Irfan Ahmed, PhD

Valuing LBOs . A LBO can be evaluated from the perspective of common equity investors or of all investors and lenders . LBOs make sense from viewpoint of investors and lenders if present value of free cash flows to the firm is greater than or equal to the total investment consisting of debt and common and preferred equity . However, a LBO can make sense to common equity investors but not to other investors and lenders.   The market value of debt and preferred stock held before the transaction may decline due to a perceived reduction in the firm’s ability to - Repay such debt as the firm assumes substantial amounts of new debt and to - Pay interest and dividends on a timely basis. Valuing LBOs: Variable Risk Method Adjust for the varying level of risk as the firm’s total debt is repaid. . Step 1: Project annual cash flows until target D/E achieved . Step 2: Project debt-to-equity ratios . Step 3: Calculate terminal value . Step 4: Adjust discount rate to reflect changing risk . St...