Lagoon Inc. is a multinational firm whose stable cash flows have attracted the attention of Bayou Capital, a private equity firm specialized in leveraged buyouts. An analyst at Bayou Capital has made the following projections for the next five years (all numbers in millions): Year 3 Year 4 2410 800 920 Year 5 2505 835 960 Year 1 Sales 2100 - COGS 700 - SG&A 800 Depreciation 200 = EBIT 400 - Tax 140 = NOPAT 260 + Depreciation 200 Capex 215 - Change in NWC 5 = FCF 240 Year 2 2200 730 840 210 420 147 273 210 220 2310 765 880 220 445 155.75 289.25 220 225 230 460 161 240 470 164.5 305.5 240 299 230 230 5 294 235 5 5 5 258 279.25 305.5 If the firm was unlevered, its cost of equity would be 12%. The risk-free rate is 4% and the cost of debt is 8%. The firm's marginal tax rate is 35%. After year five, the firm's free cash flow is projected to grow at a rate of 3% per year. The firm will also stop paying down its debt and its debt will grow at the same rate as its free cash flow. The firm's schedule of borrowings and principal repayments is as follows: Year o Year 1 Year 2 Year 3 Year 4 Year 5 2750 2590 2395 2155 1875 1560 Debt outstanding at year-end Principal repayment at year-end 160 195 240 280 315 Interest is paid at year-end based on the amount of principal outstanding at the end of the previous year. Today is the end of year zero. The year zero amount of debt is raised today and is subject to a 1% flotation fee on the gross proceeds raised. The flotation fee can be amortized on a straight line basis over the next five years. a) What logical mistake did the analyst make in the projection of capital expenditures? b) Ignoring the above mentioned mistake, perform an APV valuation of the Lagoon Inc LBO. Start by calculating the unlevered firm value, then add interest tax shields and subtract net flotation costs. c) What is the capital structure of this LBO? Lagoon Inc. is a multinational firm whose stable cash flows have attracted the attention of Bayou Capital, a private equity firm specialized in leveraged buyouts. An analyst at Bayou Capital has made the following projections for the next five years (all numbers in millions): Year 3 Year 4 2410 800 920 Year 5 2505 835 960 Year 1 Sales 2100 - COGS 700 - SG&A 800 Depreciation 200 = EBIT 400 - Tax 140 = NOPAT 260 + Depreciation 200 Capex 215 - Change in NWC 5 = FCF 240 Year 2 2200 730 840 210 420 147 273 210 220 2310 765 880 220 445 155.75 289.25 220 225 230 460 161 240 470 164.5 305.5 240 299 230 230 5 294 235 5 5 5 258 279.25 305.5 If the firm was unlevered, its cost of equity would be 12%. The risk-free rate is 4% and the cost of debt is 8%. The firm's marginal tax rate is 35%. After year five, the firm's free cash flow is projected to grow at a rate of 3% per year. The firm will also stop paying down its debt and its debt will grow at the same rate as its free cash flow. The firm's schedule of borrowings and principal repayments is as follows: Year o Year 1 Year 2 Year 3 Year 4 Year 5 2750 2590 2395 2155 1875 1560 Debt outstanding at year-end Principal repayment at year-end 160 195 240 280 315 Interest is paid at year-end based on the amount of principal outstanding at the end of the previous year. Today is the end of year zero. The year zero amount of debt is raised today and is subject to a 1% flotation fee on the gross proceeds raised. The flotation fee can be amortized on a straight line basis over the next five years. a) What logical mistake did the analyst make in the projection of capital expenditures? b) Ignoring the above mentioned mistake, perform an APV valuation of the Lagoon Inc LBO. Start by calculating the unlevered firm value, then add interest tax shields and subtract net flotation costs. c) What is the capital structure of this LBO