The Capitsky Group, an association of venture capitalists, is considering using

Question

The Capitsky Group, an association of venture capitalists, is considering using a leveraged buyout to purchase Amalgamated Widgets, a well-established manufacturer of high-tech goods.Amalgamated has long-term debt with a book value of $15 million and debt to equity ratio of 1:10. Their stock is currently selling at 120% of book value.Capitsky has $25 million to contribute to the buyout and feels that it will have to offer a 25% premium over the stock’s current market price in order to make the deal work.Estimate Amalgamated’s capital structure after the leveraged buyout.

Explanation / Answer

In leveraged buyout, debt is used to repurchase the equity

Here, Book Value of Debt=15

Book Value of Equity=Book Value of Debt/(Debt/Equity ratio)=150

Market Value of Equity=120%*Book Value of Equity=180

Now, it is able to offer 25 but 25 will only be able to purchase 25/1.25=20 of equity or 20/1.2=16.66 of book value of equity

Remaining 150-16.66=133.33 would have to be still funded from debt

So, Total Debt=133.33+15=148.33 million

Equity=16.66 million

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