Assignment 1 Final

FINE6150 – assignment#1

LBO Case: Toys R U’s

Assignment # 1

February 01, 2012

Basel TawilTeerapatVithayakornbundit

Sonali Dash

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ContentsExecutive Summary.......................................................................................................................................3

Question 1......................................................................................................................................................3

Question 2......................................................................................................................................................3

Question 3......................................................................................................................................................3

Question 4......................................................................................................................................................4

Question 5......................................................................................................................................................4

Question 6......................................................................................................................................................4

Question 7......................................................................................................................................................5

Question 8......................................................................................................................................................5

Question 9......................................................................................................................................................5

Appendix 1.....................................................................................................................................................6

Appendix 2.....................................................................................................................................................7

Appendix 3.....................................................................................................................................................8

Appendix 4.....................................................................................................................................................9

Appendix 5...................................................................................................................................................10

Appendix 6...................................................................................................................................................11

Appendix 7...................................................................................................................................................12

Appendix 7...................................................................................................................................................13

Appendix 8...................................................................................................................................................14

Appendix 9...................................................................................................................................................15

Appendix 10.................................................................................................................................................16

Appendix 11.................................................................................................................................................17

Appendix 12.................................................................................................................................................18

Appendix 13.................................................................................................................................................19

Appendix 14.................................................................................................................................................20

Appendix 15.................................................................................................................................................21

Appendix 16.................................................................................................................................................22

Appendix 17.................................................................................................................................................23

Appendix 18:................................................................................................................................................24

Appendix 19:................................................................................................................................................25

Appendix 20:................................................................................................................................................25

References:...................................................................................................................................................25

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Executive SummaryThis paper analyzes the public to private transaction done by Kohlberg, Kravis & Roberts (KKR), Bain Capital

Partners and Vornado Realty Trust on a major a specialty retailer, Toys R Us in March 2005. We have looked into the drivers of this deal taking into consideration the industry landscape, financial condition of the company and impacts of the change in capital structure. We have done further in-depth analysis using an LBO model and sensitivity analysis.

Question 1Toys R Us is a specialty retailer of toys, children’s apparel and baby products. It has about 1500 stores

worldwide that are either operated, licensed or franchised. The company consists of 4 major divisions; Toys R US – US, Toys R US International, Babies R US and Toysrus.com. The first two sell toys, games bicycles, and sporting goods in different markets. Babies R Us is a retailer that targets the baby/juvenile market. It sells furniture such as cribs and baby gear such as yards and highchairs. Toysrus.com is a growing model where the company sells its merchandise through the internet. The company’s business strategy is to have the concept of one stop shop for toys and related matters. In order to expand its business and return, Toys ‘R’ Us focused on two growth strategies. The first is to leverage its core competency in having a large retail store as a one stop shop for kids and find closely related products that complement toy shoppers to retail. Its second growth strategy was to expand from the U.S market into the international market.

Starting the early 2000’s, the company’s performance started deteriorating because of shifts in the retail toy industry. Discount and mass merchandisers that have greater gross margins and better supplier chains started competing fiercely in the specialty toys department. In addition, there has been a significant change in demand for toys as young kids increasingly prefer video games over conventional toys. Appendix 1 shows the growth of different categories of Toys in the U.S market.

Question 2Before the acquisition:

a) the company had 220.54 million common shares outstandingb) the market value of its equity was $5.462 billion and diluted equity value is $6.011 billionc) no dividend was paid to the share holdersd) diluted earnings per share was $1.16 in 2005e) the company’s capital structure consisted of 24 % debt, 76% of common shares and no preferred shares

The buyer paid 8% premium over the market price of $24.77 and thus the diluted equity value of the company rose to $6.4924 billion after the acquisition. The 2005 annual report of the company did not disclose the names of the major shareholders. Please refer to Appendices 2 and 9 for more details.

Question 3In 2005, the company’s capital structure consisted of 24 % debt, 76% of common shares and no preferred

shares. It had reported $1.25 billion cash from operating, financing and investing activities and $0.746 billion cash from operating activities alone. (Please refer to Appendix 7 for the historical cash flow statements). Toys R Us was a good LBO candidate because of the following reasons. a) It had maintained stable cash flows historically. This increased the probability that its business would generate

enough cash to meet debt obligations after the LBO was executed. b) It had a high current ratio of 45% (Appendix 2), this implied that a private equity (PE) firm could liquidate its

current assets to make the interest payments. c) It was a leading specialty toy retailer in 1980’s and 90’s. This shows that its business is matured and a PE firm

would not have to make long-term capital investments in this company to generate profits. This is especially favorable to PE firms, given that PE firms exit from an investment in 5 to 10 years.

d) Toys R Us had low debt in 2005, which provided it with financial flexibility. Our calculations in Appendix 3 show that its WACC decreased with the debt to equity ratio was increased. This shows that more debt could be added to the company’s capital structure without a significant increase of risks.

