Question 1: Is Congoleum a good LBO candidate? In other words, does this company have a lot of debt capacity?
To judge if a company is a good LBO candidate the following are very important factors: low levels of debt in the target, stable cash flows, excess cash on-hand, assets that can be used as collateral to raise debt and no major capital requirements to keep the business running on an on-going basis. Congoleum is an ideal LBO candidate because:
1. Low level of debt – estimated long term debt is around 15.6 million
2. High asset base with assets worth 323 million
3. Stable cash flows with estimated total revenues increasing from 559.9 million in 1978 to 937.8 million in 1984 (Note also its strong intellectual property as shown by its …show more content…

Assuming no ITS when using beta calculation formula and beta of debt = 0
YEAR 1979
Levered equity beta 1.25
Debt/Equity 0.08
Unlevered equity beta 1.16
Cost of equity (unlevered) 0.19

Step 2: Discount FCF using unlevered cost of equity

ASSUMPTIONS MADE:
1. Assuming no ITS when using beta calculation formula and beta of debt = 0
2. Assuming that cost of unlevered equity stays constant
3. Assuming cash flows grow at rate of 7% (due to high inflation) and using cost of equity as a conservative estimate of WACC (CAPV)

YEAR 1980 1981 1982 1983 1984
FCF 55.79 53.30 56.45 66.69 59.41
Cost of equity 0.19 0.19 0.19 0.19 0.19
Terminal value 529.74
Present value of FCF 46.69 37.32 33.08 32.70 241.79
Total APV 391.58

Step 3: Calculate PV of ITS

ASSUMPTIONS MADE:
1. Assuming beta of debt = 0
2. Using cost of debt at 9.50%

YEAR 1980 1981 1982 1983 1984
Total interest payments 42.92 40.56 37.33 34.12 29.87
Additional Depreciation after LBO 27.51 27.46 27.39 27.3 9.52
Tax shield 33.81 32.65 31.07 29.48 18.91
Cost of debt 9.50% 9.50% 9.50% 9.50% 9.50%
PV of ITS 30.87 27.23 23.66 20.51 12.01
Total PV of ITS 114.28

Step 4: Compare purchase price to valuation of Congoleum using APV method
Number of