Essay About Cash Flows And Moderate Leverage Financing

North Village Capital Private Equity Case
North Village Capital Private Equity Case Executive SummaryAfter analysing 3 scenarios involving different amounts of debt we advise the private equity firm to opt for moderate leverage financing. We recommend the company to be financed with an operating loan between $1.7m (economic downturn) and $2.7m (stable economy) in the first year in order to adequately serve interest payments and to avoid exceeding a balance of $3.4m in any year. The remaining debt takes the form of a $16.98 senior loan and subordinated loan of $4.25m. The remaining balance lying between $27.1 and $28.1m should be financed with equity from the private equity firm. Entering the investment at $51m and exiting after 4 years at 6xEBITDA (2014) of $108m, yields an IRR of 32.42% which is above the required rate of return of 20%. Furthermore, this scenario avoids EBITDA/Interest and Debt/EBITDA covenant breaches. ForecastsOperations – The continuing deterioration of the Canadian economy could potentially lower revenue by as much as six percent. Therefore, a financial forecast with minimum expected revenues is analyzed with revenues lowered with this amount. It seems that even under the lower revenue amounts, no covenants were breached under any leverage scenario.  Business Debt Schedule – Under each leverage scenario the difference between operating cash flows and cash flows used for investment will be used for the mandatory repayment of the senior loan. In the event there is a surplus of cash flows, these proceeds will be used to repay the operating loan to decrease interest expense for the following year. Under the moderate leverage scenario these operating loan repayments start in 2011. Furthermore, in 2013 the operating loan is paid off and the cash surplus can be used to pay off an additional $1.2m of the senior loan. Under the highly leveraged scenario, the high interest expense decreases cash flows from operations in such a way that additional financing is needed to be able to meet mandatory repayments of the senior loan. Even not using any of the operating loan credit in the first year will yield insufficient room to meet the requirement of maximum $3.4m in operating loans. A highly leveraged buyout is therefore not sensible due to the high effort requirement to remain solvent.