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e) Al though the company had been facing growth issues within its main division, other divisions, particularly Babies ‘R’ Us showed a marked improvement in revenues year to year. Appendix 4 shows the increasing margin of Babies ‘R’ Us compared to other divisions.

f) Toys R Us had higher gross margin (32%, Appendix 5) than its competitors (Staples (28%) and Office Max (20%), (Datamonitor 360, 2011)). This is an indication of the strong position of the company in the industry.

g) Toys R Us would be considered a good candidate in terms of collateral. Appendix 6 shows that the debt of 4.4 Billion could be raised using the collateral schedule of assets.

Question 4Facing both difficult industry trends and weak performance of U.S. toy stores (Appendices 7& 8), Toys .R. Us

decided to conduct a strategic evaluation of its worldwide assets and operations. The company initially decided to separate the U.S. toy retailing business and Babies R Us by running a thorough sale process for its toy retailing business, which then did not generate enough profit. However, participants in the auction determined it would be too difficult to uncouple the businesses. With no compelling bids for any of the individual businesses, pressure increased for Toys .R. Us to sell the portfolio of businesses together.

A consortium that included Cerberus, Goldman Sachs, and Kimco Realty Corp. submitted a bid for the entire business. Subsequently Kohlberg, Kravis & Roberts (KKR) teamed up with Bain Capital Partners and Vornado Realty Trust (Bain and Vornado initially joined to bid on the toy business) and submitted a rival bid. On March 17, 2005, Toys .R. Us announced that it had reached an agreement to sell the entire worldwide operations to the consortium of KKR, Bain Capital, and Vornado Realty Trust for $26.75 per share in a $6.7 billion transaction. The acquisition price represented a 122.5% premium over the stock price on the day before the announcement of the strategic review on January 7, 2004, and a 62.9% over the stockprice on August 10, 2004, the day before the Company announced it was seeking to divest its toy retailing business. This increase in share price after the declaration by the company is because of the increased expectations of the shareholders regarding the value of the company resulting from a sell-out or divestiture. After the buyout, Toys R Us went private and was not publicly traded. So there is no available share price after the transaction.

The buyout took place at 8% premium over the share price on March 17, 2005. The diluted equity value of the company increased from $ 6011.49m before the LBO to $ 6492.41m after the transaction because of the premium paid to the shareholders. (Appendix 9)

Question 5Please refer the following appendices for the LBO model and detailed explanation. Appendix 9 – Transaction assumptions Appendix 10 – Sources and uses of cash Appendix 11 – Debt and interest rate assumptions Appendix 12 – Operating assumptions and explanation of projections Appendix 13 – Income Statement projections for 6 years holding period Appendix 14 – Cashflow Statement projections for 6 years holding period Appendix 15 – Debt schedule, interest payments, net interest expenses and cash sweep Appendix 16 – Balance sheet projections for 6 years holding period Appendix 17 – Valuations and IRR calculations for different exit multiples

Question 6The leverage ratio of this deal was 6.65 compared to the average multiple of 5 in 2005. Given that the PE

firm financed through high leverage and Toys R Us operates in a difficult industry, positive macroeconomic factors and an optimistic outlook on toy industry will help mitigating the related business risks, thereby keeping the cost of capital low.

As part of this transaction, John H. Eyler, Jr. (chairman, CEO, and president of Toys .R. Us) and Christopher K. Kay (executive vice president and chief operations officer) were to leave the company. In order to run the company smoothly, it is extremely important that the management of Toys R Us is in agreement with this move. Any discord in the management level will jeopardize the future prospects of the deal.

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A stable customer demand will help the business to grow without too many risks. The returns from this deal can be maximized if the expertise of the PE firm is a right match for the business needs of Toys R Us.

Based on our analysis, PE firm can expect an IRR of 41.3% at exit multiple of 10. According to our analysis, the harvest should have occurred in 2011, six years after the transaction. We believe this has not taken place because of the unexpected economic recession in 2008.

Question 7Toys R Us decided LBO was the best way to enhance shareholder value, when it did not get right bidders for

U.S. toy retailing business in 2003. This unit was not generating profits and the management hoped to create value for shareholders by selling it off. But it did not get materialized.

Advantages of this corporate structure are as follows:a) The company doesn’t have to incur high costs pertaining to compliance, investor relations and so on which are

mandatory for public companies. b) The management can focus on increasing the value of the business rather than worrying about analysts’ opinions

about the company. Since many investors base their decisions on analysts’ reports, there is a high risk off miscommunication of information to the investors.

c) High leverage increases the return to the equity holders.d) High levels of debt pressurize management to operate efficiently so that they can meet the debt obligations. This

indirectly creates value for shareholders. e) Expertise of the PE firms brings a huge value to a company by improving operations and governance.f) PE investors engage in extensive due diligence. This reduces the problems of asymmetric information. g) High debt gives rise to tax-savings and reduces agency costs of equity. This frees up cashflows.

