The private equity firm of Officer and Associates is considering an offer to tak

Question

The private equity firm of Officer and Associates is considering an offer to take Bulldog Cable Company (BCC), a regional cable company with operations in Utah and Wyoming, private. Analysts at Officer and Associates have made the following post-LBO estimates (in thousands; assume a December 31 year end, that all cash flows occur at the end of the year, and that the 2016 cash flow is exactly one year away. In other words, the acquisition would occur on January 1st, 2016): Tax rate after the LBO: 35% Cost of good sold as % of sales: 65% BCC's pre-merger (equity) beta: 1.4 Risk-free rate: 3% Market risk premium: 4% Terminal growth rate (g): 2% BCC currently has a capital structure that is 20% debt (and therefore 80% equity), but that would be raised in the LBO to 70% debt (immediately). There are no investments in fixed assets (i.e., CAPEX) planned for BCC by the LBO sponsor (Officer and Associates). What is the unlevered cost of capital for BCC (7.82%) What are the free cash flows and interest tax shields for the first 5 post-LBO years What is BCC's enterprise value assuming that it is taken private in the proposed LBO Use the APV method of valuation (which directly employs the answers to the two questions above). ($757,502)

Explanation / Answer

a. Unlevered Cost of Capital = Risk free rate+ (beta*Risk Premium)

=3%+(1.40*4) = 8.60%

b- Calculation of Free Cash flow-

c- Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

=1.40*(1+(0.65)*.70)) =2.037

Cost of Equity =3%+2.037*4 =11.15%

Cost of Debt= 3*(1-.35) =1.95%.

Interest Rate or Value of Debt not Given Hence Cost of Debt cannot be calculated. and hence Cost of Capital also can't be calculated

2016 2017 2018 2019 2020 Sales $450.00 $518.00 $555.00 $600.00 $643.00 Less: COGS @65 OF Sales $292.50 $336.70 $360.75 $390.00 $417.95 Selling & Admin Cost $45.00 $53.00 $60.00 $68.00 $73.00 Depreciation $21.00 $22.00 $26.00 $20.00 $19.00 Interest $40.00 $45.00 $47.00 $52.00 $54.00 Income Before Tax $51.50 $61.30 $61.25 $70.00 $79.05 Less: Taxation $18.03 $21.46 $21.44 $24.50 $27.67 Income After tax $33.48 $39.85 $39.81 $45.50 $51.38 Add: Depreciation $21.00 $22.00 $26.00 $20.00 $19.00 Operating Cash Flow $54.48 $61.85 $65.81 $65.50 $70.38 Change In WC -$50.00 -$80.00 -$75.00 -$70.00 -$75.00 Free Cash Flow $4.48 -$18.16 -$9.19 -$4.50 -$4.62

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