Bed Bath and Beyond Case

The company’s leverage ratio is 28% - 72% of its assets are financed by common equity and the company was profitable in the last reporting period. The company should easily raise additional funds from creditors and a convertible debenture will be an appealing venture for creditors who would want to purchase stocks of the company in the future.

Our company will plan to finance our strategy principally through issuing stock and cash flows from operating activities generated from the company’s normal business functions. It is undesirable for our strategy to issue debt because we would like to stay away from interest payments. Our company anticipates our debt to equity leverage ratio to be around 0.5.

Company does not have big amount of debt to pay. In 1994 its outstanding debt is only 36.4% of its total assets which is a healthy rate. Its current assets are higher 2.4 times than its current liability. Also company has no outstanding interest to pay. Price earning ratio of 42.80 is highest among the competitors. (Pls. see exhibit 2, 3&4) for details. So we can safely conclude that BBBY has great potential to sustain.

Higher leverage is very likely to create value for a firm considering capital structure change by exerting financial discipline and more efficient corporate strategy changes.

By paying out excess cash and issuing debt, BBBY could improve return to equity holders and raise earnings per share (by a share repurchase).

What are the advantages of leveraging this company? The disadvantages? How would leveraging up affect the company’s taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure?

BBBY will need to trade off business risk against financial risk. They operate in an industry with fairly low business risk however BBBY's operating leverage is high which could indicate a higher than industry business risk if they are not cognizant of managing their fixed costs. In addition, BBBY's debt to total asset ratio is higher than their industry. Both of these indicate a high business and financial risk. If BBBY were to recapitalize to 80% debt to total capital it would only increase their financial risk and reduce shareholders earnings per share. Therefore the recommendation for a capital structure for BBBY would be to add more than the 40% debt to total capital but not more than 80%.

An analysis of a repurchase of stock for $400 million cash, and recapitalization to 80% debt-to-total capital by borrowing $1.27 million reveals that BBBYs return on equity will be 113%, return on assets 61% and an after tax cost of debt of 28%. ROE is > ROA and ROA > after tax cost of debt. With the 80% debt-to-total capital structure ROE exceeds the other two capital structure scenarios of no debt and 40% debt-to-total capital. While all of this looks great there are other considerations. The household and personal products industries debt to total asset ratio is 34.69% while BBBY debt to total asset ratio is at 44% ($1,270,000/$2,865,023). Increasing to this capital structure would also reduce shareholders earnings per share.

Based on our projections for the years 2002-2004, the biggest driver that effects debt is the company’s operating expenses. Based on the history of the upward trend of operating expenses, our recommendation is that The Body Shop needs to concentrate on lowering the operating expenses, and keeping those expenses around 45% or lower in order to avoid borrowing money. Our 45% recommendation includes a safety net which will prevent having The Body Shop borrowing cash if sale do not continue to climb at a significant rate.

The statement of cash flows outlines some of the changes to the capital structure. The company added $164.5 million in a consolidated loan facility, and it paid out $138.1 million in dividends. There were no share buybacks during the year. The company states in the annual report (p.4) that it intends to maintain a conservative gearing ratio. The company in this section attributes its increased borrowings to projects and opportunities on which it has embarked. These investments lie within the integrated retail, franchise and property system. One of the

Based upon the firm’s low target leverage of 5%, low degree of operating leverage, and favorable credit history and financial outlook, the model assumes a cost of debt in line with AAA corporate debt at 7.02%. This estimate seems reasonable and sensitivity analysis shows a 1% decrease in the forecasted share price requires at least a 2.4% increase in the cost of debt.

Managing debt levels to maintain an investment grade credit rating as well as operate with an efficient capital structure for its growth plans and industry

Higher leverage is very likely to create value for a firm considering capital structure change by exerting financial discipline and more efficient corporate strategy changes.

Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that

Bodie Industrial Supply has funded itself mostly through loans. These loans include a bank loan, transport loan, mortage payable and CCB mortage payable. They took out a loan in 2005 in order to pay for the purchase of land, building and equipment. Liz Bodie expects sales growth to increase in 2007 and thus needs funding to build an extension to the warehouse to hold more inventory. Looking at BIS’s cashflow statements, you notice a significant increase in net cash flow from financing from 2005-2006. There is also an increase from the cash flow of operations from 2005-2006. In 2005 net cash flow was -$13,500 and increased rapidly in 2006 to a healthy net cash flow of $49,720. Based on current ratio, the company is losing liquidity, decreasing from 2.63 in 2004 to 1.52 in 2006. The quick ratio is another indication