1.

What are the effects of the proposed repurchase on Blaine Kitchenware, Incorporated’s 2006
a. Balance sheet?
First, we use all the cash & cash equivalents to make the repurchase of shares and by looking at the
original 2006 number we can see that cash & cash equivalents are not enough. Therefore, will the
rest of the cash come from selling the marketable Securities, but we do not need to sell all the
market securities. We need 209 million and we have cash + marketable securities =
66557+164309=230886. To make the repurchase we need debt which I have assumed is long-term,
where I have added a line, which will be equal to 50000 and increase the total liabilities and
decrease the shareholders equity there is found with the following formula:
'
Shareholder s Equity=Total Assets – Total Liabilities

Assets: 2004 2005 2006 2006*

Cash & Cash Equivalents 67.391 70.853 66.557 21.866
Marketable Securities 218.403 196.763 164.309 0
Accounts Receivable 40.709 43.235 48.780 48.780
Inventor
y 47.262 49.728 54.874 54.874
Other Current Assets 2.586 3.871 5.157 5.157
Total Current Assets 376.351 364.449 339.678 130.678

Property, Plant & Equipment 99.402 138.546 174.321 174.321

Goodwill 8.134 20.439 38.281 38.281
Other Assets 13.331 27.394 39.973 39.973
Total Assets 497.217 550.829 592.253 383.253

Liabilities & Shareholders' Equity:

Accounts Payable 26.106 28.589 31.936 31.936
Accrued Liabilities 22.605 24.921 27.761 27.761
Taxes Payable 14.225 17.196 16.884 16.884
Total Current Liabilities 62.935 70.705 76.581 76.581
Long Term debt 0 0 0 50.000
Other liabilities 1.794 3.151 4.814 4.814
Deferred Taxes 15.111 18.434 22.495 22.495
Total Liabilities 79.840 92.290 103.890 153.890
Shareholders' Equity 417.377 458.538 488.363 229.363
Total Liabilities & Shareholders' Equity 497.217 550.829 592.253 383.253

It makes most sense to let some cash still being part of asset and sell all the marketable securities.

Income statement?
In the income statement - we only need to add one line which is the interest expenses which is due
to the new long-term debt. Interest rate of the long-term debt was equal to 6.75%. It will then
impact all values below.
Operating Results: 2004 2005 2006
Revenue 291.940 307.964 342.251 342.251
Less: Cost of Goods Sold 204.265 220.234 249.794 249.794
Gross Profit 87.676 87.731 92.458 92.458
Less: Selling, General & Administrative 25.293 27.049 28.512 28.512
Operating Income 62.383 60.682 63.946 63.946
Plus: Depreciation & Amortization 6.987 8.213 9.914 9.914
EBITDA 69.370 68.895 73.860 73.860

EBIT 62.383 60.682 63.946 63.946

Plus: Other Income (expense) 15.719 16.057 13.506 0
Minus: Interest expense 0 0 0 -3.375
Earnings Before
Tax 78.101 76.738 77.451 60.571
Less: Taxes 24.989 24.303 23.821 18.629
Net Income 53.112 52.435 53.630 41.942
Dividend
s 18.589 22.871 28.345 28.345

Margins:
Revenue Growth 3,2% 5,5% 11,1% 11,1%
Gross Margin 30,0% 28,5% 27,0% 27,0%
EBIT Margin 21,4% 19,7% 18,7% 18,7%
EBITDA Margin 23,8% 22,4% 21,6% 21,6%
Effective Tax Rate (1) 32,0% 31,7% 30,8% 30,8%
Net Income Margin 18,2% 17,0% 15,7% 12,3%
Dividend payout
ratio 35,0% 43,6% 52,9% 67,6%

Assumptions: Other income is assumed to be interest on the marketable securities, but as we have
used all this to finance the repurchase of shares there will no longer be any form of income.

b. Interest coverage, debt ratio, EPS, and ROE?

