Suppose that you are an experienced entrepreneur. At the end of 2019, you consider acquiring a struggling business, SUFE One, which does not have any liability. Its 2019 revenues and expenses are shown in the provided spreadsheet. The 2019 depreciation of $100 is associated with the firm’s historical long-term investments. The same amount will incur each year throughout the analysis. The fair market value of SUFE One’s assets, which is also the acquiring price, is estimated to be $2000. But you only have $600 available to invest. Fortunately, the University Board is convinced to lend you the rest of the funds needed at the annual interest rate of 8%. Clearly, this acquisition will result in a highly levered company. And we typically call such transaction leveraged buyout or LBO. Please answer the questions in the following scenarios, given the income tax rate is always 33%.

1) After the LBO, what are the amounts of debt and equity shown on the balance sheet of the new company?

2) Suppose that you plan to expand the business in 2020 by investing $100 in PPE. This investment depreciates over a 12-year period. As a result, the gross margin and operating expenses will both increase by 8%. What is the net income for 2020? (Hint: the total depreciation is the sum of the $100 from historical investments and the depreciation from the new investment. The interest expense is the charge based on the debt balance at the end of 2019.) Compared with 2019, does the change in net income reflect that of the operational profitability?

 

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Capitalization Senior debt Subordinated debt Total debt Common equity Total capital Projected Income Statement Sales December 31, 2010 Cost of sales Depreciation Selling, general, and administrative expense Operating income Interest expense Income before income taxes Provision (credit) for income Taxes Net Income Projected Cash Flow Net income Depreciation Cash from operations Less: Property and equipment additions Cash available for debt reduction Projected Capitalization Senior debt Subordinated debt Total debt Common equity Total capital 900 500 1,400 600 $2,000 2010 (Act.) $1,429 800 100 286 243 45 198 65 $ 133 2010 (Act.) $ 900 500 1,400 600 45% 25% 70% 30% 100% 2012 2013 2014 2011 $1,543 $1,667 $1,800 $1,944 864 933 1,008 1,089 108 117 309 333 262 108 154 51 $ 103 2011 S 103 108 $ 211 100 $ 111 2011 $ 789 500 1,289 $ 703 283 100 183 60 S 123 2012 S 123 117 $ 239 108 $ 131 2012 $ 657 500 1,157 $ 826 126 360 306 91 215 71 $ 144 2013 $ 144 126 $ 270 117 $ 153 2013 $ 504 500 136 389 331 80 250 83 $ 168 2014 $ 168 136 $ 304 126 $ 178 2014 $326 500 1,004 826 $970 $1,138 $2,000 $1,992 $1,983 $1,974 $1,964 2015 $2,100 1,176 147 420 357 68 289 95 S 194 2015 $ 194 147 $341 136 $ 205 2015 $ 121 500 621 $1,332 $1,953 1.08 1.083333 1.076923 1.079365 0.194175 0.170732 0.166667 177.984 8.230453 2156.379 2329.218 867 1,172 Capitalization Senior debt Subordinated debt Total debt Common equity Total capital Projected Income Statement Sales December 31, 2010 Cost of sales Depreciation Selling, general, and administrative expense Operating income Interest expense Income before income taxes Provision (credit) for income Taxes Net Income Projected Cash Flow Net income Depreciation Cash from operations Less: Property and equipment additions Cash available for debt reduction Projected Capitalization Senior debt Subordinated debt Total debt Common equity Total capital 900 500 1,400 600 $2,000 2010 (Act.) $1,429 800 100 286 243 45 198 65 $ 133 2010 (Act.) $ 900 500 1,400 600 45% 25% 70% 30% 100% 2012 2013 2014 2011 $1,543 $1,667 $1,800 $1,944 864 933 1,008 1,089 108 117 309 333 262 108 154 51 $ 103 2011 S 103 108 $ 211 100 $ 111 2011 $ 789 500 1,289 $ 703 283 100 183 60 S 123 2012 S 123 117 $ 239 108 $ 131 2012 $ 657 500 1,157 $ 826 126 360 306 91 215 71 $ 144 2013 $ 144 126 $ 270 117 $ 153 2013 $ 504 500 136 389 331 80 250 83 $ 168 2014 $ 168 136 $ 304 126 $ 178 2014 $326 500 1,004 826 $970 $1,138 $2,000 $1,992 $1,983 $1,974 $1,964 2015 $2,100 1,176 147 420 357 68 289 95 S 194 2015 $ 194 147 $341 136 $ 205 2015 $ 121 500 621 $1,332 $1,953 1.08 1.083333 1.076923 1.079365 0.194175 0.170732 0.166667 177.984 8.230453 2156.379 2329.218 867 1,172

Answer rating: 100% (QA)

31Dec19 31Dec20 31Dec21 31Dec22 31Dec23 31Dec24 Gross Margin 629 679 734 792 856 924 Depreciation ... View the full answer