Problem . You are the CEO of a leveraged buyout firm and are evaluating a potent

Question

Problem . You are the CEO of a leveraged buyout firm and are evaluating a potential buyout of BAD Company. BAD's stock price is S20, and it has 2 million shares outstanding. The company currently has no debt, nor does it have any cash. You believe that if you buy the company and replace its management, its total (enterprise) value will increase by 40%. You are planning on doing a leveraged buyout of BAD (ie, through borrowing money/using debt), and will offer $25 per share for control of the company Assuming you succeed and get 50% control (ie. you bought 50% of all the shares outstanding at a price of $25 per share by borrowing the necessary amount of money), what is the equity value of the company BAD after the leveraged buyout? [After the leveraged buyout, you took the debt (ie. the money you borrowed for the buyout) onto the company BAD's balance sheet.]

Explanation / Answer

Answer:

The value should indicate the expected improvent that will replace the management, therefore the value of the company will be $40 million + 40% = $56 million. If you buy 50% of the shares for $25 a piece, you will buy 1 million shares, paying $25 million. However, you will borrow this money by pledging the shares as collateral and then assign loan to the company once controlled. It means that new equity value would be $56 million - $25 million in debt = $31 million. With 2 million shares outstanding, the price of the equity will fall to $15.50.

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