First, we will find the interest coverage ratio, with the following formula:
EBIT
Coverage ratio=
Interest expense
Before:
Inser values:
63946
Coverage ratio= =n . a .
0
After:
Insert values.
 63946
Coverage ratio= =18.95
3375
The interest coverage as a rule of thumb should be acceptable but will be highly dependent on
industry.
Next, we need to find the debt ratio, which we can do with the following formula:
Book value - debt ratio
debt
debt ratio=
total assets
Before:
Insert values:
0
debt ratio= =n. a .
592253
After:
Insert values:

50000
debt ratio= =13.05 %
383253
This number is based on book values. It describes the solvency ratio, financial stability and
cabaitillites

Then, we need to find the earnings per share (EPS):

Earnings(Net Income)
EPS=
Shares outstanding
Before the repurchase the number of outstanding shares 59.052. There was repurchased 14000
shares resulting in there only being 45.052 shares outstanding. Insert values in formula:
53630 41942
Before−EPS= , After−EPS= =0.93
59052 45052
Lastly, we need to find the return on equity, which is given by the formula.
Net income
ROE=
end of year shareholders equity
Insert values - the reason why we end of year shareholders equity is due to them using that in the
article - footnote on page 3 - ROE us computed here as net income divided by end-of-period book
equity. It is possible to make an argument for using average shareholder equity.
Before:
 53630
ROE= =10.98 %
592253
After:
41942
ROE= =18.29 %
229362
c. Company cost of capital, WACC (assume a risk free rate of 5.02%, and a market risk
premium of 5 %)?
Before repurchasing:
Calculate the cost of equity using CAPM:
Re =r f + β e ( r m−r f )
We have been given the information that the risk-free rate is equal to 5.02% and a market risk
premium of 5%. In addition, we can find information of beta equity is equal to 0.56. Insert values:
Re =r f + β e ( r m−r f )=R e =5.02 %+0.56∗5 %=7.82 %
Now we need to find an approximate level for cost of debt, as we need to incorporate the negative
net debt - we use the risk of 5.02% as a proxy for cost of debt, thereby assuming the cash and
securities earns an interest close to a risk-free investment. Cost of debt is equal to 5.02%.
Exhibit 3 gives us the following informaiton:
D
=−31.68 %
V
E
=131.68 % →1−(−31.68 % )
V
Which tax rate would you use.
We apply the 40% marginal tax rate in our analysis aligning with the forward-looking nature of the
WACC, no influence of tax credits a deafer of tax future. WACC formula:
E R D∗D
WACC = ∗R E + ∗( 1−T )
V V
Insert values:
WACC =131.68 %∗7.82 %+5.02 %∗−31.68 %∗(1−0.40 ) =9.34 %

