IAI Actuarial Core Principles · Business Finance · Corporate growth, restructuring and divestment
A group's managers propose a leveraged management buy-out (MBO) of one of its divisions, funded mostly by bank debt and private equity. Which risk is most characteristic of this structure?
The characteristic risk is high gearing: the debt used to buy the division must be serviced from the division's own cash flows, so interest and repayment obligations create significant financial risk if trading falls short.
- AHigh gearing creating heavy interest and repayment burdens on the divisional cash flowsCorrect
- BDilution of the parent's earnings per share
- CLoss of limited liability for the managers
- DInability to use any debt finance
- Automatic delisting of the parent company
Explanation
A leveraged MBO puts substantial debt on the acquired business, so interest and repayments must be met from its cash flows, raising financial risk. The other options do not follow from the structure, since debt is used and the buyer is a new vehicle.
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