How to Answer “How do you build the debt schedule in an LBO model?” in Private Equity Interviews
“How do you build the debt schedule in an LBO model?” comes up frequently in Private Equity associate interviews because the debt schedule drives interest, cash flow available for repayment, and ultimately equity value and IRR.
A strong answer shows you can turn a capital structure into an auditable debt schedule LBO model: tranche-by-tranche roll-forward, a clear cash sweep, correct interest mechanics, and clean three-statement links—exactly what good LBO interview prep targets.
What PE Interviewers Look for in Debt Schedule Construction
Interviewers want to see whether you understand how leveraged capital structures actually behave over time: mandatory amortisation vs. optional prepayments, revolver mechanics, and the difference between cash-pay and PIK interest. In other words, they’re testing judgment in debt schedule construction, not just a memorised formula.
They also assess modelling hygiene: correct timing (beginning vs. average balances), hard constraints (no negative balances, revolver capacity, minimum cash), and whether you can manage circularity between interest expense and cash available for paydown without creating unstable logic.
Finally, this is a communication test typical of private equity interview questions. A good candidate can explain the workflow in a repeatable way, flag key assumptions from the term sheet, and add quick reasonableness checks (deleveraging trend, improving interest coverage, revolver draws only when needed).
Debt Schedule LBO Model Framework (Step-by-Step)
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Step 1: Map the capital structure and inputs (pricing, amort, fees, covenants)
Start by listing each tranche you’re modelling (e.g., Revolver, Term Loan B, Senior Notes, Mezz/PIK) and capture only the assumptions that change the schedule. For each: opening principal at close, maturity, mandatory amortisation (% of original or straight-line), optional prepayability/call protection, interest type (floating vs fixed), and whether interest is cash-pay or PIK.
Add revolver-specific terms: commitment size, minimum cash policy (what triggers draws), unused commitment fee, and any LC/availability haircuts if relevant. If the question is in a technical interview setting, explicitly state your sign convention and where each output will link: balances to the balance sheet, interest to the income statement, and borrowings/repayments to cash flow from financing.
Keep inputs modular in one place so you can run LBO modeling techniques like sensitivities (rates, cash sweep %, EBITDA downside) without rebuilding the schedule.
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Step 2: Build a tranche-by-tranche principal roll-forward (begin + draw − repay = end)
For each period and each tranche, build the roll-forward: Beginning Balance + Draws − Mandatory Amortisation − Optional Prepayments = Ending Balance. Mandatory amortisation is driven directly by the debt terms (often a % of original principal for loans). Optional prepayment is driven by the cash sweep and constrained by debt terms.
Add the guardrails that make the schedule interview-ready: (1) no tranche can go below zero, (2) revolver cannot exceed commitment, (3) some tranches may be non-prepayable until a call date or may have penalties (you can note these even if you don’t model the premium explicitly).
A simple LBO model debt schedule example you can describe verbally: mandatory amort hits first, then any excess cash sweeps into the most senior, most prepayable tranche (often the revolver, then term loans), which is the behaviour interviewers expect to hear.
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Step 3: Build the cash sweep / waterfall to determine optional paydowns
Compute “cash available for debt repayment” from the model’s cash flow: operating cash flow minus capex, taxes, changes in working capital, and any required minimum cash balance (and sometimes after mandatory amort, depending on your convention). That cash available amount is what funds optional prepayments.
Then allocate optional paydowns by priority of payments consistent with the credit docs—commonly revolver first (because it’s flexible and reduces liquidity risk), then term loans, then junior tranches. If there’s a minimum cash requirement, the revolver becomes the balancing item: draw if projected cash would fall below the minimum; repay when cash is above minimum.
This step is where many LBO analysis questions dig in: you should mention constraints and ordering clearly, because small logic errors can create unrealistic deleveraging or “negative debt” outcomes.
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Step 4: Calculate interest and fees on the correct base (cash-pay vs PIK)
Calculate interest in a way that matches timing. In most interview models, interest is computed on the average balance of the period (average of beginning and ending) to approximate intra-period repayments and avoid overstating interest. For floating-rate debt, use the reference rate + margin and incorporate floors/caps if the term sheet calls for them.
Separate cash interest from PIK interest. Cash interest is an expense on the income statement and a cash outflow; PIK interest accrues to principal, so it increases the debt balance in the roll-forward rather than reducing cash. For revolvers, include unused commitment fees on the undrawn portion and interest on the drawn portion (often using average drawn balance).
Acknowledge circularity: interest depends on debt balances, but debt paydown depends on cash after interest. In practice you either enable iteration, use an average-balance approach with a mild circularity breaker, or solve via a consistent plug method.
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Step 5: Link the schedule to the three statements and sanity-check outputs
Make the linkages explicit. Ending debt balances by tranche flow to the balance sheet. Interest expense (and, if modelled, amortisation of financing fees) flows through the income statement. Debt draws and repayments flow through cash flow from financing, while cash interest paid reduces cash (placement in CFO can vary by convention; consistency matters more than the exact line).
