Deаl Structuring with Cоmmоn аnd Cоnvertible Stock (14 points)Setting:Riveroаk Industries is a closely-held, mid-market specialty distributor. The founder/CEO is retiring. After a long negotiation, she has anchored on a headline enterprise value of $300M and has told her advisor, in writing, that she will not entertain offers below that number.Cardinal Capital (a mid-market PE fund) is interested. Cardinal’s deal team has done its work:The bank will lend up to $150M at 7% (pre-tax). No room above that.Cardinal’s investment committee has authorized a $100M equity check for this transaction (it is a control deal). No room above that either.That leaves a $50M financing gap, which the seller agrees to close by rolling $50M of her proceeds into common stock of NewCo. (She walks away with $250M of cash and a common-equity stake at close.)Cardinal’s required return. The deal team underwrites every transaction to a 25% expected IRR hurdle on its committed equity. If the expected IRR comes in below 25%, the team cannot recommend the investment.The proposed split. Cardinal will take a controlling 66.67% of common (a $100M check on a $150M post-debt-equity pool); the seller’s rolled $50M maps to 33.33% of common. This is internally consistent with the $300M headline.Shared assumptionsHold period: 5 years.Marginal/average tax rate: 25%.All available FCF after interest is swept to bank-debt amortization.Operating projections ($M):Year12345FCF2025303540The deal team carries two equally likely exit scenarios at end of Year 5:Low: exit EV = $300M (no EV growth — multiple compression).High: exit EV = $600M.Bank-debt schedule (provided). The year-by-year bank-debt amortization schedule has already been built and is provided to you in the accompanying spreadsheet deal-structure-student.xlsx. The bank is never fully repaid by exit: at the end of Year 5, the closing bank debt is $29.97M. Use this figure in all IRR calculations below — you do not need to rebuild the schedule yourself.Part (a) – IRR with plain common (3 points)Suppose Cardinal takes its 66.67% stake as plain common stock — no liquidation preference, no conversion features, just common.(i) Compute Cardinal’s IRR in the Low scenario and the High scenario.(ii) Compute Cardinal’s expected IRR under equal-probability scenarios.Part (b) – Adding a liquidation preference (6 points)The deal team proposes restructuring Cardinal’s $100M as convertible preferred stock with a 2.5× liquidation preference (face value $250M), convertible into 66.67% of common. At exit, the preferred takes the better of its liquidation preference and its as-converted common value. No preferred dividend during the hold.(i) Recompute Cardinal’s IRR in the Low and High scenarios.(ii) Recompute the expected IRR.Part (c) – Discussion (5 points)(i) Which of the two deal structures do you think Cardinal would offer, and why?(ii) Why might Riveroak’s seller agree to — or push back on — those terms?
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