Evaluation on Share Repurchase Proposal of Blaine Kitchenware Inc.

Topics: Dividend yield, Stock market, Stock Pages: 7 (1979 words) Published: December 7, 2014
Evaluation on Share Repurchase Proposal of Blaine Kitchenware Inc. Group 7

Contents
Executive Summary3
Overview of problems3
Analysis on Capital Structure & Payout Policies of Blaine3
1. Inappropriate current capital structure and payout policies3 2. Advantages and disadvantages of large share repurchase proposal4 a. Effects of share repurchase on assets, liabilities and equity on balance sheet5 b. Effects of share repurchase on debt ratios and interest coverage ratio5 c. Effects of share repurchase on Earnings Per Share and Return On Equity5 d. Bonus question—effects on wacc6

4. Effects of the proposed share repurchase on shareholders6 Appendix7

Executive Summary
The main problem faced by BKI is over liquidity and under leverage. The capital structure of Blaine is too conservative. The main source of funding for business comes from equity capital. It would not be rational for a public company to be funded only by equity, which caused the company’s Return on Equity much lower than the industry average. In the meantime, current payout policies make payout ratio go up, lowering efficiency of the firm. The company can solve these problems by issuing debt to repurchase its stock. Debt is a lower cost source of financing and allows a higher return to the. In addition, the company can benefit from tax-deductible interest and thus lower tax burden. However, debt is not always excellent, and we should analyze whether the profitability of raising the debt is greater than the cost of leverage. Overview of problems

Blaine Kitchenware was a mid-sized producer of small appliances primarily used in residential kitchens. By 2006, the company’s products consisted of a wide range of small kitchen appliances including deep fryers, griddles, toasters, ovens etc. Blaine had just fewer than 10% of the $2.3 billion U.S. market for small kitchen appliances. During the year ended December 31, 2006, Blaine earned net income of $53.6 million on revenue of $342 million. Approximately 85% of Blaine’s revenue and 80% of its operating income came from the sale of mid-tier products. Despite the company’s profitability, returns to shareholders had been somewhat below average. Blaine’s return on equity (ROE) was significantly below that of its publicly traded peers. Moreover, its earnings per share had fallen significantly since 2004, partly due to dilutive acquisitions. Blaine’s financial posture was conservative; only twice in the history had the company borrowed beyond seasonal working capital needs. The first was during World War II and second during oil shock of 1970s. Analysis on Capital Structure & Payout Policies of Blaine

1. Inappropriate current capital structure and payout policies Currently, the main source of funding for its business comes from equity capital. However, this capital structure and payout policies for Blaine’s Kitchenware Inc. is not the most appropriate. Here are some explanations. First, current capital structure makes high cost of financing despite its low risk. Although risk will increase as debt increases, debt financing will lower the cost of capital and increase returns to shareholders. Debt is a lower cost source of funds and allows a higher return to the shareholders by leveraging their money. Additionally, the company can benefit from tax shield by tax-deductible interest payment. Second, current capital structure may lower efficiency of the firm. In 2006, the company Return on Equity (ROE) was 11%, which is below the industry average of 19.5%, which would lead outsiders undervalue the firm. This evidence shows that shareholders are paying for this over-liquid and under-levered capital structure. As stated in the case, “Despite the company’s profitability, returns to shareholders have been somewhat below average”. In other words, it hurts the value of firm in the long run. They are not maximizing firm value by staying away from debt financing. Under current payout policies, the...
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