An all-equity financed company has a cost of capital of 10 percent. It owns one asset: a mine capable of generating $100 million in free cash flow every year for five years, at which time it will be abandoned. A buyout firm proposes to purchase the company for $400 million financed with $350 million in debt to be repaid in five, equal, end-of year payments and carrying an interest rate of 6 percent.
a. Calculate the annual debt-service payments required on the debt.
b. Ignoring taxes, estimate the rate of return to the buyout firm on the acquisition after debt-service.
c. Assuming the company’s cost of capital is 10 percent, does the buyout look attractive? Why or why not?
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