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Lagoon Inc. is a multinational firm whose stable cash flows have attracted the attention of Bayou Capital, a private equity firm specialized in leveraged buyouts. An analyst at Bayou Capital has made the following projections for the next five years (all numbers in millions):

	Year 1	Year 2	Year 3	Year 4	Year 5
Sales	2100	2200	2310	2410	2505
- COGS	700	730	765	800	835
- SG&A	800	840	880	920	960
- Depreciation	200	210	220	230	240
= EBIT	400	420	445	460	470
- Tax	140	147	155.75	161	164.5
= NOPAT	260	273	289.25	299	305.5
+ Depreciation	200	210	220	230	240
- Capex	215	220	225	230	235
- Change in NWC	5	5	5	5	5
= FCF	240	258	279.25	294	305.5

If the firm was unlevered, its cost of equity would be 12%. The risk-free rate is 4% and the cost of debt is 8%. The firms marginal tax rate is 35%.

1

After year five, the firms free cash flow is projected to grow at a rate of 3% per year. The firm will also stop paying down its debt and its debt will grow at the same rate as its free cash flow. The firms schedule of borrowings and principal repayments is as follows:

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Debt outstanding at year-end	2750	2590	2395	2155	1875	1560
Principal repayment at year-end		160	195	240	280	315

Interest is paid at year-end based on the amount of principal outstanding at the end of the previous year. Today is the end of year zero. The year zero amount of debt is raised today and is subject to a 1% flotation fee on the gross proceeds raised. The flotation fee can be amortized on a straight line basis over the next five years.

a) What logical mistake did the analyst make in the projection of capital expenditures?

b) Ignoring the above mentioned mistake, perform an APV valuation of the Lagoon Inc LBO. Start by calculating the unlevered firm value, then add interest tax shields and subtract net flotation costs.

c) What is the capital structure of this LBO?

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