How can returns be boosted in an LBO scenario?

In a leveraged buyout (LBO) scenario, returns can be significantly enhanced through the strategy of reducing the purchase price while simultaneously increasing the amount of debt used to finance the acquisition. This approach allows the acquiring firm to maximize leverage, which can amplify the returns on equity.

When the purchase price is lower, the equity contribution required from the investors is reduced, while the increased use of debt creates a greater gap between the company's operating cash flows and the service of that debt. As a result, if the company can improve its performance or maintain its cash flow levels, the returns on equity investments become much higher due to the smaller equity base relative to the larger debt financing.

This approach hinges on the premise that a successful operational improvement or value-creation strategy can lead to a higher valuation at exit. Therefore, using a combination of strategic purchasing and financial leverage effectively boosts the return on investment in an LBO.

Other options, while they may seem plausible, either do not enhance returns effectively (like increasing capital expenditures, which might necessitate more immediate cash outflows without guaranteed returns) or could counterintuitively reduce overall returns, such as increasing the equity contribution or lowering the exit price.