Should Ust Undertake the $1 Billion Recapitalization?

5.) Should UST undertake the $1 billion recapitalization?(a)Prepare a pro-forma (1999) income statements to evaluate UST's ability to make interest payments.

Exhibit TN-4: Income Statement ProjectionsActual 1998Pro-forma 1999 (I)Pro-forma 1999 (II)Pro-forma 1999 (III)Pro-forma 1999 (IV)Sales1423.21494.361494.361494.361494.365% Annual GrowthEBIT753.3792.01792.01792.01792.0153% of salesInterest Expense-2.2070.578.287Pre-tax earnings755.5790.52721.51713.81705.01Taxes287.6300.40274.17271.25267.9038% tax rateNet Income467.9490.12447.34442.56437.11Net debt00100010001000Interest Rate--0.07050.07820.087Interest Coverage--11.210.139.10EBIT/Interest ExpenseDebt Rating--ABBBBBWhen examining UST's ability to make interest payments, it is important to focus on the interest coverage ratio under each of the different pro-forma scenarios. The interest coverage ratio illustrates the ability of the company (in this case, UST) to make interest payments on the outstanding debt. As the interest coverage ratio approaches 1, the ability of the company to make these interest payments becomes problematic. From a bondholder's perspective, the bondholder wants to be sure that the company is always able to make the interest payments. For UST, in this case, as the debt rating of UST decreases from a bond rating of A (Scenario II) to a debt rating of BB (Scenario II), the interest coverage ratio is decreasing. However, from the bondholder's perspective, the decrease does not warrant a cause for alarm just yet. The 9.10 coverage ratio is still a quality measure, and shows that UST is able to meet the demand for the interest payments as of the current projection.

(b) Calculate the valuation impact of the recapitalization plan by estimating the value of the interest tax shields, assuming a corporate tax rate of 38%. What other factors, beyond the corporate interest tax shields, should UST consider in assessing the valuation impact of the plan?Exhibit TN-5: Valuation ModelStatus Quo$1 Billion Recap PlanPV Tax Shields (tD)0.00380.00 38%*$1000Value of UST (S = Vu)6,469.006,849.00 $380 + 6469Net Debt0.001,000.00Stock Price34.8836.92 6849/185.5Shares Repurchasedn/a27.08Shares 185.50158.42Market Equity6,469.006,849.00Debt/Market Equity0.000.15 1000/6849There are other factors, beyond the corporate tax shield, that UST should consider when assessing the impact of the $1 billion dollar recapitalization plan. Some of these factors include the signal that UST will be sending to investors with this recapitalization plan. The effect that the recapitalization will have on the value of the firm; due to the change of the capital structure. Since the firm will be adding debt, and incurring tax savings, this will have a positive effect on the stock price (Yes, it is true that the number of shares will also be decreasing, leading to a higher E.P.S). Another factor that should be considered is the fact that this recapitalization will have