blain kitchenware cf case
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BLAIN KITCHENWARE CASE
BY-GROUP 3AAINA SHARMAABHINAV SINGHAJAY RAGHUVANSHIANKUR DEEPANSHUL TRIPATHIANURAG CHANDEL
Q.1What is conflict between share holders and bond holders ? Why or why not A bondholder is the lender to the firm whereas
a shareholder is the owner of the firm. The shareholder has a primary right over
firm’s earnings while a bondholder has control over firm’s operational decisions that affect cash flow and firm’s risk scenario.
These different interests leads to opposing opinions and ultimately arises conflicts regarding various issues like dividend distribution, participation rights and project selection
PROJECT SELECTION PARTICIPATION RIGHTS DIVIDEND DISTRIBUTION ISSUE OF NEW EQUITY
Share holder value is created either by increasing
the value of the firm or issuing substantial new
debt are ways to redistribute wealth from bond
holder to share holders .share holders do not like
excessive debt.
Q.2 Explain the trade of theory –cost of financial distress and agency cost ?
Firm choose to optimal leverage after a comparison of the losses and the gain with debt or equity corporate tax may offer a debt tax shield owing to the deductibility of interest and incentive to increase Debt .
there are direct and indirect bankruptcy cast of debt. The degree of business risk of a firm depends on the degree of operating leverage (production of fixed cost).
Financial distress may ultimate force a company to insolvency .
direct cost of financial distress including
cost of insolvency .financial distress with or
without insolvency also has many indirect cost .
Agency cost it may conflict of interest share holders and debt holder and management these conflict give rise to agency problem, which involve agency costs. Agency cost have their influence on a firm capital structure .
Share holder –debt-holder conflict Share holder –management conflict Monitoring and agency cost.
Q.3 What the effect of corporate and personal taxes On value of levered and unlevered firm ?
Levered Firm: A Firm that finance its assets by equity and debt is called a Levered firm.
Unlevered Firm: A firm that that uses no debt and finances its assets entirely by equity is called unlevered firm.
Financial Leverage affect the value of firm when personal tax and corporate are considered.
After-Tax income of the firm will be reduced when the personal rate of lenders is higher than personal rate of shareholders.
The value of the firm will increase with debt due to the deductibility of interest charges for tax computation, and the value of the levered firm will be higher than of the unlevered firm.
Cash Flows: Cash flows are after the corporate and personal tax ,the appropriate discount rate will be pure-equity capitalization rate adjusted for personal taxes.
Q.4 EXPLAIN THE VARIOUS APPROACHES OF ESTABLISHING TARGET CAPITAL STRUCTURE ?The capital structure will be planed initially when a Company is incorporated .EBIT-EPS APPROACHES :- The EBIT-EPS approach to capital structure decisions involves selecting the capital structure that maximizes EPS over the expected range of EBIT.A constant level of EBIT- constant business risk- is assumed in order to isolate the impact on returns of the financing costs associated with alternative capital structures
EBIT-EPS analysis tends to concentrate on the maximization of earnings rather than shareholders’ wealth and ignores risk. This method involves the comparison of alternative methods of financing under various assumptions as to EBIT. To determine EBIT breakeven or
indifference points between the various financing alternatives, EPS values are calculated for
a hypothetical level of EBIT for each
alternative.
VALUATION APPOROACHES shareholders assume a high degree of risk than
debt-holders .Hence debt is a cheaper source of funds than equity. But debt causes financial risk, which increases the cost of equity.
Higher debt increases the costs of financial distress and the agency costs also increase.
The tax deducibility of interest charges, however, adds value to shareholders. Thus, there is a trade-off between the tax benefits and the costs of financial distress and agency problems.
CASH FLOW APPORACHES the firm’s ability to carry debt without
getting into serious financial distress is to carry out a comprehensive cash flow analysis over a long period of time.
A sound capital structure is expected to be conservative. Conservatism does not mean employing no debt or small amount of debt.
Conservatism is related to the firms ability to-generate cash to meet the fixed charges created by the use of debt in the capital structure under adverse conditions.
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Q.1 Do you believe Blaine’s current capital structure and layout
policies are appropriate? The capital structure of Blaine is prudent and conservative.
