Question

Blaine Kitchenware:Consider the following repurchase proposal: Blaine will use $209 million of cash and $50 million in new debt borrowed at 6.75% to repurchase 14 million shares at a price of $18.50 per share. Evaluate the proposal and its effect on the company's financials statements, EPS,ROE, interest coverage ratio,debt ratio, among other measures. Based on analysis of this proposal anwser the following. Are the post-repo and interest coverage ratio unreasonable?

Answer 1

Deciding to go for leveraged recap, BKI will borrow $50 million at 6.75% interest rate. In this option, BKI will use $50 million debt and $209 million cash to buy back $259 worth of share at $18.5 per share multiple by $14 million shares.

Table 1: Key Indicators for Share Buyback

Actual Share Buyback

Interest Rate . 0.00% . 6.75%

TaxRate 40.00% 40.00%

# of Shares Outstanding 59,052 45,052

Debt 0 50,000

TaxShields (40%) 0 20,000

CashPayout 0 -209,000

MV of Equity 959,596 720,596

TotalCapital 959,596 770,596

Share Price 16.25 15.99

EPS 0.89 1.12

ROE. 10.78% 13.59%

InterestCoverage N/A 21.88

Family Ownership %. 40% 52%

?U 0.56 0.87

rf 5.10% 5.10%

rA 8.46% 10.29%

rE(CAPM) 8.46% 10.44%

rD 6.75% 6.75%

WACC 8.46% 10.03%

The company’s business risk increases after discharging of $209 million cash and securities. So we reweighed the unlevered Beta of Asset (?U) ? unlevered = (E/V) ?e + (D/V) ?d and got 0.87. We choose rf= 5.10%, which is the 30 year treasury rate, the reason are the same as the former case Midland. Many of the projects are longer than 10yrs; as a result, the best choice would probably be the 30yr T-bond. Then we get the Levered Cost of Equity (rE) and rA by CAPM and then the Weighted Average Cost of Capital (WACC) by its equation. The actual situation shows same WACC and rE 8.46% due to no debt, the second situation shows a bit smaller WACC than rEwhich is also common sense, because usually the cost of debt is less than cost of equity.

Thanks