LANDMARK FACILITY SOLUTIONS Case SolutionÂ
Â Would Broadway be capable of servicing its debt after the acquisition?
The valuation of the acquisition opportunity has been performed on the basis of both the scenarios. Looking at the valuations of the Landmark Company, it could be seen that the alternative 2 of financing which is going for 50% debt and 50% equity is the best financing alternative for the company. The firm value under this financing alternative is highest and significantly high with a cost of capital of 4.67% under this alternative. Moreover, funding the entire acquisition by 100% of debt might prove to be risky for the company in future; therefore, the best financing alternative for the management is to basically go ahead with a mix of debt and equity financing.
In order to determine that whether Broadway would be able to service its debt or not, first of all the operating income and the free cash flows for the Broadway company have been calculated on the basis of the optimistic and the pessimistic assumptions for both the financing alternatives. The relative interest payments under both the financing alternatives have also been calculated based upon the structures of the $ 120 million and $ 60 million loans under alternative 1 and 2. Moreover, the interest coverage ratio and the free cash flow over interest expense ratios have been calculated.
The average interest coverage ratio and the FCF/Interest expense ratio for first financing alternative under the best case and worst case scenario for Broadway would be (2.16, 1.4) and (1.64, 2.03) times. These ratios for both the financing alternatives for optimistic and pessimistic case would be (3.61, 2.34) and (2.85, 3.63) times. Again it could be seen that these ratios are much higher for the second financing alternative. Nonetheless, debt has advantagesas it is much cheaper as compared to equity and the reason for this is that the interest expenses on the debt are basically tax deductible and this results in the increase of the firm value also. However, if the level of debt increases beyond a certain optimal level then the firm is at risk. Therefore, the best financing alternative for the company in order to fund this $ 120 million acquisition opportunity is to seek 50% debt and 50% equity.
Â What is the relative cost of equity dilution?
If Harris opts for the mix of debt and equity financing, then he will be giving up on the value of the shareholders. This is because if Harris had opted for 100% of debt for financing this transaction, then the cost of equity of the equity holders would have also increased significantly. However, now the debt would be 50% rather than 100%, therefore, the cost of equity of the equity holders would be lower and in this way Harris gives up on the value of the shareholders by opting for a mix of debt and equity for the acquisition opportunity…………………..
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