There are only two borrows in history. The main source of funding for business comes from
equity capital. In 2007 BKI has $231 million cash and no debt Take over Threat – The $231 cash and securities
will attract hostile takeovers because the acquire can use the cash to pay the acquisition cost.
Cash also can be called as negative debt and reduces the enterprise value of BKI from $959 to $729 making the acquisition a better deal.
Reinvestment Threat- If the company has a lot of surplus cash there will be big risk of capital misallocation.
The Mgmt. would think the capital is free and they will invest in value destroying projects.
It's too inefficient. In 2006 the company Return
on Equity (ROE) was 11%, which is below the industry average of 19.5.
In addition, the company can deduct the interest paid on the debt from their income and thus reduce the tax burden.
With an increase of future corporate tax from 30.8% to 40%, it would be beneficial for the firm to deduct interest payments to pay fewer taxes. Debt greatly reduces the role of integrated enterprise cost of capital
Therefore, it can increase earnings per share and its stock value by improving the proportion of corporate debt appropriately, which assumes a crucial role of financial leverage
Q.2 Should Dubinski recommend a large share repurchase to Blaine’s board? What are primary advantages and disadvantages of such a move? Dubinski should recommend a large share repurchase to
the board using cash and cash equivalents and raising some debt.
1. Debt is a lower cost source of funds and allows a higher return to the equity investors by leveraging their money.
2. The company can use the increase in leverage to invest in its business or acquire another company without increasing shareholders' equity.
3. Assuming that family members held on to their shares, their percentage ownership of Blaine would rise, reversing a downward trend dating from BKI’s IPO. It also would give the board more flexibility in setting future dividends per share .
4.The company will have a better Return on Equity.
Since, debt is being raised – the WACC will come down as a) cost of equity decreases b) the contribution of cost of equity to WACC decreases with cost of debt being included; which is usually less than COE due to tax benefits.
Disadvantage-
High Price
Market Signaling
Loss of investment income-The interest that could have been earned from investment of surplus cash is lost.
Q.3 Consider the following share repurchase proposal: Blaine will use USD 209 million of cash from its balance sheet and USD 50 million in new debt bearing interest at the rate of 6.75% to repurchase 14.0 million shares at USD 18.50 per share. How should such a buyback affect Blaine? Consider the impact on EPS, ROE, and interest coverage and debt ratios.
Forecasted EBIT : $ 66.979 Million
Loss due to use up of cash & cash equivalents andmarket securities = $209 Million @ 4.92%= $ 10.282 Million
Revised EBIT : $ 56.697 Million
Debt Interest : $ 3.375 Million
Tax @ Rate 40% : $ 21.328 Million
Net Income : $ 31.992 Million
EPS & Ratios • EPS : $ 0.710 • ROE : 11.46 % • Interest Coverage Ratio : 16.79 • D/E Ratio : 0.178 Calculation for the amount of debt
to be raised: 1.No. of shares to be bought back =
22.439 million shares.
2. Total Price = 22.439*$18.5 = $415.121 million3.(Less) Cash and Cash Equivalents and market securities = $224.309 million4. Total debt required for total buyback = $190.812million @ a rate of 6.35%
Interest to be paid
• 6.35 % of 190.812 million dollars= $
12.116 million
EBIT = $ 66.979 million • (Less) Loss due to use up of cash &
cash equivalents and market securities = 60.557 +164.309= $224.866 Million
• Interest @ 4.92% = $11.06 Million
[Exhibit 4 – Avg of yields on US Treasury Securities]
So, Revised Data
Revised EBIT = $ 55.919 million
Less interest (@ 6.35%)= $ 12.116 million[calculated earlier]
Earnings before tax= $ 43.803 million
Tax (@ 40%)= $ 17.52 million [Note]
Net income= $ 26.283 million
EPS = Net income/total no. of shares remaining= 26.283 / 36.612= $ 0.717
ROE Net income = $ 26.283 million Shareholders' equity = $ 263.477
million ROE = ($ 26.283 million / $ 263.477
million) * 100= 9.97 % Debt Ratio Debt to equity: Debt/Equity= 0.724 Interest Coverage = EBIT/Interest Expense= 4.589