hard · Investment Banking
Two sponsors model the same LBO. Sponsor A assumes the target's existing debt is repaid at close and refinanced into the new capital structure (a change-of-control redemption); Sponsor B assumes the existing notes — trading at 92 cents on the dollar and bearing a below-market 3% coupon — are ASSUMED and left outstanding. Both use identical operating assumptions, the same total leverage, and the same exit.
Why might Sponsor B's model show a higher equity IRR despite identical leverage?
- The assumed notes carry a below-market coupon, so lower cash interest preserves more FCF for incremental debt paydown over the hold, lifting the equity return
- Assuming the notes avoids the call premium and tender costs of redemption, which lowers the equity check at close and mechanically raises IRR even with identical interest expense
- The notes trade at 92, so assuming them lets Sponsor B mark them to market and book the 8-point discount as immediate equity value at close
- Leaving the notes outstanding reduces the new-money debt raised, lowering total interest expense and freeing cash flow for sweep
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