CALCULATION OF FREE CASH FLOWS for LBO VALUATION

FORECAST HORIZON
1 2 3 4 5
Revenues 3,000,000 3,450,000 3,967,500 4,562,625 5,247,019
Less: Operating exp. 2,100,000 2,415,000 2,777,250 3,193,838 3,672,913
= EBITDA 900,000 1,035,000 1,190,250 1,368,788 1,574,106
Less: Depreciation 200,000 230,000 264,500 304,175 349,801
=EBIT 700,000 805,000 925,750 1,064,613 1,224,304
Less: Interest 550,000 500,000 450,000 400,000 350,000
=PBT 150,000 305,000 475,750 664,612 874,304
Less: Tax @ 40% 60,000 122,000 190,300 265,845 349,722
=PAT (actual PAT) 90,000 183,000 285,450 398,768 524,583
Add: Depreciation 200,000 230,000 264,500 304,175 349,801
Less: Capex 250,000 287,500 330,625 380,219 437,252
Less: Change in WC 150,000 172,500 198,375 228,131 262,351
PAT (for FCF calc) 420,000 483,000 555,450 638,768 734,583
Free Cash Flows 220,000 253,000 290,950 334,593 384,781
Terminal Value FCF 8894465
Total Free Cash Flow 220,000 253,000 290,950 334,593 9,279,247
Discount rate @ WACC 0.8795 0.7819 0.7020 0.6355 0.5787
Discounted FCF 193,493 197,814 204,256 212,618 5,369,746
Value of the Firm, V 6,177,927 < 65 L, hence the LBO is not worthwhile
Less: Debt 5,500,000
Value of Equity, E 677,927 < 10 L, hence not worthwhile from Eq Sh point of view as well !!!
Total LBO is not a profitable deal !!!
Repayment Schedule of the Debt

1 2 3 4 5
Debt in the beginning 5,500,000 5,000,000 4,500,000 4,000,000 3,500,000
Interest on above @10% 550,000 500,000 450,000 400,000 350,000
Repayment during the year 500,000 500,000 500,000 500,000 500,000
Debt at the end of the year 5,000,000 4,500,000 4,000,000 3,500,000 3,000,000

Calculation of D/E Ratio

1 2 3 4 5
Debt 5,000,000 4,500,000 4,000,000 3,500,000 3,000,000
Equity 1,090,000 1,273,000 1,558,450 1,957,218 2,481,800
D/E Ratio 4.587 3.535 2.567 1.788 1.209

Calculation of WACC (year-wise)

Beta 3.000 Given D/E proportion 55 : 10
Risk free rate, Rf 7% D/E ratio of above 5.500
Risk Premium, Rm - Rf 5.5% Cost of Debt, Kd 10.00%
Tax rate, T 40.0%
Target D/E ratio 0.50
Unlevered beta = Levered Beta / {1 + D/E*(1 -T)}
so, Unlev beta is 0.698
Relev beta =Unlev beta * {1+D/e*(1 - T)}
WACC formula = Wd * Kd * (1 -T) + We * Ke
1 2 3 4 5
Re-levered beta 2.62 2.18 1.77 1.45 1.20
Cost of Equity using CAPM, Ke 21.40% 18.98% 16.75% 14.95% 13.62%
WACC 13.70% 12.49% 11.37% 10.48% 9.81%

Schematic Diagram of Discounting in case of LBO

Year FCF Discount factor @ WACC
1 220,000 =1/(1+13.70%)
2 253,000 =1/(1+13.70%)*1/(1+12.49%)
3 290,950 =1/(1+13.70%)*1/(1+12.49%)*1/(1+11.37%)
4 334,593
5 9,279,247
 Termin Val
Year
5,509,370
3,856,559
1,652,811
367,291
1,285,520
300,000 <== we don't show in FCF calculations
985,520
394,208
591,312 <== same as accounting PAT
367,291
459,114
275,468
771,312 <== EBIT*(1 - T)
404,020 <== EBIT*(1-T)+dep-Capex+/- Inc in WC
<== FCFn+1/(WACC-g)

point of view as well !!!

Termin Val
Year
3,000,000
300,000
0
3,000,000

Termin Val
Year
3,000,000
3,073,112 <== this is why we calc actual PAT !!!
0.976
 Termin Val
Year
1.11
13.08%
9.54%

/(1+11.37%)
 LBO - leveraged Buy Out, or HLT, primary source of funding is DEBT !

MBO - Management Buy Out

Step by Step procedure of LBO:

1 Forecast the FCF for the forecast horizon (incl TV)

2 Discount the above using WACC as follows:
a Prepare the loan repayment schedule
b Calculate the D/E ratios for the entire period
c Calculate the Unlevered beta
d Compute the re-levered beta in the light of the D/E ratios
e Based on above, calculate WACC for the entire period (year-wise)
3 Compare the V with the purchase consideration
compare the E with the equity portion of purchase consideration