Blaine Kitchenware

Blaine Kitchenware founded in 1927 which is a producer of kitchen appliances. Although its gone public, a majority of the shares are held by the original family.

 1. Are Blaine’s current capital structure and payout policies optimal? Why? Why not? (1 point)

They haven’t raised any debt as of yet and so their financial structure isn’t optimal because they are not making use of any tax shields.

2. Consider the following share buyback proposal: Blaine will use $209 million of existing cash and $50 million in new borrowing with an interest rate of 6.75% to repurchase 14 million shares at a price of $18.50 per share. How should such a buyback affect Blaine’s shareholders? Specifically calculate impact of this decision on the balance sheet, income statement and cash flows available to equity and debt holders in 2006 by focusing on, among other things, debt ratios, earnings per share, ROE, interest coverage by comparing pre-buy and post buy back situations . You may find sections titled “Levered and Unlevered Betas” (page 492-4) and “Cash and Net Debt” (page 417) in Berk and DeMarzo helpful. (2 points)

Use of debt will improve the company’s financial ratios.

A buyback will increase EPS, which is very beneficial for the shareholders. It will also improve the equity share of each shareholder. Buybacks are always positive for owners of the company as well as its share price.

3. Does buyback create additional interest tax shields? How much at the end of 2006? Assuming these tax shields are in perpetuity what additional value is created? (Chapter 15.1 through 15.3 in Berk/DeMarzo will be helpful)). (1 Point)

Yes it does. 18626 at the end of 2006.

18626/(0.0675) = 275,940

4. Compare price per share including tax shield (computed in q. 3) with the price being offered ($18.50) in buyback. If there is a difference between two prices, which other factors can explain the difference? No Calculations are necessary. (1 Point)

Please refer to spreadsheet

5. Is the firm borrowing $50 million or $259 million? Is Blaine a net borrower or lender before buyback? After buyback? Provide your arguments briefly and clearly. No calculations are necessary. (1 Point)

Firm is borrowing 50. It’s a net borrower before the buyback. After buyback, it was a net lender.

Talk about the Debt/Equity ratios both before and after buyback.

6. How does buyback proposal differ from a special dividend of $4.39 (259M /59 million shares) per share? Will special dividends be more preferable from shareholders’ perspective and why? No calculations are necessary. (1 Point)

Buyback is a safer option.

Dividends create a precedent and are then expected on a yearly basis. So, this wont help if the company cannot repeat the good performance of 2006.