA grows by the same amount each year, net income also grows linearly. So:

Total FCF = Year 3 FCF × 5 = $26.25M × 5 = $131.25M

The middle year of a linear series always equals the average. Interviewers love seeing this.

Remaining Debt at Exit

• Ending debt = $250M − $131.25M = $118.75M

Step 4: Exit Value and Exit Equity

Apply the exit multiple to Year 5 EBITDA:

• Exit enterprise value = $75M × 10.0x = $750M
• Exit equity = $750M − $118.75M = $631.25M

Step 5: Calculate Returns

MOIC

• MOIC = $631.25M ÷ $250M = ~2.5x

IRR Without a Calculator

You won't compute IRR exactly by hand. Instead, memorize a few benchmarks:

Our 2.5x over 5 years lands at roughly 20% IRR. (The precise figure is about 20.4%, but "about 20%" is exactly what an interviewer wants to hear.)

For anything in between, interpolate. A 2.2x over 5 years? Somewhere around 17%.

Explain Where the Returns Came From

This is the part that separates strong candidates. Once you have the answer, break the equity gain into its drivers.

Total equity value created: $631.25M − $250M = $381.25M

• EBITDA growth: $25M more EBITDA × 10.0x = $250M
• Multiple expansion: entry and exit at 10.0x = $0
• Debt paydown: $131.25M

Check: $250M + $0 + $131.25M = $381.25M. It ties.

Saying "about two-thirds of the return came from operating growth and one-third from deleveraging, with no help from multiple expansion" is a great closing line. It shows you understand the deal, not just the math.

Common Follow-Up Questions (With Answers)

Interviewers rarely stop at the base case. Here are the usual curveballs, worked out.

"What if we exit at 9.0x instead?"

• Exit EV = $75M × 9.0x = $675M
• Exit equity = $675M − $118.75M = $556.25M
• MOIC = ~2.2x, IRR = ~17%

One turn of multiple contraction cost about 3 points of IRR.

"What if we exit at 11.0x?"

• Exit EV = $75M × 11.0x = $825M
• Exit equity = $825M − $118.75M = $706.25M
• MOIC = ~2.8x, IRR = ~23%

"What if we use 6.0x leverage instead of 5.0x?"

• Debt = $300M, equity = $200M
• Interest = $300M × 8% = $24M, so $4M more per year
• After tax, that's $3M less net income per year, or $15M less over 5 years
• Total FCF = $131.25M − $15M = $116.25M
• Ending debt = $300M − $116.25M = $183.75M
• Exit equity = $750M − $183.75M = $566.25M
• MOIC = $566.25M ÷ $200M = ~2.8x, IRR = ~23%

More leverage, smaller equity check, higher return. That's the core logic of an LBO. Just be ready to add that more debt also means more risk if the business underperforms.

"Why don't PE firms just use 100% debt?"

Lenders won't allow it. Debt capacity is limited by how much interest and principal the company's cash flow can cover, and too much leverage raises the risk of default. Equity is the cushion that makes lenders comfortable.

Mistakes That Cost Candidates the Most

• Forgetting taxes. Interest is deductible, but the company still pays tax on pre-tax income. Don't skip that line.
• Using EBITDA as cash flow. EBITDA ignores interest, taxes, capex and working capital. Paying down debt with EBITDA massively overstates returns.
• Applying the exit multiple to the wrong year. Use exit-year EBITDA, not entry EBITDA.
• Subtracting initial debt at exit. Subtract the debt that's left after paydown.
• Going silent. Talk through each step out loud. If you make an error, the interviewer can follow your logic and steer you back.

How to Get Fast Enough

Five minutes sounds tight, but it's very doable with practice:

• Do 10 to 15 practice problems with different numbers until the 5 steps feel automatic.
• Time yourself. Aim for under 5 minutes, including the returns attribution.
• Memorize the IRR table above. It's the single biggest time saver.
• Practice saying it out loud. Walking through it verbally is a different skill from doing it silently on paper.
• Change one variable at a time (exit multiple, leverage, growth) to build intuition for what really moves returns.

Once you can do this cleanly, the paper LBO stops being a scary test and becomes an easy chance to show you think like an investor. Grab a blank sheet, change the numbers above, and run it again.