Question
Leveraged Buyout (LBO) operations, or leveraged acquisitions, refer to the acquisition of part or all of an asset, such as a company, using third party
Leveraged Buyout (LBO) operations, or leveraged acquisitions, refer to the acquisition of part or all of an asset, such as a company, using third party capital (debt) as a significant part of the transaction value. Leveraged acquisitions began to be used in the USA by private equity funds and gained prominence in the 1980s, a period in which the cost of capital was low and allowed them to take high risks to make some acquisitions feasible. The purpose of leveraged acquisitions is to allow the investor to make major acquisitions in the market, without the need to compromise or contribute the total value of the business. The investor who chooses to acquire a company via LBO only needs to commit a small portion of the total capital allocated to the purchase of the new business. In contrast, the largest portion is due to the use of debt, which will be issued by the acquired company itself. An LBO operation is very similar to a mortgage loan, where the financing is guaranteed by the property to be purchased, whereas, in the LBO, the debt contracted is secured by the assets of the acquired company. The most iconic LBO operation that has ever occurred was that of RJR Nabisco, an American group formed by the merger of the companies R. J. Reynolds (manufacturer of cigarettes) and Nabisco (of food products). RJR Nabisco was acquired in an LBO transaction carried out by the PE Kohlberg Kravis Roberts & Co. fund in 1988 for $ 25 billion. RJR Nabisco's Unlevered beta at the time was 0.69, which meant that the group was relatively insensitive to market fluctuations, in addition to low levels of indebtedness, made RJR Nabisco a good attractive business for an LBO operation. The expectation with leveraged acquisitions is that the return generated on the acquisition offsets the interest paid on the debt, thus making it attractive to experience high returns while the company that runs the LBO only risks a small amount of equity.
Do you agree with above statement? why or why not? write at least 250 words. Also, give example .
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