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Assuming Swedish Match faces a 28% tax rate on income and can issue bonds at

a fixed krona yield of 4.5%, how much will the company save in taxes for a SEK4
billion recapitalization? What is the value of this interest tax shield?
Also there is a tax advantages of issuing debt, this is because the order the
payment are done by law. When some debt is outstanding and you have to pay
the interest on these debts, you pay them before you pay the taxes, so by issuing
debt you decrease the tax payments. For Swedish match in this case, which are
subject to a corporate tax rate of 28% and want to issue 4 billion SEK in debt
against an interest rate of 4.5% annually, their tax saving is:

4.5 4.000.000 .000 SEK28 =50.400 .000 SEK

annually

The rate for a 10 year BBB bond is closed to 4,5%. So we assume the debt is
issued for 10 years. Thus the present value of the tax-shield is equivalent to a 10year annuity with a 4.5% discount rate.

50.400 .000
1
1
=SEK 398.800 .996
10
0,045
1,045

2. What will Swedish Matchs book value balance sheet look like after it
completes the debt issuance and share repurchase?
A tax shield is not something which represents a book value, so there will be no
change on assets side of the balance. However, on the liabilities side the post
Total Interest-Bearing Debt will increase by SEK 4 billion because we issued SEK 4
billion in bonds. And the post Equity will decrease with SEK 4 billion because we
bought back SEK 4 billion in shareholders equity.
See appendix for book balance sheet

3. What will Swedish Matchs market value balance sheet look like: a. Right after
it announces the leveraged recap? b. When it completes the issuance of SEK 4
billion in debt? c. When it completes the share repurchase?
The initial market value of the equity is equal to:

SEK 77 322,1 million=SEK 24.801,7 million


We saw earlier that the issuance of 10-year Bonds for the amount of SEK 4 billion
will lead to a SEK 399 million tax shield. Thus when this debt is issued the market
value of the equity will raise by the amount of SEK 399 million. And the amount
of Cash and short-term investments will increase by SEK 4 billion. So after the
Debt issuance the market value of equity will be equal to:

SEK 24.802 million+ SEK 399 million=SEK 25.201 million


But the market value of the company will already increase to this level when the
recap is Announced. Because otherwise there would exist an arbitrage
opportunity and investors could buy shares and sell them immediately afterward
at a higher price.

Because the market value of equity has increased the share price has increased
as well to the new level of:

SEK 35.039 million


=SEK 78,24
322,1 million shares
Now that we know the new share price we can calculate how much shares we can
buy with the SEK 4 billion:

SEK 4.000 million


=51,13 million shares
SEK 78,24
After we bought al these shares back the amount of Cash and Short-term
Investments will drop by SEK 4.000 million (the value of the repurchased shares)
and because of this the market value of the equity will drop to:

SEK 25.201 millionSEK 4.000 million=SEK 21.201million


and the amount of shares to:

322,1 million shars51,13 million shares=270,97 million shares

See appendix for market value sheet

Nog te doen:
4. Can Swedish Match afford to borrow this much money? What are the risks? Is
it realistic to expect a BBB+ rating?
The net income of Swedish match is SEK 2083 million a year in the initial
situation, so issuing 4000 million debt isnt risky because the profit over the 10
year at which the debt is in the firm they earn enough to pay-back these loan. So
in the initial situation the leverage is 41% at book value and 11% at market
value. At these rates theyre provided with an A- rate. If we compare this to a
company which is rated at the BBB+ (the rate that is expected to be given after
the debt issuance). One company is BAT. If we analyze their leverage ratios, we
can conclude that they have a book-value leverage of 54% and a market-value
leverage of 28% (which are higher than the initial ratios of Swedish Match).
After the issue of the debt the ratios of Swedish Match will change. So the new
book-value leverage is

7529
=35,5
21201

7529
=50,54 , and a market value leverage
14898

. The market value leverage is almost comparable to the other

BBB+ rated firm, if we compare these numbers with an even lower rated firm,
like Gallaher which is BBB rated. Gallaher has book leverage of 102% and market
leverage of 36%. These say that the market value leverage also comparable for
market value leverage then for Swedish match.

But these leverage ratios dont tell the total story if we look the ratio of
debt/EBITDA. We can compute that Swedish matchs ratio is

7529
=3,2 ,
2344

which is somewhat higher then BATs (2,5 times). If we look at the number of
times the earnings can cover the interest payments. We can see that Swedish
Match can pay these interest expenses

1865
=4,18
266 +( 40000.045)

with the

current EBIT, if we once again compare this to BAT (6,8 times). So overall we can
conclude that BAT is somewhat better then Swedish Match. But Swedish Match is
very comparable to Gallaher which is BBB rated, so an BBB rating is more likely
also with comparing these figures with the estimates of the credit-ratingagencies.
But the issuance of the debt will provide some risks to the company. Increasing
debt will always increase the likelihood of financial distress, because the interest
payments will decrease the net income. These net income is used to repay debts
or even the EBIT is not enough to pay interest at all and the company will go into
default.
5. What else speaks in your opinion in favor or against the leveraged recap?
Should the company go ahead with this new financial policy? If so, would you
even approve a larger recapitalization?

Book Value
Balance Sheet
Assets
Cash and Shortterm
Investments
Current Assets
PP&E
Other assets
Total Assets
Liabilities
Current Liabilitiesd
Total InterestBearing Debt
Other Liabilitiese
Equity
Total Liabilities+
equity
Market Value
Balance Sheet
Assets

Share
Repurchase

Initial

Initial

3.002

3.002

4.884
2.712
4.300
14.898

4.884
2.712
4.300
14.898

3.776

3.776

3.529

7.529

2.533
5.060

2.533
1.060

14.898

14.898

Recap
Announced

Debt
Issuance

Share
Repurchase

Cash and Shortterm Investments


Original Assets
(VU)
Tax shield
Total Assets
Liabilities
Current Liabilitiesd
Total InterestBearing Debt
Other Liabilitiese
Total Liabilities
Equity (Assets Liabilities)
Shares
Outstanding
(million)
Price per Share
(SEK)

3.002

3.002

7.002

3.002

31.638

31.638

31.638

31.638

0
34.640

399
35.039

399
39.039

399
35.039

3.776

3.776

3.776

3.776

3.529

3.529

7.529

7.529

2.533
9.838

2.533
9.838

2.533
13.838

2.533
13.838

24.802

25.201

25.201

21.201

322,1

322,1

322,1

270,974436

77

78,24

78,24

78,24