Disadvantages of this structure are:a) High leverage increases risk and cost of capital of a company. b) The company could be in a deep trouble in case it misses out on any of its interest payments.

The company also receives a higher benefit of tax shield because interest payments on debt are tax deductible. For example, in 2005, the total debt was $1,860 million at effective tax rate of 34% compared to the total debt in 2006 of $4,400 million at the same effective tax rate. By adding more debt, Toy “R” Us receive an additional benefit of tax shield of $762 million.

Question 8Toys R Us went private from public through this transaction. So all the advantages discussed in the last

question also hold true for Toys R Us. KKR and Bain Capital have high reputation for their financial engineering capabilities and expertise in carrying out large transactions. In addition, since real estate represented 20% of its assets in 2005, Toys R Us would be benefitted by expertise of Vornado Realty Trust, which was one of the largest owners and managers of real estate in the United States. Our calculations in Appendix 19 shows a significant tax saving that Toys R Us could make because of the leverage involved in this LBO transaction.

Question 9Our calculations in Appendices 17 and 20 show that the PE firms’ consortium could have made an exit from

this transaction in 2010 or 2011 with returns ranging from 28% to 41%. But since the harvest did not occur, we believe that it could be because of the following reasons. a) economic recession in 2008b) The PE firm might be looking to take the company public, but the market condition did not give them the

desired valuations.c) They might be looking for a longer holding period with this investment because of future growth in earnings. d) They are finding it difficult to get a potential buyer

In our opinion, the consortium should have exited from the transaction in 2011, because this would have decreased the risk of potential downsize of the earnings arising due to bad economy.

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Appendix 1

U.S retail Toy industry $ in BillionCategory 2004 2005 Growth

Action figures 1.25 1.30 3.8%Arts & Crafts 2.50 2.40 -4.2%Building Sets 0.60 0.70 14.3%Dolls 2.76 2.70 -2.2%Puzzles 2.64 2.40 -10.0%Outdoor sports 2.78 2.70 -3.0%Infant 3.13 3.10 -1.0%Learning 0.37 0.39 5.1%Plush 1.53 1.30 -17.7%Vehicles 1.96 1.80 -8.9%Others 2.60 2.50 -4.0%

Total tradional toys 22.12 21.29 -3.9%

Video Games 9.91 10.5 5.6%

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Appendix 2

Balance Sheet 2005 2004 Balance Sheet 2005 2004ASSETS LIABILITIES AND STOCKHOLDERS' EQUITY

Current Assets: Current Liabilities:Cash and cash equivalents 1250 1432 Short-term borrowings - -Short-term investments 953 571 Accounts payable 1023 1022Accounts and other receivables 153 146 Accrued expenses and other current liabilities 881 866Merchandise inventories 1884 2094 Income taxes payable 245 319Net property assets held for sale 7 163 Current portion of long-term debt 452 657Current portion of derivative assets 1 162Prepaid expenses and other current assets 159 161 Total current liabilities 2601 2864Total current assets 4407 4729

Long-term debt 1860 2349Property and Equipment: Deferred income taxes 485 538Real estate, net 2393 2165 Derivative liabilities 16 26Other, net 1946 2274 Deferred rent liability 269 280Total property and equipment 4339 4439 Other liabilities 212 225

Minority interest in Toysrus.com - 9Goodwill, net 353 348 Total Liability 5443 6291Derivative assets 43 77Deferred tax asset 426 399 Stockholders' Equity:Other assets 200 273 Common stock 30 30

Additional paid-in-capital 405 407Total Assets 9768 10265 Retained earnings 5560 5308

Accumulated other comprehensive loss -7 -64Total Debt 1860 23.6% Restricted stock -5 -Total Equity (Diluted Equity) 6011 76.4% Treasury shares, at cost -1658 -1707Preferred Equity 0 0.0%Total 7871 Total stockholders' equity 4325 3974

Total Equity + Liability 9768 10265Current Ratio: 0.451Debt/Equity Ratio 0.31

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Appendix 3

Debt 1860 Rd 6.99%Equity 6011.49 Re 8.39%Value 7871.49D/V 0.2362958 Beta 1 Beta of Target is 0.89 and I thinkE/V 0.7637042 Rf 4.31% its allitle riskier

MRP 4.08%Tax rate: 34% R e 8.39%WACC 7.50%

Debt 3000 Rd 6.99%Equity 4871.49 Re 8.39%Value 7871.49D/V 0.38112225 Beta 1 Beta of Target is 0.89, used 1 for higher riskE/V 0.61887775 Rf 4.31% Extracted from Damadaran Online

