Ust Debt Answers

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3. Should UST Inc. undertake the $1 billion recapitalization? Calculate the marginal (or incremental) effect on UST’s value, assuming that the entire recapitalization is implemented immediately (January 1, 1999). a. Assume a 38% tax rate. b. Prepare a pro-forma income statement to analyze whether UST will be able to make interest payments. c. For the basic analysis, assume the $1 billion in new debt is constant and perpetual. Should UST alter the new debt via a different level or a change in the amount of debt through time. (50 marks) UST should undertake the $1 billion recapitalization. Valuation Impact of recapitalization (in millions, except per-share data and ratios) Status Quo (12/31/1998) $1 billion Recap Plan PV Tax…show more content…
Assume the UST takes the recapitalization, the payout ratio is going to rise to 90%, which will significantly undercut the reinvestment in R&D since R&D is usually the first victim of budget cut in a company. Given the increasingly competitive value sector of the market, a weakened R&D will dramatically hamper UST s ability to maintain the market share, hence the net sales. Second, with the possible passage of the anti-trust law, the threshold of companies entering the tobacco market gets lowered. Market prospect for UST is not positive given the fierce competition evolved with guerrilla tactics from small companies. Third, litigation cost on health issues as well as anti-trust law suite will inflict UST heavier (near) bankruptcy cost and brings UST closer to the fringe of bankruptcy. Finally, the grip of power by the managers due to the increase weigh in the voting power from diminishing total market share number might lead to serious agency cost as UST had traditionally be unsuccessful in non-core operation investments. In conclusion, even though UST will be able to cover both the interest and dividend in the near future, the long run effect of the 1 billion recapitalization is uncertain. A cautious measure is

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