Case Study Solutions Blaine Kitchenware Essay Example

Case Study Solutions Blaine Kitchenware Paper Mr.. Dubbings the CEO since 1992 and great-grandson of one of the founders, successfully completed an PIP in 1994 and gradually moved the production abroad in the early ass. BIKE s current strategy is to complement its product offerings by acquiring small independent manufacturers or the kitchen appliance product lines of larger diversified manufacturers. The financial data at the end of 2006 reflects a strong financial position: The company has raised nearly no debt, it is very liquid, but also under-levered. BIG is one of the strongest companies in this industry in terms of EBITDA margin (22% in 2006), high level to cash holdings and no debt. However, the Shiite toward higher-end product line could not prevent the margins from a slight decline over the last three years. This was mainly explained by the integration costs and inventory write-downs due to the acquisitions completed so far, The other reason was that its organic revenue growth had suffered in recent years, as some of the core products lost market share. The growth of the top line was mainly due to the acquisitions. Bibs annual return on equity is significantly below that of its publicly traded peers: compared to an average of 25,g and a median of 19. 5 Now the over-liquid and under-levered BIG is facing strong pressure from a private equity group interested in buying the company ; s common stock. Thus, the CEO considers a stock repurchase to avoid a hostile takeover. The company decided to distribute all excess cash as a dividend. We will write a custom essay sample on Case Study Solutions Blaine Kitchenware specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Case Study Solutions Blaine Kitchenware specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Case Study Solutions Blaine Kitchenware specifically for you FOR ONLY $16.38 $13.9/page Hire Writer The second step will be the rationalization plan to hold permanently $ mm of debt on the balance sheet, which is a difficult decision due to the first sign of the mortgage crisis. Moreover, the company expects annual revenue decline of 4% in 2007-2009, and a permanent 2% growth rate afterwards. 2. METHODOLOGY AND VALUATION From a company ;5 perspective, the benefit of debt is the tax shields created, which are captured by equity holders. The family-controlled company in our case has little experience with holding debt and the board of directors might not easily accept the restructuring plan. What they should know is that the right amount of debt increases the firms value and discourages the takeovers. However, a too-high level of debt can lead to financial distress, lower credit rating. And higher interest expenses. For BIKE, the credit rating regressed from A (Iteration 1) to A- (Iteration 10), accordingly changing the credit spread from o 1. 65%. Our aim is to asses the how the proposed rationalization Will affect the enterprise value. After the distribution of the excess cash as dividends, by using APP. We estimate the present value of the firm as if it were all-equity financed (VIC), then we add the present value of tax shield associated with the new debt (permanent debt with market value of 300 ml ACIDS), and subtract the present value of bankruptcy costs. We have to estimate expected after-tax operating cash flows the expected tax shields and discount them at two different discount rates: (unaltered cost of UAPITA) and (usually , cost of debt), For the present value of the bankruptcy costs, we have to first estimate the risk-neutral probability of default of the company. FL = VIC IV (future tax shields from debt) -? IV (bankruptcy costs), or rewritten as threshold coverage ratio for default probability of firm default conditional on surviving up to a specified period We start with a forecast of expected after-tax operating cash flows. We assume the annual 4% decline in revenues between 2007 and 2009 from the 2006 level, and a permanent 2% growth afterwards. Analyzing the historical values of he operating margins from the Income Statement, we forecast values for the 2007-2009 period. The executives of BIG expect the firm to achieve operating margins at least as high as the historical ones. Thus, we took averages and slightly adjusted them toward higher values, Since the declining tendency in the last three years was cause by integration costs and inventory write- downs associated with acquisitions, which already have been completed. To the BIT, estimated by using those margins, subtract the taxes, Cape, adjust for Depreciation, Amortization and change in Working capital. The capital expenditures were just over $mm on average per year. Then we calculate their present value using the appropriate discount rate reflecting the risk, art (or rd)_ Poor the bankruptcy cost, we have the percentage of the unaltered-firm value of 20%, but for the present value, we need to estimate the risk-neutral probability of default q _ This probability is calculated iteratively starting from the coverage ratio (Bite-1 / Interest Expense). We match the coverage ratio number with the corresponding credit rating, Which then has a corresponding default. This gives us the yield on debt y, the cost of debt rd, and the risk-neutral probability of default q. The formula for q is where p is the recovery rate in case Of default, given here as 41 In order to lactate the expected interest coverage ratio, we took the average BIT between 2007 and 2009 for the mean of pre-tax cash flows, as well as the according standard deviation, since our estimation is future based. After iterations, the convergence values for the coverage ratio is 3. 54, which corresponds to a credit rating of A-. The credit spread for A- is 1. 65%. Yield on debt y Risk-free rate RFC Recovery probability if default p These give the values for: Risk-neutral probability of default q Cost of debt rd 6. 48% Finally, we combine the components of the APP formula to obtain the levered alee of the firm. According to the APP method, the levered value of ASK is FL mm. 2. SENSITIVITY ANALYSIS AND CONCLUSION We can conclude that by raising debt to mm the company would be better of, since the value of the levered firm would be higher that the value of the unaltered firm and will discourage the takeovers. However, the sensitivity analysis gives us an optimal value of debt of mm, which would lead to an optimal ratio between the IV of tax shields and bankruptcy costs and, thus, a value of maximal levered firm of mm, given that our assumptions for APP will be realized in the future.