Anatomy of a Leveraged Buyout - NYU Stern School of Business

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The “key” determinants of debt capacity are tax rates and cash flows In all three approaches, the capacity of a firm to borrow money is determined by its cash flows, not its market value or growth prospects. • The greater the cash flows generated are as a percent of enterprise value, the higher the optimal debt ratio of a firm. • The more stable and predictable these cash flows are, the higher the optimal debt ratio of a firm. The most significant benefit of debt is a tax benefit. Higher tax rates should lead to higher debt ratios. With a zero tax rate the optimal debt ratio will be zero. Implication: Mature or declining firms in businesses that generate high and predictable cash flows will be the best candidates for financial leverage. Does Harman pass the test? Aswath Damodaran 26
The macro environment has a relatively small effect on optimal debt ratios Myth 1: Optimal debt ratios will increase as interest rates decline. While it is true that lower interest rates push down the cost of debt, they also push down the cost of equity. Myth 2: Optimal debt ratios will increase as default spreads decline. Default spreads have historically declined in buoyant markets, which also push equity risk premiums down. In other words, both the cost of debt and equity become cheaper. Aswath Damodaran 27
Page 1 and 2: Anatomy of a Leveraged Buyout: Leve
Page 3 and 4: One Example: The Harman Deal Pre-de
Page 5 and 6: I. Value and Leverage Aswath Damoda
Page 7 and 8: The fundamental question: Does the
Page 9 and 10: 1. Tax Benefit: Debt: The Basic Tra
Page 11 and 12: The Miller-Modigliani Theorem In a
Page 13 and 14: Tools for assessing the effects of
Page 15 and 16: How the debt trade off manifests it
Page 17 and 18: Harman : Working out the mechanics.
Page 19 and 20: Limitations of the Cost of Capital
Page 21 and 22: Estimating the Distress Effect- Har
Page 23 and 24: c. The APV Approach to Optimal Capi
Page 25: Harman: APV at Debt Ratios Based up
Page 29 and 30: II. The Value of Control Aswath Dam
Page 31 and 32: What is the value of control? The
Page 33 and 34: Reinvestment Rate 42.00% Current Ca
Page 35 and 36: Reinvestment Rate 70.00% Current Ca
Page 37 and 38: Implications for the control premiu
Page 39 and 40: III. The Public/ Private Transition
Page 41 and 42: Perceived Risk: Private versus Publ
Page 43 and 44: Why go private? Agency issues: The
Page 45 and 46: Good candidates for going private..
Page 47 and 48: Leverage and Control The good: A f
Page 49 and 50: Leverage and Going Private The Goo

Anatomy of a Leveraged Buyout - NYU Stern School of Business

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