How does leverage amplify returns?
A core Private Equity interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
If you buy a €100M company with €40M equity and €60M debt, and sell it for €150M while repaying €30M of debt: your equity is now €150M - €30M remaining debt = €120M. That's 3.0x on your €40M. Without leverage, €100M equity in, €150M out = only 1.5x. Leverage doubled the return — but also doubled the risk, because debt must be repaid regardless of company performance.
WHAT INTERVIEWERS LISTEN FOR
- ✓Debt increases equity return
- ✓Fixed debt repayment obligation
- ✓Risk is magnified
- ✓Numerical example demonstrates effect
COMMON MISTAKES
- ✗Ignores debt repayment risk
- ✗Confuses leverage with profit
- ✗Omits downside scenario
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