In an LBO valuation, why might the value be lower than a DCF with the same assumptions?

• A. Because you value only terminal value and ignore near-term cash flows
• B. Because DCF ignores terminal value
• C. Because LBO uses fewer debt instruments
• D. Because LBO gives more weight to early cash flows

Answer: (A)

In an LBO, the value the investor looks to capture is the equity value at exit, after the debt used to finance the purchase has been paid down. A large portion of the operating cash flow in the early years is typically dedicated to servicing debt rather than building up equity value today. If you model the scenario by focusing on the terminal exit value and treat near-term cash flows as not contributing to the current equity value, you end up with a lower present value compared with a DCF that discounts the entire stream of cash flows, including near-term ones. In other words, the LBO framework often sacrifices early cash flows to debt service and emphasizes the exit, which can produce a lower value than a full DCF that incorporates those near-term cash flows.