Y, Inc. has no debt right now. You project that this company can generate EBIT o
ID: 2801363 • Letter: Y
Question
Y, Inc. has no debt right now. You project that this company can generate EBIT of 8 million per year for the next few years. There is no depreciation. You plan to attempt a leveraged buyout of this company. Your plan is to operate the company for three years and sell the company then. You think the company can be sold at price to EBIT ratio of 9.5 three years from now. You plan to borrow 60 million in three-year interest only loan and putting 10 millions of your own equity to buy the company. (Note that the loan is interest only and you do not plan to retire any debt before you sell the company. Your interest payment will remain the same for the three years.) The interest rate on the loan is 10% and the tax rate is 40%.
1) What is the cash flow to the equity investor in the third year in millions (the final year of the project, including sale proceeds and loan repayment)?
2) What is the rate of return to you as the equity investor (in percentage)?
Explanation / Answer
EBIT $8,000,000 Plan to operate the company 3 Years Price to EBIT ratio 9.5 Lets take stock price X Stock Price EBIT X 9.5 8000000 Tax rate 40% X Stock Value 76000000 Refer1 Borrowd Money $6,000,000 Interest loan 10% =$6,000,000*10%(1-0.40) 1080000 360000 Cost of debt $6,360,000 Refer2 Putting money in own equity 1000000 Cost of equity Price of stock paid+ buying own equity =76000000+1000000 Cost of equity $77,000,000 Refer 3 1) What is the cash flow to the equity investor in the third year in millions (the final year of the project, including sale proceeds and loan repayment)? Cost Of equity+ Cost of debt $82,360,000 2) What is the rate of return to you as the equity investor (in percentage)? Cost Of equity+ Cost of debt $83,360,000 By refer1,2,3 EBIT $8,000,000 Cost of capital $83,360,000 Rate of return 10%
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