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2. Operating Cash Flows 2019 2020 2021 2022 Sales COGS 10000 13,000 16,250 19,500 SG&A 6,500 8,125 9,750 Depreciation ,300 1,625 1,950 1,200 EBIT 1,500 1,800 Tax 4,000 5,000 6,000 1,600 EBIAT 2,000 2,400 Depreciation 2,400 3,000 3,600 1,200 1,500 Gross Cash Flows 1,800 Cap Ex Investments 3,600 4,500 5,400 1,200 1,500 Unlevered Cash Flows 1,800 2,400 3,000 3,600 Answer to Question 1 5. Valuation at Target Capital Structure 2019 2020 2021 2022 Unlevered Cash Flows 2,400 3,000 3,600 Levered Terminal Value 29,605 Answer to Question 3 PV of UCF (1-3) at wacc 7,076 PV of LTV at wacc 20,982 Value at Target D/E 28,058 Answer to Question 4 Levered Terminal Value Unlevered Terminal Value Tax Shield in LTV Terminal Equity Value Just Before Recap note: this is after CADS is filled out Terminal Equity Value Just After Recap3. Flows available for debt service 2019 2020 2021 2022 EBIT 4,000 5,000 6,000 Interest expense: Senior debt 1,200 1,080 893 Subordinated debt 800 800 800 EBT 2,000 3,120 4,307 Taxes 800 1,248 1,723 EAT 1,200 1,872 2,584 Depreciation 1,200 1,500 1,800 Cash Flow 2,400 3,372 4,384 Investment 1,200 1,500 1,800 Available for bank debt 1,200 1,872 2,584 Note that these are FCFs , i.e. UFCF - after-tax interest Outstanding Debt: Bank Debt 12,000 10,800 8,928 6,344 Subordinated Debt 10,000 10,000 10,000 10,000 Total Debt 22,000 20,800 18,928 16,3446. MBO Valuation 2019 2020 2021 2022 Interest tax shield of bank debt Interest tax shield of sub debt Unlevered Value of the firm PV of tax savings of bank debt, (1-3), at Rd=10% PV of tax savings of sub debt, (1-3), at Rd=15% PV of tax shield in TV, at Rd=10% What is the implicit assumption? PVTS Total value of the firm7. Flows to lie: Fin 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 Princiial Flows Value of Debt Component Value of Equity Component E Fraction of Equity Total Cash Flows Valuation 1151611356: 1' arauyne lllc. Paradyne Inc. has decided to divest one of its divisions. They are in the process of negotiating with the management team (MT hereafter) of the division which is trying to arrange a leveraged buyout. The asking price for this group is set at $22.5 million. The sales level of the division during the last year was $10 million. MT feels that, over the next three years, the new rm's sales can grow at successive rates of 30%, 25% and 20%. However, to attain this sales growth, they will have to make investments (into xed and working capital) in successive amounts of 1.2, 1.5 and 1.8 million dollars during the next three years. (Assume that depreciation charges during all future years will be equal to investment amounts.) MT also feels that the sales will stabilize after the third year. However, they think that they will be able to maintain their market share as long as they continue to make sustaining investments of $1.8 million every year. MT concluded at the end of a careful cost analysis that the cost of sales (excluding depreciation) will be 50% and selling and general expenses will be 10% of projected sales levels in each year. MT is negotiating with a major bank for a senior loan of $12 million at 10% with a maturity of 8 years. The draft agreement restricts any dividend payments during the rst three years and requires that the residual after tax cash ows, after deducting the amounts for necessary investments, be used as principal payments on this loan. It also requires that the principal balance remaining at the end of the third year is to be paid in ve equal annual installments thereafter. MT is also negotiating with a private equity (PE) group to raise an additional $10 million as subordinated debt. However, MT feels that it is not prudent to promise 15% coupon rate the market demands for this security. Similarly, any principal payment in earlier years is undesirable for MT. Therefore, they are offering a coupon rate of 8% and a balloon payment of $10 million at maturity, i.e., this is an "interest only" loan. The principal is due either at the end of 10 years or when LED is reversed, whichever comes earlier. In order to sweeten the deal, the private equity group will also receive warrants which could be exercised at any time after LED is reversed. [The strike price of these warrants is negligible] MT believes that the target capital structure for their new company is a debt to equity ratio of 1.5 (at market value weights) and that they can reach that level by the end of the third year and maintain that level thereafter. They also feel that the end of the third year (or beginning of the fourth year) would be a good time for reversing the LBO by either going public or looking for a buyer. Please help with the analysis of this proposal by answering the questions given on the next page using the assumptions that follow: 10. What will be the rate of return to the private equity group if they cash out their warrants (amount calculated in Question 9) when the rm is sold at the end of year three