RJR Nabisco still among top 10 LBO's

There has been extensive media coverage on the resurgence of leveraged buyouts (LBO's), including a recent cover story, "The Buyout Binge" in the April issue of "CFO Magazine." Nine of the top ten LBO's were recent, and then there was the 1988 acquisition of RJR Nabisco by Kohlberg Kravis Roberts. I showed a segment of the movie "Barbarians at the Gate" to my NYU finance class, and also highly recommend the book. The RJR Nabisco deal highlights the importance that understanding business fundamentals plays in any business deal. Henry Kravis knew he needed a better understanding of RJR Nabisco's core operations so he could price his bid accurately and compete with the insider buyout bid by CEO Ross Johnson. This made Kravis dependent on RJR Nabisco executives such as John Greeniaus, CEO of Nabisco, for their cooperation. Despite Ross Johnson's entreaty, "Johnny, I'm going to make you rich!" Greeniaus eventually did share valuable insights with the KKR team. Hopefully dealmakers are not losing sight of business fundamentals in today's overheated LBO market. The year after the RJR Nabisco deal the market dropped 200 points (a lot in 1989) due to the failure of Robert Campeau's US retail operations, and the unraveling of a $6.8 billion buyout of United Airlines. Nobody wants to see a similar market meltdown resulting from the most recent crop of LBO's.

Finance Exam Questions - Can you solve 'em?

I haven't posted in the last three months to this blog because of a heavy teaching load at NYU School of Continuing Professional Studies, where I teach "Fundamentals of Corporate Finance." Here are five questions from a practice exam I recently gave to my students; how many of these can you solve?

1. If a company with $3 million annual revenue decreases its accounts receivables from 45 days outstanding to 30 days outstanding how much cash is freed up?

2. An investor buys a 30-year, 10% interest bond, for $100,000. If interest rates increase to 20%, the value of this bond would change to:
a. $50,211
b. $91,667
c. $104,762
d. $176,862


3. Which of the following statements distinguishing debt versus equity is true?

a. Debt is an ownership interest, while equity is not
b. A publicly-owned firm’s equity has a fluctuating market price, not its debt
c. An all-debt firm is more likely to go bankrupt than an all-equity firm
d. Companies must have some debt in place before they can sell equity

4. A firm has operating income of $50 million, interest expense of $18 million, dividends paid of $15 million, and a 40% tax rate, what is net income?
a. $10.2 million
b. $12.8 million
c. $19.2 million
d. $21.0 million

5. A premium bond has a coupon rate that:
a. is less than the yield to maturity.
b. equals zero.
c. must be variable.
d. equals the current yield.
e. exceeds the yield to maturity


ANSWERS: 1. $123,288, 2A, 3C, 4C, 5E