Private Equity Partners, LP (PEP) is considering a leveraged buyout of Specialty
ID: 2740718 • Letter: P
Question
Private Equity Partners, LP (PEP) is considering a leveraged buyout of Specialty Components, Inc. (SCI), a closely held company as an add-on acquisition to its current investment in the industrial components sector. The acquisition price is $10 million. The following information is available for SCI ($ in 000): FCF year 2014 = $1,500 10 year T Bond Rate = 4% Market Risk Premium = 5% Debt equity ratio = 3 Debt ( Bank 9% Notes – since bank debt ignore debt beta) Marginal tax rate =40% Average unlevered beta for industry peers 1.20 Industry FCF multiple = 6.5 Total assets = 2,940 Total equity = 735 SCI has a competitive advantage in its main component line because of patent protection, which expires in three years. As a result, its growth rate in FCFF is estimated to be 7% during until the patent expires. After that, SCI will grow at the same rate as the overall economy and the capital structure will be stable and the debt equity ratio will be 3. PEP’s bankers have arranged acquisition financing for 90% of the acquisition price of, including taking out the existing debt. The interest rate of the new debt will be 9%. The acquisition debt will remain in place for three years then the debt equity ratio will be reduced to 3 at the end of three years. Compute Enterprise Valuation for SCI. Since SCI’s Capital Structure is fluid, using the Adjusted Present Value Method (APV) for the Planning Periods and use Relative Valuation for Terminal Value with 20% illiquidity discount. The present value of the Terminal Value should be determined using WACC.
Explanation / Answer
Enterpirse Value =12.39 Million (Refer the table below for detailed calculation)
2014 2015 2016 2017 FCF (Using Growth Rate of 7% for the next 3 years) 1500 1605 1717.35 1837.565 Unlevered Cost of Capital (= Rf + Unlevered Beta x Market Risk Premium) 10.0% Marginal Tax Rate (Given) 40% Unlevered Value (NPV of FCF using Unlevered Cost of Capital as Discount Factor) 4258.98 Debt (90% of 10,000) 9000 Tax Shield (= Debt x Cost Debt x Tax Rate) 324 324 324 Value of Tax Shield (Using NPV of Tax Shield and Unlevered Cost of Capital as Discount Factor) 805.74 Levered Beta (= Unlevered Bet x (1 + D/E x (1-T)) 3.36 Cost of Equity (= Rf + Levered Beta x Market Risk Premium) 20.800% Cost of Debt (Given) 9% E/V (Given D/E = 3, V =D+E) 0.25 D/V (Given D/E = 3, V= D+E) 0.75 Terminal WACC (=Cost of Equity x (E/V) + Cost Debt x (D/V) x (1-T)) 9.25% FCF Multiple (Given) 6.50 Terminal Value (=FCF of 2017 x FCF Multiple) 9555.335 PV of TV (Discount Terminal Value Using Terminal WACC) 7327.9348 Enterprise Value (= Unlevered Value + Value of Tax Shield + PV of Terminal ) 12392.65Related Questions
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