Assume that, based on similar transactions, an analyst believes that a buyout firm will be able to borrow about 5.5 times first-year EBITDA of $200 million (i.e., about $1.1 billion) and that the buyout firm has a target senior to subordinated debt split of 75% to 25%. Further assume that investors in the buyout firm wish to exit the business within eight years after having repaid all of the senior debt. To accomplish this objective, the investors intend to use 100% of cash available for debt reduction to pay off senior debt; the subordinated debt will be is payable as a balloon note beyond year 8. Using the scenario in the template “Excel-Based Model to Estimate Firm Borrowing Capacity” on the companion site as the base case, answer the following questions:
a. Will the buyout firm be able to exit its investment by the eighth year if sales grow at 3% rather than the 5% assumed in the base case and still satisfy the assumptions in the base case scenario? After rerunning the model using the lower sales growth rate, what does this tell you about the model’s sensitivity to relatively small changes in assumptions?
b. How does this slower sales growth scenario affect the amount the buyout firm could borrow initially if the investors still want to exit the business by the eighth year after paying off 100% of the senior debt and maintain the same senior to subordinated debt split?