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A small group of engineers and armed forces veterans is considering a leveraged buyout of the security services division of their firm. For several months they have worked closely with a private equity firm on analysing the possibilities. At last they have come up with some numbers to show the banks and potential equity investors. The idea is that they would form a new company, Mushroom Energy, to buy the division. The new company would issue 13 million shares with a par value of $10. The proposed purchase price is $400 million. In addition, the new company would refinance $60 million worth of existing debt obligations of the firm (at an interest rate of 8%). Fees are expected to run at 3% of the purchase price. Expected new capex and restructuring costs are estimated at 7% up front. Ongoing capital expenditure will be 10% of EBIT. The tax rate is 35% The company expects to have EBIT of $85 million in the 12 months prior to purchase. This is predicted to grow at 7% for the first 3 years and 3% thereafter. Discussions with banks suggest that for this kind of business it might be difficult to get an acquisition loan unless EBIT/interest ratio is at least 1.6. Loan, if granted, will be at a rate of 10%. If the banks provide a loan, it won't be more than the amount the engineers invest in the deal. The engineers, who would run the company, have managed to raise $10 million among themselves to invest in the company. The remainder must be raised by the private equity firm, whose partners generally expect a dividend of 2% of the invested amount every year, and look for an exit plan after 5 years at a total return on investment of 35%. Similar companies have been able to go public at a multiple of 7x EBITDA in the past. a) How much additional financing is needed from the private equity firm? [10] b) What rate of return can the engineers expect to make if the predictions work out? [20] A small group of engineers and armed forces veterans is considering a leveraged buyout of the security services division of their firm. For several months they have worked closely with a private equity firm on analysing the possibilities. At last they have come up with some numbers to show the banks and potential equity investors. The idea is that they would form a new company, Mushroom Energy, to buy the division. The new company would issue 13 million shares with a par value of $10. The proposed purchase price is $400 million. In addition, the new company would refinance $60 million worth of existing debt obligations of the firm (at an interest rate of 8%). Fees are expected to run at 3% of the purchase price. Expected new capex and restructuring costs are estimated at 7% up front. Ongoing capital expenditure will be 10% of EBIT. The tax rate is 35% The company expects to have EBIT of $85 million in the 12 months prior to purchase. This is predicted to grow at 7% for the first 3 years and 3% thereafter. Discussions with banks suggest that for this kind of business it might be difficult to get an acquisition loan unless EBIT/interest ratio is at least 1.6. Loan, if granted, will be at a rate of 10%. If the banks provide a loan, it won't be more than the amount the engineers invest in the deal. The engineers, who would run the company, have managed to raise $10 million among themselves to invest in the company. The remainder must be raised by the private equity firm, whose partners generally expect a dividend of 2% of the invested amount every year, and look for an exit plan after 5 years at a total return on investment of 35%. Similar companies have been able to go public at a multiple of 7x EBITDA in the past. a) How much additional financing is needed from the private equity firm? [10] b) What rate of return can the engineers expect to make if the predictions work out? [20]