MRP 4.08% Extracted from Damadaran OnlineTax rate: 34% R e 8.39%WACC 6.95%

Debt 5000 Rd 6.99%Equity 2871.49 Re 8.39%Value 7871.49D/V 0.63520375 Beta 1 Beta of Target is 0.89, used 1 for higher riskE/V 0.36479625 Rf 4.31% Extracted from Damadaran Online

MRP 4.08% Extracted from Damadaran OnlineTax rate: 34% R e 8.39%WACC 5.99%

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Appendix 4Profit Margin by Division 2003 2004 2005

Toys R US -U.S 6.60% 4.20% 5.30%Toys R US - International 9.70% 9.20% 10.80%Babies R US 12.40% 12.80% 14.10%

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Appendix 5

Income Statement 2005 2004 2003

Net sales 11,100.00$ 11,320.00$ 11,305.00$ Cost of sales 7,505.00$ 7,646.00$ 7,799.00$

Gross margin 3,594.00$ 3,674.00$ 3,506.00$ Margin % 32% 32% 31%Selling, general and administrative expenses 2,932.00$ 3,026.00$ 2,724.00$ Depreciation and amortization 354.00$ 368.00$ 339.00$ Restructuring and other charges 4.00$ 63.00$

Total operating expenses 3,290.00$ 3,457.00$ 3,063.00$ Operating earnings 304.00$ 217.00$ 443.00$

Other (expense) income:Interest expense (130.00)$ (142.00)$ (119.00)$ Interest and other income 19.00$ 18.00$ 9.00$ Earnings before income taxes 193.00$ 93.00$ 333.00$ Income tax (benefit) / expense (59.00)$ 30.00$ 120.00$

Net earnings 252.00$ 63.00$ 213.00$ Basic earnings per share 1.17$ 0.30$ 1.03$ Diluted earnings per share 1.16$ 0.29$ 1.02$

Outstanding Shares 215384615.4 210000000 206796116.5

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Appendix 6

Asset (Million $) Balance Min % Minimum Lending Max % Maximum Lending

Accounts receivable 153 70% 107.1 85% 130.05Inventories 1884 35% 6.594 55% 1036.2Property, Plant & Equipment 4339 55% 23.8645 75% 3254.25

Total 137.5585 Maximum 4420.5Minimum

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Appendix 7

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Cash Flow Statement 2005 2004 2003Cash Flows from Operating Activities:Net earnings 252.00$ 63.00$ 213.00$ Adjustments to reconcile net earnings to net cash from operating activities:Depreciation and amortization 354.00$ 368.00$ 339.00$ Amortization of restricted stock 7.00$ - -Deferred income taxes (40.00)$ 27.00$ 99.00$ Minority interest in Toysrus.com (6.00)$ (8.00)$ (14.00)$ Other non-cash items 2.00$ 1.00$ (9.00)$ Non-cash portion of restructuring and other charges 4.00$ 63.00$ -

Changes in operating assets and liabilities:Accounts and other receivables (5.00)$ 62.00$ 8.00$ Merchandise inventories 221.00$ 133.00$ (100.00)$ Prepaid expenses and other operating assets 76.00$ 28.00$ (118.00)$ Accounts payable, accrued expenses and other liabilities (45.00)$ 117.00$ 109.00$ Income taxes payable (74.00)$ (53.00)$ 48.00$

Net cash provided by operating activities 746.00$ 801.00$ 575.00$

Cash Flows from Investing Activities:Capital expenditures, net (269.00)$ (262.00)$ (395.00)$ Proceeds from sale of fixed assets 216.00$ - -Purchase of SB Toys, Inc. (42.00)$ - -Purchase of short – term investments and other (382.00)$ (572.00)$ -

Net cash used in investing activities (477.00)$ (834.00)$ (395.00)$

Cash Flows from Financing Activities:Short-term borrowings, net - - -Long-term borrowings - 792.00$ 548.00$ Long-term debt repayment (503.00)$ (370.00)$ (141.00)$ Decrease / (increase) in restricted cash - 60.00$ (60.00)$ Proceeds from issuance of stock and contracts to purchase stock - - 266.00$ Proceeds from exercise of stock options 27.00$ - -

Net cash (used in) provided by financing activities (476.00)$ 482.00$ 613.00$

Effect of exchange rate changes on cash and cash equivalents 25.00$ (40.00)$ (53.00)$ Cash and Cash Equivalents - - -(Decrease) increase during year (182.00)$ 409.00$ 740.00$

Beginning of year 1,432.00$ 1,023.00$ 283.00$ End of year 1,250.00$ 1,432.00$ 1,023.00$

Net income tax payments 27.00$ 33.00$ 32.00$ Interest payments 143.00$ 117.00$ 93.00$

