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Hi..
I have written down an extract from BPP. I am confused with one aspect. I will first write down the question.The directors of ER have decided to concentrate the company’s activities on three core areas, bus services, road freight and taxis. As a result the company has offered for sale a regional airport that it owns. The airport handles a mixture of short-haul scheduled services, holiday charter flights and air freight, but does not have a long runway for long-haul international operations.
The existing managers of the airport, along with some employees, are attempting to purchase the airport through a leveraged management buy-out and would form a new unquoted company, AIR, The total value of the airport (free of any debt) has been independently assessed at $35 million. The managers and employees can raise a maximum of $4 million towards this cost This would be invested in new ordinary shares issued at the par value of 50c per share. ER, as a condition of the sale. proposes to subscribe to an initial 20% equity holding in the company, and would repay an debt of the airport prior to the sale.
EPP Bank is prepared to offer a floating rate loan of $20 million to the management team, at an initial interest rate of LIBOR plus 3%. LIBOR is currently at 10%, This loan ‘would be for a period of seven years. repayable upon maturity, and would be secured against the airport’s land and buildings, A condition of the loan is that gearing, measured by the book value of total loans to equity, is no more than 100% at the end of four years. If this condition is not met the bank has the tight to call in Its loan at one month’s notice AIR would be able to purchase a tour year interest rate cap at 15% tor its loan from EPP Bank for an up-front premium of $800,000.
A venture capital company. AV, is willing to provide up to $15 million in the form of unsecured mezzanine debt with attached warrants. This loan would be for a five year period with principal repayable in equal annual installments, and have a fixed interest rate of 18% per year The warrants would allow AV to purchase 10 AIR shares at a price of 100 cents each for every $100 of initial debt Provided at any time after two years from the date the loan IS agreed, The warrants would expire after five years.The Answer to this (JUST A PART) as per BPP:
FInancial Mix
1. 8 million purchased from managers & Shareholders $ 4 M
2. 2 million purchased by ER $ 1 M
3. EPP bank $ 20 M
4. AV (Balance fig) $ 10 MMY QUESTION IS HOW DOES THE FIGURE COME: 2 MILLION PURCHASED BY ER
THANKS
Hi,
ER, as a condition of the sale. proposes to subscribe to an initial 20% equity holding in the company,So MBO- 8 m
ER – 2m
so total 10 m,
ER- 20%- Topics: 2
- Replies: 6
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Hi Deep,
The Question states:
1. Directors & Employees contribute $4 million
2. ER will contribute Initial 20% of shareholding.
3. The bank will provide a loan with covenants of $ 20 million.
4. Venture capitalist will provide finance UP TO $ 15 million.CALCULATING TOTAL FINANCIAL MIX:
First we need to calculate the TOTAL SHAREHOLDING. In this question there are 4 sources of finance: 2 Equity (ER & Staff) & 2 Debt ( Bank & Venture)For total shareholding, we are aware that $ 4 million (By staff) is already given. We need to find the equity source from ER
STAFF – $ 4 million (therefore, total shares issues 4/0.5 = 8 million shares)
ER – There are only 2 sources of equity finance of which one is given. ER
contributes 20%. Therefore the staff has contributed 80% of total shares.
Total Share = 8 million 80%
x 100%
hence, x = 80*8 / 100 = 10 million
, ER contribution = 10 * 20% = 2 million sharesTotal financing mix
1. Staff $ 4 Million (8/.5)
2. ER $ 1 Million (2/.5)
3. Bank $ 20 M
4. Venture $ 10 M
(Venture capital is balancing figure as total finance required is $35 M)Hope this helps
Hello. Sorry for my English. It is said that the loan would be for a five year period with principal repayable in equal annual installments. In the solution, such a payment is 2 000 000 pa (10 000 000 / 5). Why should it not be 3 197 778? From 10 000 000 / 3.1272, where 3.1272 is anuity for 18% for 5y.
Another thing. The solution says that:
… If the warrants attached to the mezzanine debt are exercised, AV will be able to purchase 1 million new shares in AIR for $1 each. This is a cheap price considering that the book value per share at the date of bu~out is $3.50 ($35m/10 million shares). …
How does that work? Because if you exchange $10 000 000 debt for 1 000 000 shares, it means that the price is 10 mln/1 mln = $10, but not $1.
Moreover, the terms say that te exachge can be done only after 2 years. After 2 years some part of debt is already repaid by $4 mln ($2 mln per year) and the actual price should be 6mln (10-4) divided by 1mln shares which is $6 per share, but not $1 per share.In terms of your first question, it’s because of the way The interest is calculated. Since the principal is payable in five equal instalments then the interest is calculated this way (on the remaining balance of the loan).
So interest in year 1 = $10mn × 0.18= $1.8mn
Interest in year 2= $8mn × 0.18= $1.44mn
In year 3 = $6mn × 0.18= $1.08mn
The pattern above continues for the duration of the loan.
In terms of your second question it’s because no trade is being made of debt for equity. The warrant give a right to buy a million shares at a strike price of $1 a share after two years. This doesn’t impact the debt part of the agreement.
The point is that according to my initial calculation, IN FACT at the beginning, the price is 10$ but 1$ per share. I will repost the calculation bellow. How about you my friend provide your calculation?
Because if you exchange $10 000 000 debt for 1 000 000 shares, it means that the price is 10 mln/1 mln = $10, but not $1.
No exchange of debt for equity is to occur. Please read my initial response.
$10mn debt Provided
10 shares for every $100 of debt provided.
$10mn/100 = 100000.
10 x 100000 = 1mn shares.
100 cent=$1 strike price for each share.
$1mn cost if option is exercised in full. Are you happy with the response to the interest question that you asked?
I asked the AI on this site for the definition of an equity warrant. The following was its response-
“An equity warrant is a financial instrument that gives the holder the right, but not the obligation, to purchase shares of a company’s stock at a predetermined price (known as the exercise or strike price) within a specified time frame. Warrants are similar to call options, but they are issued by the company itself rather than being traded on an exchange. They are often used as a “perk” to make debt offerings more attractive to investors, allowing them to benefit from potential increases in the company’s stock price. If the market price of the shares exceeds the exercise price, the holder can exercise the warrant to buy shares at the lower price, potentially realizing a profit”.
I asked the AI on this site for the definition of an equity warrant. The following was its response-
“An equity warrant is a financial instrument that gives the holder the right, but not the obligation, to purchase shares of a company’s stock at a predetermined price (known as the exercise or strike price) within a specified time frame. Warrants are similar to call options, but they are issued by the company itself rather than being traded on an exchange. They are often used as a “perk” to make debt offerings more attractive to investors, allowing them to benefit from potential increases in the company’s stock price. If the market price of the shares exceeds the exercise price, the holder can exercise the warrant to buy shares at the lower price, potentially realizing a profit”.
About the calculation you have provided on the share price (it is actually similar to what the book provides). I found some issues there and you did not (as I see). Well if it is absolutely logical to you then I can not do anything. As I said before that Net Net it is still:
$10 000 000 debt for 1 000 000 shares, means that the price is 10 mln/1 mln = $10, but not $1. And Net Net after 2 years will be 6mln (10-4) divided by 1mln shares which is $6 per share, but not $1 per share.
Perhaps I am so stupid that I do not see any errors in my calculation. I will check it twice with my mentor later.
About the percentage question, I am not happy. I remember to do the same calculation and it is clear how to calculate interest payment (no big deal). I will respond later in a couple of days I full if you allow me to do so. No time now. (Sorry for my English).
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