Bain Capital is considering a potential candidate, PubCo, for a highly leveraged buyout. Bain will contribute 25% of the deal value into the new “Merger Sub” as cash infusion in exchange for equity. A syndicate led by JP Morgan has agreed to provide debt financing for the remaining 75%. After a thorough study of PubCo’s peer firms, the analyst has determined that the applicable average P/E ratio should be 6, levered beta be 2.4, and debt-equity ratio be 0.3. The equity risk premium is 6.0%. The 10-year Treasury bond rate is 5.0%. The firm’s marginal tax rate is 40%, and there is no cap on the tax deductibility of net interest expense.
If the buyout can be completed in the current year 2014, then starting 2015 Bain Capital can initiate the operation reform with the aim to reduce PubCo’s debt- equity ratio from 1.5 to the target level of 0.05 within five years. After that, the firm’s cost of equity is expected to be 10%, and equity cash flow is expected to grow annually by 4.5%. The analyst also expects that PubCo’s net income can reach $25 billion, and the market average P/E ratio remains unchanged in 2019. The detailed projected free cash flow to equity and debt-equity ratio for the five years from 2015 to 2019 are provided below:

Calculate the total present value of equity cash flow from 2015 to 2019. Show your work.
 

 

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Assumptions Projected Equity CF Debt-Equity ratio 2015 0.50 1.50 2016 0.90 0.64 2017 1.70 0.27 2018 3.30 0.12 2019 6.50 0.05 Assumptions Projected Equity CF Debt-Equity ratio 2015 0.50 1.50 2016 0.90 0.64 2017 1.70 0.27 2018 3.30 0.12 2019 6.50 0.05

Answer rating: 100% (QA)

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