Problem
2.6 and 2.7 The buyer of Problem 2.5
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2.6 The buyer of Problem 2.5 is also considering the possibility of
financing the acquisition with an alternative structure designed to maintain the interest coverage
ratio at 4.87 times. (Interest coverage is here defined as the ratio of EBITDA to interest expense.) The casts of debt and equity would he 7% and 14.21%,
respectively, and the tax rate would be 38%. How
much can the buyer afford to pay for Fleet Meat Packing Co. under this
financing plan? Compare your result
to those obtained for the previous two problems and explain the differences, if any.
2.7 TN
Inc.. a
manufacturer of computer storage devices, is planning to go public at the end of 2007. The purpose of the IPO
is to retire debt and liquefy the position of some of its original investors.
Future growth will he financed by TPI's internally generated cash flow and the additional borrowing made possible by the
expected increase in the company debt capacity.
The company has put together the following projection:
 |
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(S millions)
|
2008
|
2009
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2010
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2011
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2012
|
|
EBIT
|
24.8
|
28.0
|
32.0
|
34.0
|
37.0
|
|
Depreciation
|
5.8
|
7.6
|
9.2
|
10.2
|
11.0
|
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Increase in deferred taxes
|
0.8
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0.6
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0.7
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0.7
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1.0
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Capital expenditures
|
18.2
|
12.2
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14.3
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14.3
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12.0
|
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Net working capital change
|
(0.8)
|
(0.8)
|
1.0
|
1.8
|
0
|
Currently, TPI has net
debt of $112 million, but its CFO has already negotiated retiring $53
million with the proceeds of the equity issue and refinancing the rest at
7.86%. As a consequence, TPI • expected to
begin 2008 with its net debt reduced to $59 million and its interest coverage ratio (here defined as
EBIT-to-interest) increased to about 5.99. The CFO plans to maintain the
coverage ratio at that level afterwards and expects to raise future debt at an interest rate of about 8%. As
far as the debt-ratio is concerned, the goal is to keep it at about 26%
of enterprise value. The CFO believes that debt ratio would be consistent with the target coverage ratio.
TPI's corporate tax rate is 38%. Its cost of equity is estimated
accounting for risk and its relatively
small size (its beta for the planned capital structure equals 2.0, the Treasury
yield is 4.5%, the equity premium is 4.4%, and the micro-cap size premium is
3.9%). TPI has issued 10 million
shares to its present owners and plans to issue 5 milli
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