Calculate the expected IRR of the following leveraged buyout. The target company is acquired at 5 times

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Question:

Calculate the expected IRR of the following leveraged buyout.

The target company is acquired at 5 times EBITDA (LTM) and is expected to be sold at 5 times EBITDA (LTM) after seven years. The target company’s sales for the financial year that has just concluded was $48 million. The company’s sales are expected to be $50 million in the first year. After the first year, sales will increase by $2 million each year. The company’s EBITDA margin is always 25%, and its EBIT margin is 20%. The company’s working capital does not change, and its depreciation is equal to capital expenditures.

The buyout will be financed with 60% debt. Two-thirds of the debt will be borrowed from banks at an annual interest rate of 9%, and the rest will be borrowed by issuing bonds at par with a coupon rate of 8%, paid annually. The bond will not be repaid until it is matured, which is in seven years. In contrast, the bank debt will be repaid using cash available for debt repayment each year. The interest on the bank debt will be calculated on the ending balance of the previous year’s debt. If the bank debt is fully repaid, the cash available for debt repayment will be paid to the leveraged buyout firm in the form of dividends. The target company’s tax rate is 30%, and all cash flows occur at the end of the year.