Appendix 7

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3.8% decrease

Appendix 8

1/31/2004 1/29/2005–6.4 –3.514.30 10.909.00 7.209.10 –1.3–8.6 –93.30.10 –1.9

Babies “R” UsToysrus.comKids “R” UsConsolidated net sales

For the Year Ended GROWTH BY SEGMENT (%)

Financial Performance by Segment ($ in millions)

Toys “R” Us—U.S.NET SALES BY SEGMENT

Toys “R” Us—International

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Poor Performance

Appendix 9

Transaction Assumptions ($ in billions)

Current Share Price: $24.77 Equity Purchase Price: $6.4924Offer Premium: 8.00% Enterprise Value: $6.6014Offer Price Per Share: $26.75 EBITDA Purchase Multiple: 9.9719 xLeverage Ratio: 6.6500 x Debt Required: $4.4023

Equity Used: $2.0901EBITDA Exit Multiple: 10.0 x

Purchase Price Calculations:Basic Shares Outstanding: 220.5476 EBITDA of 2005 $0.6620Basic Equity Value: $5.9000Diluted Shares Outstanding: 242.6925Diluted Equity Value: $6.4924

Less: Cash & Investments $2.2030Plus: Debt $2.3120

Enterprise Value: $6.6014

TranchNumber of options

(in millions) PriceDilution (in

millions)Tranche A 4.70 $8.00 3.18Tranche B 6.00 $6.00 4.55Tranche C 12.20 $5.00 9.74Tranche D 5.40 $6.00 4.09Tranche E 0.70 $4.00 0.59

Total 29.00 22.14

CALCULATION OF DILUTED SHARES OUTSTANDING (USING TREASURY STOCK METHOD)

Diluted Equity Value before the LBO = 242.69 million * $ 24.77 = $ 6011.49 million

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Appendix 10

Sources & Uses ($ in billions)

Sources: Uses:Available cash $0.9660 Purchase of common stock $5.9000$2 billion senior secured credit facility $0.7000 Purchase of stock options and restricted stock $0.2270Unsecured bridge loan $1.9000 Settlement of equity security units $0.1140Secured European bridge loan $1.0000 Purchase of all stock warrants $0.0170Mortgage loan agreements $0.8000 Transaction fees $0.3680Investor Equity: $1.3000 Severance, bonuses and related payroll taxes $0.0400Total Sources: $6.6660 Total Uses: $6.6660

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Appendix 11

Debt Assumptions($ in billions)

Debt Required: $4.4023$2 billion senior secured credit facility 15.9% $2 billion senior secured credit facility $0.7000Unsecured bridge loan 43.2% Unsecured bridge loan $1.9000Secured European bridge loan 22.7% Secured European bridge loan $1.0000Mortgage loan agreements 18.2% Mortgage loan agreements $0.8000

Interest payments: Principal payments:$2 billion senior secured credit facility LIBOR+2.75% $2 billion senior secured credit facility 10.0%Unsecured bridge loan LIBOR+5.25% Unsecured bridge loan 5.0%Secured European bridge loan LIBOR+1.5% Secured European bridge loan 0.0%Mortgage loan agreements LIBOR+1.3% Mortgage loan agreements 0.0%

$2billion senior secured credit facility is the senior debt and hence has to be paid back as soon as possible. The other debts are junior subordinate debts and the prepayment of these debts is not possible. The term of these debts are 6 years.

$2billion senior secured credit facility – 1.05 times EBITDA Unsecured bridge loan – 2.87 times EBITDA Secured European bridge loan – 1.51 times EBITDA Mortgage loan agreements – 1.208 times EBITDA

1 Year LIBOR Historical Chart 2006 2007 2008 2009 2010 2011January 4.9410% 5.4410% 4.2238% 2.0038% 0.9844% 0.7809%

February 5.1530% 5.3330% 2.8494% 1.9750% 0.8463% 0.7813%

March 5.2480% 5.2010% 2.7088% 2.1194% 0.8394% 0.7903%

April 5.4220% 5.2970% 2.4863% 1.9719% 0.9200% 0.7825%

May 5.4140% 5.3885% 3.0788% 1.8769% 1.0156% 0.7610%

June 5.7660% 5.4048% 3.1638% 1.6000% 1.2041% 0.7295%

July 5.5910% 5.4256% 3.3106% 1.1731% 1.6063% 0.7335%

August 5.4500% 5.2450% 3.2525% 1.4975% 1.0367% 0.7603%

September 5.2990% 5.2750% 3.2069% 1.3300% 0.8431% 0.8000%

October 5.3350% 4.9013% 3.9625% 1.2638% 0.7778% 0.8649%

November 5.2440% 4.6375% 3.1738% 1.1994% 0.7622% 0.9356%

December 5.3140% 4.4575% 2.7663% 1.0175% 0.7866% 1.0711%

Average Value 5.3481% 5.1673% 3.1820% 1.5857% 0.9685% 0.8159%

Interest Rate Assumptions: 2006 2007 2008 2009 2010 2011$2 billion senior secured credit facility 8.10% 7.92% 5.93% 4.34% 3.72% 3.5659%Unsecured bridge loan 10.60% 10.42% 8.43% 6.84% 6.22% 6.0659%Secured European bridge loan 6.85% 6.67% 4.68% 3.09% 2.47% 2.3159%Mortgage loan agreements 6.65% 6.47% 4.48% 2.89% 2.27% 2.1159%

