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Leverage Buyouts Essay

An acquisition of a company or a division of a company with a substantial portion of funds is being generated by utilizing debt financing. Besides creating a tax shield, since interest payments on debt are tax deductible while dividend payments on equity are not. A leveraged buyout has many significant good and bad impacts on the financial statements of the parent company. On the Balance Sheet of the parent company, the debt portion will rise further in shape of increased long term/short term debt depending on the type of financing the company has utilized for the acquisition.

Therefore, the long and short term liability portion on debt side will increase (Rosenbaum and Pearl, 2009). On the assets side of Balance Sheet, the acquired firm and its assets will be added as short as well as long term assets. However, on balance sheet, the company might inherit some depreciated and aged assets which can increase the maintenance and depreciation costs of the company which will be reflected on profit and loss statement (Chung, 2009). LBOs will also affect the cash flows as heavy outflows for significant interest and capital repayments will be made.

Therefore, it is important that the acquiring firm should have

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stable cash flows (Chung, 2009). Also the firm that is being acquired should also have stable cash flows. In Cash Flow from investing activities, there will be significant amount of cash outflow equivalent to 25% of acquired firm’s value. The impact of LBO will also be revealed in profit and loss statement in terms of increased interest charges which will result in decrease in tax charges as the interest payments are tax deductible. This will maximize the overall profit of shareholders, thereby, increasing the return on equity.

Also read about profit leverage effect

The wages will also increase until the management issues are resolved. Overall the Leveraged Buyout with 75% debt and 25% equity will increase the debt portion of company as the parent company is already highly leveraged (68% debt), however, at the same time the company can capitalize on this investment and generate higher returns on assets and equity. Chung, J. W. , 2009, Leveraged Buyouts of Private Companies, http://www. cob. ohiostate. edu/fin/students/Leveraged_buyouts_of_Private_Companies_Chung. pdf Rosenbaum, J. , and Pearl, J. , 2009, Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions, John Wiley and Sons

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