Capital Structure Changes

Levering Up

With little debt, excess cash, and substantial earnings, Ideko appears to be significantly underleveraged. You plan to greatly increase the firm’s debt and have obtained bank commitments for loans of $100 million should an agreement be reached.

These term loans will have an interest rate of 6.8%, and Ideko will pay interest only during the next five years. The firm will seek additional financing in 20X8 and 20X9 associated with the expansion of its manufacturing plant, as shown in the spreadsheet below. While Ideko’s credit quality should improve over time, the steep slope of the yield curve suggests interest rates may increase; therefore, on balance, you expect Ideko’s borrowing rate to remain at 6.8%.


Given Ideko’s outstanding debt, its interest expense each year is computed as:

\[\begin{align*} & \text{Interet in Year } t = \text{Interest Rate} * \text{Ending Balance in Year} (t - 1) \end{align*}\]

The interest on the debt will provide a valuable tax shield to offset Ideko’s taxable income.

Sources and Uses of Funds for Ideko Acquisition

In addition to the tax benefit, taking out a loan would allow Kleiner Perkins to limit its investment in Ideko and preserve its capital for other investments and acquisitions. The sources and uses of funds for the acquisition are shown below:


In addition to the $150 million purchase price for Ideko’s equity, $4.5 million will be used to repay Ideko’s existing debt. With $5 million in advisory and other fees associated with the transaction, the acquisition will require $159.5 million in total funds. Kleiner Perkins’ sources of funds include the new loan of $100 million as well as Ideko’s own excess cash (which Kleiner Perkins will have access to). Thus, Kleiner Perkins’ required equity contribution to the transaction would be 159.5 - 100 - 6.5 = $53 million.