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Appendix 12

($ in millions)Operating Assumptions

Initial Cash Balance: $284Minimum Cash Balance: $1,000

Historical Projections2003 2004 2005 2006 2007 2008 2009 2010 2011

Revenue Growth %: 0.13% -1.94% 7% 7% 7% 7% 7% 7%COGS % Revenue: 68.99% 67.54% 67.62% 68.05% 68.05% 68.05% 68.05% 68.05% 68.05%R&D % Revenue: 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%SG&A % Revenue: 24.10% 26.73% 26.41% 25.75% 25.75% 25.75% 25.75% 25.75% 25.75%

Stock-Based Compensation % Revenue: 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Depreciation & Amortization % Revenue: 3.00% 3.25% 3.19% 3.15% 3.15% 3.15% 3.15% 3.15% 3.15%Effective Tax Rate: 36.04% 32.26% -30.57% 34.00% 34.00% 34.00% 34.00% 34.00% 34.00%

Restructuring and other charges % Revenue: 0.00% 0.56% 0.04% 0.20% 0.20% 0.20% 0.20% 0.20% 0.20%Change in Working Capital % Revenue: 12.65% 11.26% 11.96% 11.96% 11.96% 11.96% 11.96% 11.96%CapEx % Revenue: 2.3% 2.4% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00%

When projecting the sales for the holding period, a constant increase in sales of 7% was assumed. In estimating this percentage growth we have taken an average of historical growth estimates of Babies R Us (8 %) and growth estimates of Toys R Us International (10 %) minus 3% because the international division is a growing market as opposed to the mature U.S market. Since the U.S division of Toys R Us has not shown any growth in revenue, and since the private equity firm is expected to enhance revenue for the coming years for this division, it will not be included in the projection of growth estimates.

The other projections were based on historical performances.

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Appendix 13

Income Statement2003 2004 2005 2006 2007 2008 2009 2010 2011

Revenue: $11,305.00 $11,320.00 $11,100.00 $11,877 $12,708 $13,598 $14,550 $15,568 $16,658Cost of Goods Sold: $7,799.00 $7,646.00 $7,506.00 $8,082 $8,648 $9,254 $9,901 $10,594 $11,336

Gross Profit: $3,506 $3,674 $3,594 $3,795 $4,060 $4,344 $4,649 $4,974 $5,322Operating Expenses:

Research & Development: $0 $0 $0 $0 $0 $0 $0 $0 $0Selling, General & Administrative: $2,724 $3,026 $2,932 $3,058 $3,272 $3,501 $3,747 $4,009 $4,289

Total Operating Expenses: $2,724 $3,026 $2,932 $3,058 $3,272 $3,501 $3,747 $4,009 $4,289

Depreciation & Amortization of PP&E: $339.00 $368.00 $354.00 $374 $400 $428 $458 $490 $525Restructuring and other charges $0 $63 $4 $23 $25 $27 $29 $31 $33Stock-Based Compensation: $0 $0 $0 $0 $0 $0 $0 $0 $0

Operating Income: $443 $217 $304 $339 $362 $388 $415 $444 $475Interest expense -$119.00 -$142.00 -$130.00Interest and other income $9.00 $18.00 $19.00Net Interest Income / (Expense): -$110.00 -$124.00 -$111.00 -$346.34 -$301.49 -$222.86 -$161.09 -$134.40 -$63.26

Pre-Tax Income: $333 $93 $193 ($8) $61 $165 $254 $310 $412Income Tax Provision: $1,511 $2,828 $3,831 ($3) $21 $56 $86 $105 $140

Net Income: ($1,178) ($2,735) ($3,638) ($5) $40 $109 $168 $204 $272EBITDA: $782 $648 $662 $736 $788 $843 $902 $965 $1,033

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Appendix 14

Cash Flow Statement ($ in millions)2006 2007 2008 2009 2010 2011

Operating Activities:Net Income: ($5) $40 $109 $168 $204 $272

Depreciation & Amortization of PP&E: $374 $400 $428 $458 $490 $525Restructuring and other charges ($23) ($25) ($27) ($29) ($31) ($33)Decrease (Increase) in Working Capital: $1,420 $1,519 $1,626 $1,740 $1,861 $1,992

Cash Flow from Operations: $1,766 $1,935 $2,136 $2,337 $2,525 $2,755

Capital Expenditures: ($238) ($254) ($272) ($291) ($311) ($333)

