553 The Leveraged Buyout of Cheek Products Ltd. tsLtd. (CPL) was founded 53 years ago and originally sold snack foods such and pretzels. Through acquisitions. nglomerate with Meg has suggested the potential LBO to her par ners. Ben Feller and Brenda Flynn. Ben and Bre grown into have asked Meg to provide projections of the c flows for the company. Meg has a co the the snack food industry, home mates below (in millions). provided the esti majortms. cosmetics, and plastics. Addition security s mpany has several smaller divisions. In any has been underperform At the end of five years, Meg estimates that the growth rate in cash flows will be 3,5 percent per ea year. The capital expenditures are for new projects he company's management doesn't seem to and the replacement of equipment that wears out. ssively pursuing opportunitis to improve Additionally, the company would realize cash flow ing ions (and the stock price). operatto whalen is a financial analyst specializing company will sell these divisions, overall sales otential buyout targets. She believes should increase because of a more concentrated from the sale of several divisions. Even though the ing p aor changes are needed at Cheek. First, effort on the remaining divisions thinks that the company would be better off if it After plowing through the company's financials ivisions and concentrated on its core and various pro forma scenarios, Ben and Brenda ncies in snack foods and home security sys- feel that in five years they will be able to sell the nd. the company is financed entirely with company to another party or take it public again Because the cash flows of the company are They are also aware that they will have to borrow Meg thinks the company's debt- ratio should be at least 0.25. She believes these changes would significantly enhance share steady. a considerable amount of the purchase price uity holder wealth. but she also believes that the existing (in million he company is a good candidate for an LBO. interest payments on the debt for each of the next five years if the LBO is undertaken are shown below board and company management are unlikely to take the necessary actions. As a result. Meg thinks 2015 2016 2017 2018 2019 Interest An LBO is the acquisition by a small group of equity investors of a public or private company Generally, an LBO is financed primarily with debt. The new shareholders service the heavy interest and principal payments with cash from operations and/ or asset sales. Shareholders generally hope to reverse the LBO within three to seven years by way of a pub- ic offering or sale of the company to another firm A buyout is therefore likely to be successful only if the firm generates enough cash to service the debt in the early years and if the company is attractive to payments $1,927 S1,85s The company currently has a required return on assets of 14 percent. Because of the high debt level. the debt will carry a yield to maturity of 12.5 per cent for the next five years. When the debt is refi nanced in five years, they believe the new yield to maturity will be 8 percent CPL currently has 425 million shares of stock outstanding that sell for $29 per share. The corpo rate tax rate is 40 percent. If Meg, Ben, a ctive to decide to undertake the LBO, what is the most they other buyers a few years down the road. should offer per share? 2015 2017 2018 400 $3,539 Sales $3,322 564 537 $1 De preciation Earnings before taxes Capital expenditures Change in net working capital $1,815 $1,608 53 279 $1,028