Do You Believe Blaines Current Capital Structure Finance Essay

Do You Believe Blaines Current Capital Structure Finance Essay Do you believe Blaines current capital structure and payout policies are appropriate? Why or why not? Blaines capital structure and dividend policy are not entirely appropriate from the point of view of a shareholder of the firm. The reasons for that can be summed up as follows: No leverage: The optimum mix of debt and equity in the capital structure will maximize shareholders return. Company should take on debt to acquire new firms and expand its operations. Low ROE : Attributed to Low leverage 2006 ROE data clearly shows up that ROE of all the comparable firms are much higher than that of Blaine. Increasing Dividend payout ratio As calculated in Question no.3, the cost of equity of the firm is close to 9% whereas ROE is 11%. This is a good proposition for shareholders. This can be enhanced by acquiring other companies using cash balance that the company has. Decreasing EPS Even when EPS is constantly decreasing over the last three years, the policy of giving more or less same amount in dividend may cost company in future. Way of financing of new acquisitions Blaine Inc. should rather raise capital in debt rather than issuing new stocks to raise capital. This will ensure EPS constant and will be good for shareholders. Should Dubinski recommend a large share repurchase to Blaines board? What are the primary advantages and disadvantages of such a move? No, Dubinski should not recommend a large share repurchase to the board. The reason for that is although the firm is public listed, still a large percentage of share is owned by family itself. Therefore, buying back the shares is as good as unlisting the company. Secondly, there are growth avenues wherein the company may require cash. The company should, like last two years, go for acquisition. This will bring value to shareholders. Else, during the times of new acquisitions, company would have to raise capital from the market and due to flotation cost; the cost of equity will be much higher. Consider the following share repurchase proposal: Blaine will use $209 million of cash from its balance sheet and $50 million in new debt-bearing interest at the rate of 6.75% to repurchase 14.0 million shares at a price of $18.50 per share. How would such a buyback affect Blaine? Consider the impact on, among other things, BKIs earnings per share and ROE, its interest coverage and debt ratios, the familys ownership interest, and the companys cost of capital. Effect of Share Buyback Particulars Value Remarks Equity Capital_Pre Buyback ($) 488,363,000 2006, Exhibit 2 Equity Capital_Post ($) 279,363,000 No. of Shares outstanding before buyback 59,052,000 No. of shares bought back 14,000,000 Total outstanding Shares 45,052,000 EPS_Old($) 0.91 EPS_New ($) 1.19 Percent change in EPS 31.08% P/E ratio 17.86 Market Price (S) 21.30 Percent change in Share price 19.28% Debt_equity Book Value 17.90% Debt_equity Market Value 5.21% Debt interest rate 6.75% Interest to be paid ($) 3375000 Interest coverage ratio 0.05 ROE 0.11 ROE_new 0.19 Change in ROE 74.52% Cost of Equity 9.01% Cost of Debt 6.25% Effective Tax rate 40.00% Expected future tax rate D/V 4.95% WACC 8.75% WACC_Old 9.01% Change in WACC -2.89% Equity beta Calculation for the Firm Market Cap Equity beta (Net)D/E Net Debt Cash Securities Total Debt D/E (1) (2) (3) (4)=(1)x(3) (5) (6)=(4)+(5) (7)=(6)/(1) Home and Hearth Design 776,427 1.03 45.18% 350,790 21,495 372,285 47.95% AutoTech Appliances 13,978,375 1.24 31.74% 4,436,736 536,099 4,972,835 35.58% XQL Corp. 5,290,145 0.96 17.97% 950,639 21,425 972,064 18.37% Bunkerhill Inc. 3,962,780 0.92 6.01% 238,163 153,680 391,843 9.89% Easyliving Systems 418,749 0.67 -15.47% -64,780 242,102 177,322 42.35% Blaine Kitchenware 959,596 0.56 -24.06% -230,879 230,866 -13 0.00% Average 25,386,072 0.90 10.23% 25.69% Unlevered Beta 0.78 Beta_Blaine 0.80 Ownership Scenario: For last 3 years and post share buyback 2004 2005 2006 2007 Outstanding Shares 41,309,000 48,790,000 59,052,000 45,052,000 Ownership of Founders descendants 62% 52% 43% 57% Assumptions Used Effective Tax rate has been taken equal to 40%, same as for Blaine. As a member of Blaines controlling family, would you be in favor of this proposal? Would you be in favor of it as a non-family shareholder? As a family member of Blaine, the news of buyback has to be evaluated in both the ways. The Pros are: Consolidating Control- This will increase the shareholding close to 57%. Return of Cash Surplus to Shareholders-As of now in April, 2007, there are no any plans of buybacks. Therefore, keeping cash intact leads to opportunity cost of shareholders. This will add value for shareholders. An effective defense against takeover- as the market is consolidating, it will be a wise decision to protect the company from hostile takeovers. The cons are: Effect on expansionary plans- As cash will be used to buy back shares and the company wont be able to raise money from markets in the near future, opportunities of acquisitions will be marred. Even if, company will raise capital from equity market, flotation cost will be high and so cost of equity will be comparatively high. Use of Leverage- the Company has been against the policy of taking debt. Taking debt of $50 million for share buyback will not go in line with the companys policy.