hard · Investment Banking accounting
An LBO model shows a 'Cash Sweep' that prepays Senior Debt. If the Mezzanine tranche is PIK-only, how does the PIK interest interact with the sweep?
- The PIK interest is paid off first by the sweep because it is deemed the most expensive debt tranche outstanding.
- There is no meaningful interaction between the two mechanisms in a standard LBO model in practice.
- The sweep amount actually shrinks because the accruing PIK interest is simply added onto the outstanding debt principal.
- The PIK interest provides more cash for the sweep by generating a tax shield and requiring no cash interest.
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