1. What are the primary business risks associated with UST Inc.? What are the attributes of UST Inc.? Evaluate from the viewpoint of credit analyst or bond holder.
UST Inc. is a smokeless tobacco company with a long tradition and a recognizable brand name. A strong brand name can have lots of associations with high quality, revenues, soundness, growth, etc. But, this is one of the characteristics that can be like two edged sward. On one side, company with long tradition is expected to to operate in a stable and prosperous way as it always did, but on the other side, company itself can get too self confident and fail to see the newcomers and other threats. UST has ignored newcomers, and now they all have a growing market shares,
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Should UST, Inc., alter the new debt via a different level or a change in the amount of debt through time?
In order to answer the question, I calculated if financing through debt was the right choice. I used EBIT-EPS analysis. Two choices were analyzed: debt or equity financing.
I thought that 5% would be cost of debt, taking into account the company 's high S&P credit rating (AAA investment grade).
EPS = earnings per share,
EBIT = earnings before interest and taxes,
I = interest expense,
T = tax rate
P = preferred stocks,
S = number of common shares outstanding
=> EBIT=373.511997 *a - $1bil was divided by price of shares in order to get how many shares would have to be sold to raise $1 bil Breakeven point of EBIT is at $373.511997 mil. If EBIT is higher than this number (and it is:$753.3 mil), than debt should be chosen. But for EBIT lower than $373.5 mil equity financing would be wiser choice.
Breakeven point of EBIT:
stock Debt
EBIT 373,511,997 373,511,997
- interest 0 50,000,000
EBT 373,511,997 323,511,997
- tax (38%) 141,934,558 122,934,559
EAT 231,577,439 200,577,438
No.of shares outstanding 214,169,725 185,500,000
EPS 1.08 1.08
For EBIT lower than breakeven point:
stock Debt
EBIT 200,000,000 200,000,000
- interest 0 50,000,000
EBT 200,000,000 150,000,000
- tax
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.
I do not think it is proper. Since hurdle rate is the key factor to determine whether we should accept a project, it is concerned with a specific investment opportunity belonging to a division. As we can see in Table 1, each of Midland`s divisions had its own target debt ratio. Those
In general, using external funds, i.e. debt or equity, to finance increasing growth is riskier to the corporation. When issuing debt the company needs to be certain to cover both the repayment of the principal and the interest payments on time (because if they do not this could cause them to have problems securing financing in the future). When issuing additional shares of stock (equity) the value of existing traded stock is diluted (in proportion) and as such the current ownership might lose control (and may even be voted out by shareholders if dilution is substantial enough). Furthermore, with both debt and equity financing, a fast growing company needs to be aware that payments to either may hamper future expansion because payments that need to be send out in the forms of dividends or interest cannot be retained and invested in future projects.
The company position is strong enough so its better that company should use debt financing instead of equity financing.
9. What is the Cost of Debt, before and after taxes? Using the interest rate for the largest debt…cannot use the weighted interest rate for the debt since it includes capital lease obligations with no stated rate and could not find in the notes to the financials. 5.4% After tax cost is .054 x (1-.36) = 3.5%
Given that the cost of equity is 9.4% and the cost of debt is 12.2%, Star’s cost of capital can be calculated as 9.14% (Appendix B). The company was also considering raising the cost of debt to the industry average of 19%. At this cost of debt, Star Company would have a lower cost of capital of 8.24% (Appendix B) because interest on debt capital is deductible whereas dividend payments on equity capital are not.
In accordance ASC 470-50-40-21b Modifications to or exchanges of line-of-credit or revolving-debt arrangements resulting in either a new line-of-credit or revolving-debt arrangement or resulting in a traditional term-debt arrangement shall be evaluated in the following manner:“ If the borrowing capacity of the new arrangement is greater than or equal to the borrowing capacity of the old arrangement, then any unamortized deferred costs, any fees paid to the creditor, and any third-party costs incurred shall be associated with the new arrangement (that is, deferred and amortized over the term of the new arrangement.”
If BBBY were to use $400 million in excess cash and $636.3 million in borrowed funds to repurchase it's shares they would increase their basic earnings per share from 1.35 to 1.41 and their diluted earnings per share from 1.31 to 1.37. If BBBY were to use $400 million in excess cash, and borrow $1.27 billion to repurchase their shares, the increase of the basic earnings per share would only be 0.3 while the difference from zero debt to
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 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.
Thus the WAVG Cost of Debt (including L/T debt and preferred stock) = rd = 8.633%
We assume linear increase in the EBIT and EBITDA at 3% for 1999 from 1998 figures. Considering the debt will be long-term, we test both 10- and 20-year corporate yields as interest rates to see what would be the coverage ratios, using the 1999 projected figures.
In Scenario A, the Debt would remain at 0 for good. This results in a D/V ratio of 0 which gives us a WACC of 9.21. Using the WACC to derive the Enterprise value of the company, it is found to be $3.043B. Subtracting the debt of $1.25B, we have a Value of Equity of $1.79B. Subtracting the $765M that is
Market value proportions of: Debt = $1,147,200 / $4,897,200 = 23.4% Pref. Share = $1,250,000 / $4,897,200 = 25.5% Common equity = $2,500,000 / $4,897,200 = 51.1%
If company doesn’t have any debt, it means that WACC is equal to cost of equity.