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Do You Believe Blaines Current Capital Structure Finance Essay

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Do you believe Blaine's 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 shareholder's 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 Blaine's 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, BKI's earnings per share and ROE, its interest coverage and debt ratios, the family's ownership interest, and the company's 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 Blaine's 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 won't 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 company's policy.


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