You are the CEO of a publicly traded firm that is currently financed with $$1,000,000$ of debt and

$$9,000,000$ of equity, both stated in market values. You are considering a management buyout

of the firm. You are proposing to buy all of the outstanding public stock for $$11,000,000.$

$($Ignore the public debt, you can assume that the managers used the firm's cash to pay off the

public debt$)$ You and the other managers of the buyout group will put up $$1,000,000$ of your

own money, and you will borrow the other $$10,000,000$ from a hedge fund at an interest rate

of $15\%.$ Assume that this debt issue has no maturity; it is a perpetual bond, a perpetuity.

Therefore, there is no principal repayment, and therefore no changing capital structure $($to

keep it simple.$)$ Your firm's tax rate, either as a public or private firm, is $\mathrm{.}40.$ The common stock

of the public firm has a beta of $\mathrm{.}85.$You estimate the risk$-$free rate to be $3\%,$ and the the

expected return on the market to be $12\%.$

If you complete the buyout on the proposed terms, what is your required rate of return

for the LBO equity? $($Answer$,$ Ke is $\mathrm{.}534)$

You forecast that EBIT will be $$2,500,000$ per year, in perpetuity. What is the value of

the private equity at $t=0,$ the time that the buyout is completed? $($Answer$,$ Value of

equity is $$1,123,596)$

Should you complete the buyout under the proposed terms and forecast? $($Answer$,$ Yes,

you should be able to explain why.$)$