What is a leveraged buyout (LBO)? What are some of

a. What is a leveraged buyout (LBO)? What are some of the advantages and disadvantages of going private? Hager's Home Repair Company, a regional hardware chain that specializes in "do-it-yourself" materials and equipment rentals, is cash rich because of several consecutive good years. One of the alternative uses for the excess funds is an acquisition. Doug Zona, Hager's treasurer and your boss, has been asked to place a value on a potential target, Lyons Lighting (LL), a chain that operates in several adjacent states, and he has enlisted your help.

The table below indicates Zona's estimates of LL's earnings potential if it came under Hager's management (in million of dollars). The interest expense listed here includes the interest (1) on LL's existing debt, which is $55 million at a rate of 9%, and (2) on new debt expected to be issued over time to help finance expansion within the new "L division," the code name given to the target firm. If acquired, LL will face a 40% tax rate.

Security analysts estimate LL's beta to be 1.3. The acquisition would not change Lyons's capital structure, which is 20% debt. Zona realizes that Lyons Lighting's business plan also requires certain Levels of operating capital and that the annual investment could be significant. The required levels of total net operating capital are listed below.

Zona estimates the risk-free rate to be 7% and the market risk premium to be 4%. He also estimates that free cash flows after 2014 will grow at a constant rate of 6%. Following are projections for sales and other items.

What is a leveraged buyout (LBO)? What are some of

Hager's management is new to the merger game, so Zona has been asked to answer some basic questions about mergers as well as to perform the merger analysis. To structure the task, Zona has developed the following questions, which you must answer and then defend to Hager'shoard.

b. Several reasons have been proposed to justify mergers. Among the more prominent are (1) tax considerations, (2) risk reduction, (3) control, (4) purchase of assets at below-replacement cost, (5) synergy, and (6) globalization. In general, which of the reasons are economically justifiable? Which are not? Which fit the situation at hand? Explain.