The overall price paid by the acquiring group for VT is equal to 220 million dollars. The leverage acquisition was financed in the following way: - 38 million dollars as equity capital, coming from the two above mentioned industrial companies and from three closed-end funds specialized in LBO transactions; - 40 million dollars as mezzanine debt, coming from a specialized investment banks at a coupon rate equal to 5.25%. The investment bank has accepted a lower than usual interest rate after having obtained by the acquiring group a so-called equity kicker option, which consists in a pre- determined number of warrants on the VT's stocks owned by the New Co. The overall value of the assigned warrants is equal to the 30% of VT's equity capital. These warrants can be exercised by the end of the third year following the LBO at a strike price equal to zero. This mezzanine debt will be repaid all at once at the maturity but not before the full repayment of the senior debt. - 142 million dollars as senior debt, provided by a syndicate of banks at an interest rate of 8.15%; This interest rate is assumed to be the cost of debt applied by each bank taking into account VT's default risk. The senior debt has a maturity of 7 years and will be repaid according to the following amortization schedule: 14 million dollars at the end of year 1; 16; 18; 20; 22; 24; 28 million dollars at the end of the following 6 years. This debt can be repaid before maturity upon borrower's initiative. The acquiring syndicate expects to exit from such an investment in VT at the end of year three, through the sale of the company to a strategic buyer. Assignments: -) analyze the financial feasibility of the leveraged acquisition on VT for the syndicate of banks giving the senior debt; -) calculate the entity and equity value of VT at the LBO transaction time (to). Use as valuation method one of the many configuration of the DCF analysis. In order to estimate the terminal value, assume that the growth factor after year 3 is equal to zero; -) estimate the LBO's internal rate of return (IRR) for, respectively, the bank giving the mezzanine debt, and the equity investors. + The LBO on Vintage Textiles: A Case Study Vintage Textiles (henceforth, VT) is a company target of a leveraged acquisition by a NewCo jointly owned by two competitors of VT and some financial investors. The financial projections made by the acquirers when preparing the business plan for the LBO are reported below. VT's expected turnover the year following the LBO is equal to 120 million dollars. The acquiring NewCo expects a growth in turnover in year two and three (+ 9% per year). From the beginning of year 4, NewCo's analysts expect a stable turnover in the range of 143-145 million dollars. The incidence of VT's operating costs (before depreciation and amortization) on total turnover is assumed to be 45%. Expected depreciation and amortization items are: 12 million dollars in year 1, 13.08 millions in year 2 and 14.257 from year three. New investments in net working capital are assumed to constitute the 7% of the turnover; the acquiring group thinks capital expenditures needed for the substitution of plant and equipment can be wholly financed by depreciation and amortization costs. As far as the estimation of the equity is concerned, NewCo's analysts choose to use the standard CAPM formula: - the risk-free rate is assumed to be equal to 4.75%; - the chosen equity risk premium is 6.5%; the beta can be estimated through the bottom-up method, which makes reference to the weighted average of the beta values of 4 listed companies operating in the same industry of VT. The following table shows the beta of the comparable companies (all assumed to have a leverage ratio similar to that of VT): Company Beta Weight Factor Alfa 1.250 10% Gamma 1.430 20% Delta 1.360 40% Ipsilon 1.380 30% Company tax rate is 40% and is assumed to remain stable across the following years. In order to calculate the WACC, NewCo's analysts make reference to the target capital structure expected by the end of year 5 (D/D+E= 0.4).