After repurchasing:
We have been given the information that the risk-free rate is equal to 5.02% and a market risk
premium of 5%. I will assume that the beta on debt is equal to 0, which means we can write the beta
on equity as the following equation:
 β D∗D β E∗E
β A= +
V V
β E∗E
β A=
V
Inserting values and have assumed that beta on debt is equal to zero:
β A=0.56∗131.68 %=0.7 37
First, we will find the net debt:
50000−21866=28134
How has the value changed due to the repurchase. Answer: The present value of the tax shield
should be value creating and added to the enterprise value before the repurchase.
The value of the tax shield equals (present value)
tax rate∗debt∗r d 40 %∗259000∗6.75 %
Tax sheild = = =103600
rd 6.75 %
Assumption: Constant capital structure in perpetuity (M&M)
Market value of equity compared to debt:
net debt
debt ratio=
Enterprise value
We will start by finding the net debt.
net debt=Total debt−Cash∧securities
And total debt is equal to short + long-term debt.
net debt=50000−21866=28134
Then we need to find the enterprise value of the firm, which is given as
Enterprise value=Market capitalizatio nold −repuchase−debt+ Tax sheild +net debt
Market capitalization is given as the share price * by the number of outstanding shares. Before the
repurchase the number of outstanding shares 59.052. There was repurchased 14000 shares resulting
in there only being 45.052 shares outstanding.
Enterprise value=959596−209000−50000+103600+ 28134=832330
And then we can find the debt ratio
Insert values:
50000
debt ratio= =3.38 %
832330
We found the beta on assets earlier = 0.737
The beta on assets will not change and there we need to find the beta on equity with the target
capital structure and we can rewrite the following equation:
β A∗V
=β E
E
Insert values:
737∗1
0. =0. 76 3
(1−0 . 03 27 )
Now we have found the beta on equity with the use target capital structure is the following:
β E =0.763
Now we can use the CAPM formula to find the cost of equity:
CAPM : R E=r f + β E ( r m−r f )
Insert values and we get:
R E=5.02 % +0.763∗5 %=8.84 %
We have been informed in the text that Blaine did not have any debt and then took on 50 million in
debt to an interest rate of 6.75% - meaning that the cost of debt must be equal to 6.75%. In addition,
we have been informed that Blaine's future tax rate is assumed to revert to the statutory rate of 40%.
Now we just need to insert the values in the WACC formula:
E R D∗D
WACC = ∗R E + ∗( 1−T )
V V
Insert values:
WACC =( 1−3. 38 % )∗8.84 % +6.75 %∗3. 38 %∗( 1−0.40 )=8.67 %
2. Should Dubinski recommend the share repurchase proposal to Blaine’s board? What are the
primary advantages and disadvantages of such a move? As a member of Blaine’s controlling
family, would you be in favor of this proposal? Would you be in favor of it as a non-family
shareholder?
In the recent year Blaine’s have carried out some small acquisition which were financed using cash
and after these acquisitions still having 231 million USD in cash and securities. Besides that, in the
period of last 3 year they have only spend 10 million USD on CAPEX - it seems like there is real no
reason for them having such large surplus of cash laying around and resulting in the shareholders
obtaining a lower return on their equity. Also, since the sales of the company is seasonal in nature,
the working capital requirement of the firm also varies.
Primary Advantage: One option is to utilize this surplus of cash to buy back the shares from
minority shareholders. From the text, we know that after the IPO the collective ownership of the
family was reduced to 62% - in case of the family decides to buy back shares, it will increase the
control the family has over the firm. This will make it easier for them to make big decision of the
firm’s future and which strategies they need to implement to grow in the future. Although the firm
has done small acquisition, the growth of the revenue is only expected to grow by 3% each year in
the future. If the control of the firm is in smaller number of shareholders, they can take some major
decision like expanding and diversifying which is necessary to improve their top line. In addition,
we have seen with the forecasted growth rate of only 3% must it mean that the company was not
successful in purchasing other companies to grow.
Important advantage is that with buyback of share will make it hard for any private equity funds
to make a hostile takeover. The reason for this is when a company has a large amount of excess cash
it is a very attractive proposition of hostile takeovers due to you can use the excess cash to finance
the takeover. Blaine Kitchenware has a very good brand name in the market with a lot of trusted
consumers. A hostile takeover with change of ownership could potentially harm the business.
Taking on debt will provide them with a tax shield which will be captured by the equity holders and
is deductible while on the other hand is tax not. In addition, will health borrowing increase the value
of them as long as there is not default risk associated with the debt. Using up BKI’s debt capacity
will increase its enterprise value and discourage any form of takeovers.

Disadvantage with repurchase of shares with the use of debt - it will produce more interest
expenses and increase the management risk of the firm. The change of financial distress increases,
and the family/company has no form experience is using debt. A market might interpret such moves
as a negative indication of lacking attritive investment opportunities. One usual disadvantage of
buyback through cash is that it strains the liquidity of the company, but in this scenario Blaine
kitchenware Inc. has the option of raising debt to finance its other capital needs as currently it is
debt free. Hence, the major disadvantage of the buyback is nullified by it.

Member of Blaine’s controlling family: The repurchase option is better because they have bigger
ownership of the company and makes the possibility of a hostile takeover less. Benefits of tax
shield, but they also need to pay a premium. Better takeover defence.
Non-family shareholders: The EPS and ROE rise, meaning BKI is taking a more effective way
representing shareholders’ benefit. In addition, good (high) premium for repurchase.
less representation on the board.

Conclusion, I suggest that Blain Kitchenware should go ahead and buyback its shares.

Trade off theory:

What is the value of the tax shield?
tax rate∗debt∗r d 40 %∗259000∗6.75 %
PV (tax shield )= = =103600
rd 6.75 %
How is this relevant in the Blaine case:
Two contradiciting effects: You pay a 2.25 USD (12%) premium on the fair value (uven EMH), but
how does this relate to the value created?
PV ( tax shield )
=PV ( tax shield pr . share )
Outstanding share
103600
=1.75
59052
It therefore makes the good offer but Blaine.
How do we normally categorize costs of financial distress?
 Direct costs: Fire sale, lawyers fees
 Indirect cost. Human cost, lost faith from stakeholders
How can we calculate the costs of financial distress.
 Due to the low amount of debt used we do not expect it to result in financial distress.

Agency cost/benefits of debt