Olympus Corp is a large listed company with a number of subsidiaries in diverse industries but its core business is developing surveillance systems and intruder alarms. It has decided to sell a number of companies that it considers as non-core activities. One of these subsidiary companies is Typhoon Corp, a company involved in managing the congestion monitoring and charging systems that have been developed by Olympus Corp. Typhoon Corp is a profitable business and it is anticipated that its revenues will continue to increase at their current rate of 8% per year for the foreseeable future.

Typhoon Corps managers and some employees want to buy the company through a leveraged management buy-out. An independent assessment estimates Typhoon Corps market value at $810 million.

The managers and employees involved in the buy-out will invest $120 million for 75% of the firms common stock capital in the company, with another $40 million coming from a venture capitalist for the remaining 25% equity.

Paradise Bank has agreed to lend the balance of the required funds (650 million=810-120-40) in the form of a 9% fixed interest rate, amortizable loan. The interest is payable at the end of each year, on the loan amount outstanding at the start of each year. A covenant on the loan states that the following debt-equity ratios should not be exceeded at the end of each year for the next five years:

Year
Debt-to-equity	0.35	0.25	0.20	0.15	0.125

Shown below is an extract of the latest annual income statement for Typhoon Corp:

Latest Income statement in $ Million

Sales Revenue	600
Materials costs	120
Labor costs	220
Other costs	40
Allocated overhead payable to Olympus Corp	140
Interest paid	20
Taxable Profit (EBT)	60
Taxation (25%)	15
Retained Earnings	45

Materials costs directly vary with sales and are expected to increase at 8% per year for the next 5 years. However, labor costs and other costs are expected to increase at 5% and 10% per year, respectively, for the next 5 years.

After buy-out, the Allocated overhead payable to Olympus Corp. of $140 million per year will disappear. However, as part of the management buy-out agreement, it is expected that Olympus Corp will provide management services costing $120 million for the first year of the management buy-out, increasing by 8% per year thereafter.

Typhoon currently owes Olympus $100 million loan. It is expected that Typhoon Corp will repay $20 million of the outstanding loan (at no interest) at the end of each of the next five years from the cash flows generated from its business activity.

Depreciation on the acquired assets is estimated at 30 million per year for the next 10 years. The current tax rate is 30% on profits and it is expected that 25% of the after-tax profits will be payable as dividends every year. The remaining profits will be retained (become part of equity capital).

Required (Show all computations)

a.) Prepare a loan repayment schedule showing the amount of interest and principal payable at end of each of the next 5 years.

b.) Prepare a projected income statement for each of the next 5-years showing the net income, dividends and retained earnings.

c.) Further, derive the free cash flow to the firm (FCFF) given an investment in net working capital of $5 million at the end of year 1. Ignore investment in fixed assets. Show the amount of cash flows distributed to owners and debtholders for each year.

d.) Calculate the debt-equity ratio (long term debt/equity) for each of the next five years. Determine whether the covenant imposed by Paradise Bank on Typhoon Corp will be breached in any year over the next five-year period.

Hint: Compute the outstanding principal debt at the end of each year. Compute the total equity (common stock plus retained earnings) at the end of each year. Compute the debt-to-equity ratio per year.