Free Cash Flow: $1,528 $1,681 $1,864 $2,046 $2,214 $2,422

Beginning Cash Balance: $284 $1,647 $3,233 $5,002 $6,952 $9,071Plus: Free Cash Flow: $1,528 $1,681 $1,864 $2,046 $2,214 $2,422Less: Minimum Cash Balance: ($1,000) ($1,000) ($1,000) ($1,000) ($1,000) ($1,000)

Cash Available for Debt Repayment: $812 $2,328 $4,097 $6,047 $8,166 $10,493Cash Used for Debt Repayment: ($165) ($95) ($95) ($95) ($95) ($3,225)

Beginning Cash Balance: $284 $1,647 $3,233 $5,002 $6,952 $9,071Net Change in Cash: $1,363 $1,586 $1,769 $1,951 $2,119 ($803)

Ending Cash Balance: $1,647 $3,233 $5,002 $6,952 $9,071 $8,268

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Appendix 15

Debt & Interest Schedules ($ in millions)2006 2007 2008 2009 2010 2011

$2 billion senior secured credit facility 700.0000 0.0000 0.0000 0.0000 0.0000 0.0000Principal payment: -70.0000 0.0000 0.0000 0.0000 0.0000 0.0000Optional Repayment: -630.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Ending Bank Debt: 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Unsecured bridge loan 1900.0000 1805.0000 1710.0000 1615.0000 1520.0000 1425.0000Principal payment: -95.0000 -95.0000 -95.0000 -95.0000 -95.0000 -1425.0000Optional Repayment: 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Ending High-Yield Debt: 1805.0000 1710.0000 1615.0000 1520.0000 1425.0000 0.0000

Secured European bridge loan 1000.0000 1000.0000 1000.0000 1000.0000 1000.0000 1000.0000Principal payment: 0.0000 0.0000 0.0000 0.0000 0.0000 -1000.0000Optional Repayment: 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Ending High-Yield Debt: 1000.0000 1000.0000 1000.0000 1000.0000 1000.0000 0.0000

Mortgage loan agreements 800.0000 800.0000 800.0000 800.0000 800.0000 800.0000Principal payment: 0.0000 0.0000 0.0000 0.0000 0.0000 -800.0000Optional Repayment: 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Ending High-Yield Debt: 800.0000 800.0000 800.0000 800.0000 800.0000 0.0000

Interest paid on : $2 billion senior secured credit facility 28.3433 0.0000 0.0000 0.0000 0.0000 0.0000Unsecured bridge loan 196.3295 183.0835 140.1813 107.1495 91.5680 43.2195Secured European bridge loan 68.4808 66.6727 46.8196 30.8569 24.6854 11.5795Mortgage loan agreements 53.1847 51.7381 35.8557 23.0855 18.1483 8.4636Total interest paid on debt: 346.3383 301.4943 222.8566 161.0919 134.4018 63.2627

Net Interest Income / (Expense): 346.3383 301.4943 222.8566 161.0919 134.4018 63.2627

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Cash Sweep

Appendix 16

BALANCE SHEET ($ in millions) 2004 2005 2006 2007 2008 2009 2010ASSETS Debit CreditCash and cash equivalents 1432.00 1250.00 0.00 966.00 284.00 1647.05 3232.65 5001.73 6952.36 9071.24Short-term investments 571.00 953.00 0.00 0.00 953.00 1019.71 1091.09 1167.47 1249.19 1336.63Accounts and other receivables 146.00 153.00 0.00 0.00 153.00 163.71 175.17 187.43 200.55 214.59Merchandise inventories 2094.00 1884.00 0.00 0.00 1884.00 2015.88 2156.99 2307.98 2469.54 2642.41Net property assets held for sale 163.00 7.00 0.00 0.00 7.00 7.49 8.01 8.58 9.18 9.82Current portion of derivative assets 162.00 1.00 0.00 0.00 1.00 1.07 1.14 1.23 1.31 1.40Prepaid expenses and other current assets 161.00 159.00 0.00 0.00 159.00 170.13 182.04 194.78 208.42 223.01Total current assets 4729.00 4407.00 3441.00 5025.04 6847.10 8869.19 11090.54 13499.09PROPERTY, PLANT AND EQUIPMENTReal estate, net 2165.00 2393.00 0.00 0.00 2393.00 2560.51 2739.75 2931.53 3136.73 3356.31Other, net 2274.00 1946.00 0.00 0.00 1946.00 2082.22 2227.98 2383.93 2550.81 2729.37Total PP&E 4439.00 4339.00 4339.00 4642.73 4967.72 5315.46 5687.54 6085.67Goodwill, net 348.00 353.00 -2120.00 0.00 -1767.00 -2128.43 -4186.08 -6453.60 -8930.91 -11606.68Derivative assets 77.00 43.00 0.00 0.00 43.00 46.01 49.23 52.68 56.36 60.31Deferred tax asset 399.00 426.00 0.00 0.00 426.00 455.82 487.73 521.87 558.40 597.49Other assets 273.00 200.00 0.00 0.00 200.00 214.00 228.98 245.01 262.16 280.51Total Assets 10265.00 9768.00 6682.00 8255.17 8394.68 8550.61 8724.10 8916.39