Then run quick checks that interviewers recognise from financial modeling interview prep: debt should not amortise below zero; the revolver should draw only when cash would otherwise breach the minimum; leverage (Debt/EBITDA) should generally decline if free cash flow is positive; and interest expense should reconcile directionally to rates and average balances.
Close by noting you would test downside cases (lower EBITDA, higher rates) to see whether the model still respects constraints and whether liquidity becomes the binding issue.
Model Answer for LBO Interview Prep (Associate-Level)
I build the debt schedule in an LBO model by converting each tranche’s term sheet into a clean roll-forward that drives interest expense and cash available for paydown, then linking it through the three statements.
First, I lay out the capital structure—revolver, term loans, notes, mezz/PIK—and for each tranche I input opening principal, maturity, mandatory amortisation, pricing, fees, and whether interest is cash-pay or PIK. Then, period by period, I roll principal: beginning balance plus any draws, minus mandatory amortisation, minus optional prepayments, to arrive at ending balance, with hard constraints like no negative balances and revolver capacity.
Optional prepayments come from a cash sweep. I calculate cash available after operating cash flow, capex, taxes, working capital needs, and a minimum cash balance, then allocate that cash in priority order—typically revolver first, then term loans, then more junior tranches—subject to any call protection or non-prepayable debt.
Next, I calculate interest on the right base, usually average balances for the period. Floating-rate tranches are reference rate plus margin (and floors if relevant); revolvers also have unused commitment fees on undrawn amounts. Cash interest hits the income statement and reduces cash, while PIK interest accrues to principal and increases the debt balance.
Finally, I tie debt movements to cash flow from financing, ending balances to the balance sheet, and sanity-check that leverage trends down and the revolver only draws when cash would otherwise go below the minimum.
- Lead with the purpose: the schedule drives interest, cash flow, and equity returns in an LBO.
- Describe mechanics tranche-by-tranche; revolvers, term loans, notes, and PIK do not behave the same.
- Say how you determine optional paydown (cash available + sweep priority) and name key constraints.
- State your interest timing (average balance) and distinguish cash-pay vs PIK clearly.
- Mention circularity handling briefly, then finish with 1–2 sanity checks interviewers trust.
Common Mistakes in LBO Debt Schedules
- Modelling paydowns without a cash waterfall (or sweeping before minimum cash), which can create impossible negative cash or overstated deleveraging.
- Calculating interest on ending balances only (or mixing timing conventions), materially mis-stating cash interest and IRR.
- Forgetting revolver mechanics: commitment cap, draw/repay logic around minimum cash, and unused commitment fees on the undrawn amount.
- Treating PIK interest like cash interest, or failing to capitalise PIK into the debt balance roll-forward.
- Ignoring tranche-specific terms (mandatory amortisation, non-prepayable periods, call protection), leading to unrealistic repayment profiles.
- Not addressing circularity at all, or “fixing” it with hard-coded numbers that break when assumptions change.
Follow-Ups: LBO Analysis Questions on Interest, Sweeps, Revolvers
How do you handle circularity between interest expense and cash available for debt paydown?
I typically enable iteration and calculate interest on average balances; if iteration isn’t available, I use a simple breaker (e.g., prior-period or average-of-beg/end) so the sweep and interest converge cleanly.
What’s the difference between cash interest and PIK interest in the schedule?
Cash interest is an expense that reduces cash; PIK interest is still an expense but it capitalises into principal, increasing the debt balance rather than using cash.
How do you model a revolver with a minimum cash balance?
If projected cash falls below the minimum, I draw the revolver to bring cash back up to the minimum; if cash exceeds the minimum, I repay the revolver first, capped at the outstanding balance.
What order do you apply the cash sweep across tranches, and why?
Usually by seniority and prepay flexibility—revolver, then term loans, then junior debt—because senior facilities are often cheapest and most prepayable, subject to the credit docs.
What quick checks tell you your debt schedule construction is correct?
No negative balances, revolver only draws when needed, interest reconciles directionally to rates and average balances, and leverage/interest coverage trends make sense over time.
Financial Modeling Interview Prep to Nail LBO Modeling Techniques
- Practise a 2–3 minute explanation: tranches and inputs → roll-forward → cash sweep → interest (cash vs PIK) → three-statement links → sanity checks.
- Rehearse one small numeric story (e.g., “$20 of annual excess cash sweeps to the revolver then term loan”) to make the logic tangible without heavy maths.
- In mock interviews, force yourself to state where each item goes (income statement vs cash flow vs balance sheet); that’s a common differentiator in LBO modeling interview questions and answers.
- Do one run focused on clean constraints (minimum cash, revolver cap), and another run focused on edge cases (PIK, rate floors, non-prepayable tranches).
- Use AceTheRound to drill follow-ups on sweep priority and circularity so you can stay structured under pressure.
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