Question

how you would modify the Leverage Buy-Out Analysis model provided in the textbook to consider different states of the economy and different financial performance outcomes for the entity at the transaction exit date.

Answer 1

Leverage Buy-Out : A leveraged buyout is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition.It seeks to determine the price which could be paid by a financial buyer for a target. This analysis is useful in determining the maximum price that could be paid for a company, with financing in the current debt markets, that would generate an appropriate return to a financial buyer.

A leveraged buyout model shows what happens when a private equity firm acquires a company using a combination of equity (cash) and debt, and then sells it in 3-5 years. The PE firm aims to earn a return in the 20 – 25% range from doing this, which far exceeds the historical average annual return in the stock market. It is assumed that the buyer sells the target in the future.

In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds issued in the buyout are usually are not investment grade and are referred to as junk bonds. Further, many people regard LBOs as an especially ruthless, predatory tactic. This is because it isn't usually sanctioned by the target company. It is also seen as ironic in that a company's success, in terms of assets on the balance sheet, can be used against it as collateral by a hostile company.

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