This is for reading 48 on private equity on the Appendix 48B section on pages 89 and 95 of the CFAI book. Why is interest expense for the LBO calculated “by multiplying the interest rate times the balance of the debt outstanding at the beginning of the previous year”? Isn’t usually based on the balance during the year your working with? Also, on the CF statement, why is depreciation added back and then taken out as “reinvested depreciation”? It says b/c they cancel each other out they’re usually not shown. What does “reinvested depreciation” mean?
This interest expense calculation is very similar to the Interest Cost on the Pensions side. You have a Prior Period debt / liability. You are paying an interest cost on that. (It is an assumption). They say this also in the book: " To avoid circularity in the spreadsheet - the interest amounts are calculated by multiplying interest rate times balance of debt outstanding at the beginning of the previous year. (And footnote says - this will cause a slight overestimate of interest charges)" – so it is a simplifying assumption. Reinvested Depreciation - I am not completely sure - but I believe it has got to do with the fact that the company is not actually having the non-cash charges related to Depreciation that has been deducted on the Income Statement. (Much like the Recaptured Depreciation on fthe Real Estate side).
my thoughts is “Reinvested Depreciation” is firm used cash to purchase PP&E to cover what they lost in current year’s depreciation. In real life, many firms do that to keep current prodution capacity or service quality, to avoid affect by too many old machines. In CFAi book 5 P 95., exhibit B-1, the line under “Reinvested Depreciation” is " New (or Net) Capital Expenditures" , which= total Capital Expenditures - Depreciation. This part of Capital Expenditures is to bring firm’s capacity or service to a higher level, i.e. expansion.
Annexhuy nailed the Reinvested Depreciation part. http://www.analystforum.com/phorums/read.php?12,907678,907699#msg-907699