LIABILITIES AND STOCKHOLDERS’ EQUITYShort-term borrowings 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Accounts payable 1022.00 1023.00 0.00 0.00 1023.00 1094.61 1171.23 1253.22 1340.94 1434.81Accrued expenses and other current liabilities 866.00 881.00 0.00 0.00 881.00 942.67 1008.66 1079.26 1154.81 1235.65Income taxes payable 319.00 245.00 0.00 0.00 245.00 262.15 280.50 300.14 321.15 343.63Current portion of long-term debt 657.00 452.00 452.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Total current liabilities 2864.00 2601.00 2299.43 2460.39 2632.62 2816.90 3014.08

Long-term debt 2349.00 1860.00 1860.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Deferred income taxes 538.00 485.00 0.00 0.00 485.00 518.95 555.28 594.15 635.74 680.24Derivative liabilities 26.00 16.00 0.00 0.00 16.00 17.12 18.32 19.60 20.97 22.44Deferred rent liability 280.00 269.00 0.00 0.00 269.00 287.83 307.98 329.54 352.60 377.29Other liabilities 225.00 212.00 0.00 0.00 212.00 226.84 242.72 259.71 277.89 297.34Minority interest in Toysrus.com 9.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Mortgage loan agreements 0.00 800.00 800.00 800.00 800.00 800.00 800.00 800.00$2 billion senior secured credit facility (Senior debt) 0.00 700.00 700.00 0.00 0.00 0.00 0.00 0.00Secured European bridge loan 0.00 1000.00 1000.00 1000.00 1000.00 1000.00 1000.00 1000.00Unsecured bridge loan 0.00 1900.00 1900.00 1805.00 1710.00 1615.00 1520.00 1425.00Total liabilities 6291.00 5443.00 5382.00 6955.17 7094.68 7250.61 7424.10 7616.39

STOCKHOLDERS' EQUITYCommon stock 30.00 30.00 30.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Additional paid-in capital 407.00 405.00 405.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Retained earnings 5308.00 5560.00 5560.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Accumulated other comprehensive loss -64.00 -7.00 -7.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Restricted stock 0.00 -5.00 -5.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Investors` Equity 0.00 1300.00 1300.00 1300.00 1300.00 1300.00 1300.00 1300.00Treasury shares, at cost -1707.00 -1658.00 -1658.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Total stockholders’ equity 3974.00 4325.00 1300.00 1300.00 1300.00 1300.00 1300.00 1300.00

Total liabilities and stockholders’ equity 10265.00 9768.00 6682.00 8255.17 8394.68 8550.61 8724.10 8916.39

LBO Adjustments Opening Balance Sheet

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Appendix 17

Investor Returns2005 2006 2007 2008 2009 2010 2011

EBITDA: 662.00 $1,033Exit Multiple: 9.97 10.0 xEnterprise Value: 6601.41 $10,326Debt $0Investor Equity: -1300.00 $0 $0 $0 $0 $0 $10,326

IRR: 41.3%

EXIT MULTIPLE IRR5 25.80%6 29.70%7 33.10%8 36.10%9 38.80%10 41.30%11 43.50%12 45.60%

24

Appendix 18:

25

Appendix 19:

Tax Shield if debt was not taken = Debt * tax rate = $1860m * 34% = $632.4m

Tax Shield after the debt was taken for LBO= Debt * tax rate = $4400m * 34% = $1496m

Appendix 20:

Investor Returns2005 2006 2007 2008 2009 2010

EBITDA: 662.00 $965Exit Multiple: 9.97 10.0 xEnterprise Value: 6601.41 $9,651Debt $3,225Investor Equity: -1300.00 $0 $0 $0 $0 $6,426

IRR: 37.7%

Investor Returns2005 2006 2007 2008 2009 2010

EBITDA: 662.00 $965Exit Multiple: 9.97 8.0 xEnterprise Value: 6601.41 $7,721Debt $3,225Investor Equity: -1300.00 $0 $0 $0 $0 $4,496

IRR: 28.2%

References:1. http://money.cnn.com/2005/03/17/news/fortune500/toysrus/index.htm 2. http://www.moneycafe.com/library/libor.htm 3. NPD Group Press Release, February, 2006 4. Toys “R” Us Annual Report, 20055. KKR Tops .Club. Buyout Deals,. CNN Money.com, October 17, 20066. Toys .R. Us Company Press Release, March 17, 2005

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