CASE SOLUTIONS

Submitted to Sir Dr. Suresh Kumar Rajput

SADAF HUSSAIN MEMON

BBA8
UST background
 Manufacturing company
 Smokeless company
 Conservative debt policy
 High dividend payout ratio
 Investing in product innovation
 CAGR is declining
 Seven lawsuits have been filed
 Market share 77%
Objectives of case are
 How firm value changes when company leverages?
 How company react or respond to the environmental changes
 Business strategy
 Corporate governance issues (Debt policy give us the opinion of the CEOs.
Dilemma in the case
 Conservative debt policy
 Litigation
 Advertising ban
 Legislation
These are the things which triggers the CEO of the company.

What are the primary business risks associated with UST Inc.? What are the attributes
of UST Inc.?
Risks associated with the company:
 Seven health related lawsuits have been filed on company recently.
 Many lawmakers are trying to stop the tobacco use by young people by
making different laws.
 Insufficient market segmentation
 Less alternatives are available to UST if market erosion problem is not solved.
Market erosion according to case is that many law enforcement agencies are
these days trying to ban on some tobacco made products.
 According to case there UST cannot expand internationally immediately if
they want to expand.
 If there occurs any bad situation in the market to solve these problems
company is unsure to solve so, we can say that it is also one of risk or
weakness which might incur heavy losses for the company.
Attributes of the UST Inc.:
 Leading producer of moist smokeless tobacco. Many people perceive that
moist smokeless cigarettes are better than normal cigarettes.
  Most profitable company in America in terms of ROA, ROE and GPM.
 Its five year return on the capital was 92.1 percent
 UST has good fight strategy against its competitors.
 Geographical diversification
 Market position
 Cyclicality ( in relation to inflation they increase their prices)
 Product diversification is issue with UST
 Asset tangibility(few fixed assets)
 Legislation
 Litigations will have impact on the future cash flows

Q#2: why is UST Inc. considering a leveraged recapitalization after such a long history
of conservative debt policy?
Ans: before discussing the reason of considering the leveraged recapitalization by UST first
let’s define the leveraged recapitalization. It is techniques used by companies to change their
capital structure by issuing debt and use that funds to purchase back the stocks already issued.
The UST Inc. has used the leveraged recapitalization because it shield companies against the
interest taxes. And as we know that when we increase the debt the weighted average cost of
capital also decreases which is cost for the firm. The less WACC the more it would be
beneficial for company keeping other things constant. Moreover, the leverage or debt is also
used as good signal for the new investors and existing investors in finance we call it signaling
theory.
Qno3: 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 payment
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?
Ans: We first measured the value of the unlevered firm and then applied the text shield to
measure the effect of the shift in the capital structure of the UST value.

Introduction to debt policy answers

Qno: 5
Ans: Yeah, leverage is beneficial for stockholders because it increases the net value per share and
eventually contributes to the value development of shareholder equity.

Shareholders cannot do for themselves by leveraging the firm because debt has impact on tax shield
of the firm.

Shareholders would have to premium by issuing the debt to new shareholders.

Qno: 6

Ans: as we have been discussing when firm uses the debt up to optimal level it decreases the WACC
and gives positive signals to outsiders about the performance of the firm. Let’s discuss how it
impacts the managers and investors

Managers: If businesses use more zero-point debt, business managers or owners may get extra
funds to function and profit is generated in the real market from the additional capital. They are also
able to gain more interest from the point of view of investors in the stock market.

Investors: from the investors perspective it is also good for them also because they would earn
constant interest in the long run. It simply means that when company uses the more debt than the
managers work better because they feel if they won’t perform better company would bankrupt and
we will be fired so, they work hard and in this way they generates the profits from which debt
holders are paid.