McNabb Enterprises is considering going private through a leveraged buyout by management. Management currently owns 21 percent of the 5 million shares outstanding. Market price per share is $20, and...

McNabb Enterprises is considering going private through a leveraged buyout by management. Management currently owns 21 percent of the 5 million shares outstanding. Market price per share is $20, and it is felt that a 40 percent premium over the present price will be necessary to entice public shareholders to tender their shares in a cash offer. Management intends to keep its shares and to obtain senior debt equal to 80 percent of the funds necessary to consummate the buyout. The remaining 20 percent will come from junior subordinated debentures.

Terms on the senior debt are 2 percent above the prime rate with principal reductions of 20 percent of the initial loan at the end of each of the next five years. The junior subordinated debentures bear a 13 percent interest rate and must be retired at the end of six years with a single balloon payment. The debentures have warrants attached that enable the holders to purchase 30 percent of the stock at the end of the sixth year. Management estimates that earnings before interest and taxes will be $25 million per year. Because of tax-loss carry forwards, the company expects to pay no taxes over the next five years. The company will make capital expenditures in amounts equal to its depreciation.

a. If the prime rate is expected to average 10 percent over the next five years, is the leveraged buyout feasible?

b. What if the prime rate averages only 8 percent?

c. What minimal EBIT is necessary to service the debt?