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Inc
Inc. has no debt right now. You project that this company can generate EDT of 10 million per year for the next few years. There N no depreciation. You plan to attempt a leveraged buyout of this company. Your plan is to operate the company for three years and sell the company then. You think the company can be sold at price to FEY ratio of 8 three years from now. You plan to borrow 65 million in three-year interest only loan and putting 15 millions of your own equity to buy the company. (Note that the loan is interest only and you do not plan to retire any debt before you sell the company. Your interest payment will remain the same for the three years.) The interest rate on the loan N 10. and the tax rate N 4096.
The selling price of the company in three years is The interest expense of the company in the first year is million. The cash flow to the equity investor in the first year is The rate of return to the equity investor for this deal is 96.
Expert Solution
Computation of Selling Price:
Selling Price = 10 million*8 = 80 million
Computation of Interest Expense of the Company in First Year:
Interest Expense in First Year = EBT*(1-Tax Rate)
Here,
EBT = $10 million - ($65*10%) = $10 million - $6.5 million = $3.5 million
Interest Expense in First Year = $3.5 million*(1-40%) = $2.10 million
Computation of Cash Flow to the Equity Investor in the First Year:
Cash Flow to the Equity Investor in the First Year = EBIT + Interest Expense in First Year-Borrowed Amount
= $80 million + $2.10 million - $65 million
Cash Flow to the Equity Investor in the First Year = $17.10 million
Computation of Rate of Return to the Equity Investor:
Rate of Return = ($17.10 million/$15 million)^(1/3) - 1 = 4.46%
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