Question
Based on the Narrative below, walk through the answer calculations step by step, as I know nothing about Finance! The answers are judged by the
Based on the Narrative below, walk through the answer calculations step by step, as I know nothing about Finance! The answers are judged by the accuracy, clarity, logic, and the details of your demonstration.
Questions:
4) Prepare an external debt schedule (bank + junk bond) for the next 5 years based on the information given in the case. What will be the total amount of debt outstanding at the end of each year? (You may ignore interest expenses since your income statement only includes EBIT)
6) What will be Snacks Value of Equity at the end of Year 5? How do you know?
7) Does Huron meet its hurdle rate? If so, how? If not, why not?
Narrative
Modern Investment Banking
Group Exercise #1
Leveraged Buyout
Chicago, December 2013.
Nutrifoods, Inc. is a large and diversified agro-foods company based outside of Chicago, which produces various types of processed foods. It is divided into 3 main divisions: 1) Dairy, which includes yoghurt, processed cheeses, and desserts; 2) Beverages, mainly bottled water and juices; and 3) Snacks, including salted snacks and cookies. While its dairy and beverages divisions have done very well in the past few years, its snacks division, on the other hand, continues to show disappointing results.
Jerry Clark, the head of the Snacks division (Snacks), believes that his bosses at Nutrifoods have consistently deprived his division of the proper resources needed to boost its performance, have ignored his recommendations, and basically lost interest. In fact, he has learned that Nutrifoods is looking to divest itself from Snacks in order to focus exclusively on the other two divisions.
Convinced that Snacks is a viable and potentially very lucrative business, Clark approaches a good friend of his who works at the private equity company Huron Financial. After a few weeks of meetings between Clark and Huron, Huron agrees to make an offer for Snacks to Nutrifoods, and finance the deal via a Leveraged Buyout. The initial agreement between Clark and Huron is that Snacks current management team will remain at the helm of the company, and will provide a small portion of equity into the deal, while Huron, as financial sponsor, will provide the majority of the equity and obtain the necessary debt financing to close the deal. If all goes well, Huron plans to cash out after 5 years, either through an IPO, or through a privates sale.
Clark provides Huron with Snacks last 3 financial statements, as well as the pro-forma statements for the next 5 years. Based on its research (recent deals within the same industry), Huron believes that the current enterprise value (EV) of Snacks is about 8 times EBITDA. This multiple should remain stable for the next 5 years.
While Snacks recent revenue growth has been low up until 2013 (about 5%), Clark is confident that, without Nutrifoods constant intrusion in their decision making, Snacks can make substantial improvements:
- Revenues are to grow by 5% in 2014, and 10% in each of the following 4 years.
- COGS will remain constant in terms of sales between 2013 and 2014, then decrease to 45% of sales starting in 2015, and remain at that level in subsequent years thanks to major improvement in raw material sourcing and management.
- SGA expenses will also decrease, in the absence of heavy Nutrifoods head office expense allocations, from 25% in 2013 and 2014 down to 20% of Sales as early as 2015 and in the following years.
- Depreciation will remain constant at 10% of sales.
Snacks currently has bank debt equal to $160 Million. Huron believes that, if the LBO goes through, Snacks level of debt will have to almost double, and will be structured as follows:
1) A $160 M junk bond (to replace Snacks existing bank debt), with a 7 year maturity and an annual coupon of 7.75%. The bonds will be fully repaid at par at maturity. Assume, for the sake of simplicity, that the bond remains priced at par throughout its lifetime.
2) A 5-year $100 M term loan, with a fixed rate of 5% and equal annual installments paid in arrears.
3) A 5-year, 40 M revolving credit line, with a rate of 12 Month Libor + 1% (interest paid in arrears) and a commitment fee of 0.25%charged on the unused portion of the line. The fee is collected at the end of each year. The company plans to use only 25 M of the line on average during the full 5 years and reimburse the 25M at the end of the 5 years. The remaining undrawn $15 M is available in case of emergency.
Huron plans to invest $80 Million of its own equity in the project, while Clark and his team another $4.21 Million, so that Huron will own 95% of the shares of the company and Snacks Management the remaining 5%. Hurons hurdle rate for this project (minimum IRR) is 35%.
The LBO arrangement will cost a total of $5 Million in fees paid to lawyers, investment bankers, and other service providers. These fees are to be paid immediately at the close of the deal (Jan.1, 2014), but are to be amortized over the next 5 years on a straight line basis.
All interim cash flows generated by the company will be used to pay down debt.
Snacks last 3 years income statement figures as provided by Jerry Clark (since the narrative is in December 2013, full 2013 figures are still estimated):
(Amounts in millions of US$) | 2011 | 2012 | 2013E |
Sales | 147 | 155 | 162 |
Cost of Goods Sold | 68 | 74 | 81 |
Gross Income | 79 | 81 | 81 |
SGA Expenses | 37 | 39 | 41 |
Depreciation Expenses | 15 | 16 | 16 |
Amortization Expenses | - | - | - |
Total Operating Expenses | 51 | 54 | 57 |
Operating Income (EBIT) | 28 | 26 | 24 |
Assumptions already given:
1) EV for year 2013 = EBITDA * ebitda multiple
EBITDA = sales -cogs- SGA expenses
= 162 - 81 - 41 = 40
therefore EV = 40*8 = 320 millions
2) Equity value for the year 2013 = Enterprise value - Debts
= 320 - 180 = 140 millions
3)
(Amounts in millions of US$) | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 |
sales | 162 | 162(1.05)=170.1 | 170.1(1.10)=187.11 | 187.11 | 187.11 | 187.11 |
cogs | 81 | 81 | 81(.45)=36.45 | 36.45 | 36.45 | 36.45 |
gross income | 81 | 89.1 | 150.66 | 150.66 | 150.6 | 150.66 |
sga expense | 41 | 25% of sales=42.775 | 46.77 | 46.77 | 46.77 | 46.77 |
depreciation | 16 | 17 | 18.7 | 18.7 | 18.7 | 18.7 |
appreciation | - | - | - | - | - | - |
total operating expenses | 57 | 59.775 | 65.47 | 65.47 | 65.47 | 65.47 |
operating income(EBIT) | 24 | 29.325 | 85.19 | 85.19 | 85.19 | 85.19 |
5) EV for year 2018 = (sales - cogs - sga ) * EBITDA Multiple
=(187.11 - 36.45 - 46.77) * 8
= 103.89 * 8
= 831.12 millions
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