Special Appendix 2 Leveraged Buyouts

Leveraged buyouts “Shell corporation” is formed to acquire existing company Investor group often includes existing employees Heavy debt financing used to provide funds for stock purchase Purchase accounting methods are applied with modifications SA#2

+ + Valuing an LBO Fair value block Equity-Adjusted block Book Value block SA#2

Fair value block Shares of new shareholders and Shares held in prior company if residual interest does not exceed 5% in new company subject to constraints Residual interest: all outstanding common stock and those preferred shares that do not have liquidation or redemption features. SA#2

Fair value block, continued Constraints on inclusion of prior company shares: Individual’s residual ownership percentage has increased does not exceed 5% of new company SA#2

Fair value block, continued Constraints on inclusion (continued): Individual’s residual ownership percentage has decreased individual's voting interest in common stock < 20% and individual supplied < 20% of new company’s total capital (debt + equity) individual’s new residual interest < 5% and residual interest of all owners whose interest decreased < 20% SA#2

Fair value block, continued Limitation on number of shares to include in fair value block: If monetary consideration < 80% shares comprising market value block is limited total common shares outstanding times the monetary consideration percentage If monetary consideration  80% no limitation Monetary consideration: cash + debt + debt-type securities SA#2

Equity-adjusted cost block Shares that do not qualify for the fair value block Recorded at their simple-equity-adjusted cost basis Shareholders are referred to as “continuing” SA#2

Book value block Shares that qualified for the market block but were eliminated by the monetary consideration constraint for example, if 85% of the shares met the market block test, but monetary consideration was 70%, this would be the 15% disqualified block. SA#2

Recording a leveraged buyout The transaction is recorded as a modified direct asset acquisition using purchase rules Accounts are recorded at the sum of 3 possible values SA#2

Recording a leveraged buyout, continued Assume the blocks are 70% market, 20% equity, 10% book Market Portion - a 70% D&D schedule will assign the market value available to each account. Equity Portion - a 20% D&D schedule will assign the equity adjusted cost available to each account. Book Value Portion - 10% of each account remains at book value SA#2