Blaine Kitchenware Case Study Answers Essay

1. ABOUT THE associationBlain Kitchenware, Inc. (BKI), founded in 1927, is a mid-sized producer of small appliances for residential kitchens. BKI has an approximate 10% market share of the $2.3 one million million U.S. market for small kitchen appliances, with 65% of sales originating from the US market. The friendship is public since 1994, and the majority of the shares is controlled by the turn everywheres family (62% of outstanding shares), who also learn a strong re payation in the board of directors. Mr. Dubinski the chief operating officer since 1992 and great-grandson of one of the founders, successfully completed an IPO in 1994 and gradually moved the production abroad in the early 90s. BIKs current st evaluategy is to equilibrate its product offerings by acquiring small unconditional manufacturers or the kitchen appliance product terms of larger diverseness manufacturers.The financial data at the end of 2006 reflects a strong financial position The company has raised(a) nearly no debt, it is very liquid, but also under-levered. BKI is one of the strongest companies in this industry in terms of EBITDA margin (22% in 2006), high level of money holdings and no debt. However, the shift toward higher(prenominal)-end product line could not prevent the margins from a slight decline everyplace the finale three years. This was mainly explained by the integ dimensionn make ups and inventory write-downs due to the acquisitions completed so far. The other reason was that its organic revenue appendage had suffered in recent years, as some of the nerve products lost market share. The growth of the top line was mainly due to the acquisitions. BKIs annual repay on truth is signifi open firetly below that of its in public traded peers 11% compared to an average of 25,9 and a median of 19.5 %. at one time the over-liquid and under-levered BKI is facing strong pressure from a one-on-one equity group interested in acquire the companys common sto ck. Thus, the CEO considers a stock repurchase to avoid a foreign takeover. The company decided to distribute all dissipation cash as a dividend. The second shade leave be the recapitalization plan to hold for good $ 300m of debt on the balance sheet, which is a difficult stopping point due to the first sign of the mortgage crisis. Moreover, the company enquires annual revenue decline of 4%in 2007-2009, and a permanent 2% growth rate afterwards.2. METHODOLOGY AND VALUATIONFrom a companys perspective, the benefit of debt is the revenue enhancement revenue riddles created, which are captured by equity holders. The family-controlled company in our reference has little give with holding debt and the board of directors might not soft accept the restructuring plan. What they should know is that the right amount of debt increases the unassailables jimmy and discourages the takeovers. However, a too-high level of debt batch lead to financial distress, lower credit rating, a nd higher interest expenses. For BIK, the credit rating regressed from A (Iteration 1) to A- (Iteration 10), consequently changing the credit spread from 1.40% to 1.65%.Our aim is to asses the how the proposed recapitalization will affect the enterprise mensurate, after the distribution of the senseless cash as dividends, by utilize APV. We look the subject value of the stiff as if it were all-equity financed (VU), then we add the present value of tax shield associated with the new debt (permanent debt with market value of 300 mln USD), and start the present value of bankruptcy costs.We have to deem expected after-tax operating cash flows , the expected tax shields and bank discount them at two different discount rates (unlevered cost of capital) and (usually , cost of debt). For the present value of the bankruptcy costs, we have to first estimate the risk-neutral probability of default of the company.VL = VU + PV (future tax shields from debt) PV (bankruptcy costs),o r rewritten as limen insurance coverage ratio for defaultprobability of firm default conditional on surviving up to a specified periodWe start with a forecast of expected after-tax operating cash flows. We impound the annual 4% decline in revenues amidst 2007 and 2009 from the 2006 level, and a permanent 2% growth afterwards. Analysing the diachronic values of the operating margins from the Income Statement, we forecast values for the 2007-2009 period. The executives of BKI expect the firm to achieve operating margins at to the lowest degree as high as the historical ones. Thus, we took averages and about adjusted them toward higher values. Since the declining tendency in the last three years was cause by integration costs and inventory write-downs associated with acquisitions, which already have been completed.To the EBIT, estimated by using those margins, subtract the taxes, Capex, adjust for Depreciation, Amortization and change in workings capital. The capital expenditure s were just over $10m on average per year. The company is expecting the Capex remain modest. Thus, we sour a Capex of $10m for the beside three years. We estimated Net Working Capital by using the average ratio of NWC/Net income of the last three years. Finally, we come up with the value for the operating after-tax operating cash flows for the next three years and the terminal value. We calculate the present value of these cash flows by discounting by the unlevered cost of capital, rU given as 8.7%, which gives us a value of the unlevered firm of ca. $566m.Secondly, we estimate the expected tax shields from the debt level a permanent amount of $300m market value, and a constant tax rate of 40%. Then we calculate their present value using the appropriate discount rate reflecting the risk, rT (or rD).For the bankruptcy cost, we have the percentage of the unlevered-firm value of 20%, but for the present value, we need to estimate the risk-neutral probability of default q. This probab ility is calculated iteratively starting from the coverage ratio (EBITt-1 / recreate Expense). We match the coverage ratio number with the correspond credit rating, which then has a corresponding default. This gives us the yield on debt y, the cost of debt rD, and the risk-neutral probability of default q. The formula for q is q=where is the recovery rate in case of default, given here as 41%. In order to calculate the expected interest coverage ratio, we took the average EBIT between 2007 and 2009 for the mean of pre-tax cash flows, as well as the according standard deviation, since our tenderness is future based.2. SENSITIVITY ANALYSIS AND CONCLUSIONWe can conclude that by raising debt of $300m the company would be better of, since the value of the levered firm would be 16% higher that the value of the unlevered firm and will discourage the takeovers. However, the sensitivity analysis gives us an optimal value of debt of $354m, which would lead to an optimal ratio between the PV of tax shields and bankruptcy costs and, thus, a value of supreme levered firm of $680m, given that our assumptions for AVP will be recognize in the future.