Blaine Kitchenware: APV

Assess the value of a proposed leveraged recapitalization (recap). Suppose Blaine uses all of its current cash and marketable securities plus $50 million in new debt to repurchase equity, and will maintain its debt level at $50 million (indefinitely).

1. Take the balance sheet from December 31, 2006, as an example (Exhibit 2). How would the recap change Blaines balance sheet (book values)? Complete the following table:

	Pre-recap	Post-recap
ASSETS
Cash & Marketable Securities	230,866
Accounts Receivable	48,780
Inventory	54,874
Other Current Assets	5,157
Total Current Assets	339,678
PP&E	174,321
Goodwill	38,281
Other Assets	39,973
Total Assets	592,253
LIABILITIES
Accounts Payable	31,936
Accrued Liabilities	27,761
Taxes Payable	16,884
Total Current Liabilities	76,581
Other Liabilities	4,814
Deferred Taxes	22,495
Debt	0
Total Liabilities	103,890
Shareholders Equity	488,363
Total Liabilities & Equity	592,253

1. What is the change in net debt?
2. What is the post-recap value of net debt/enterprise value?[1]

2. ITS. Take the income statement from December 31, 2006, as an example (Exhibit 1), adjusting the tax rate to 40%.[2] Assume a 5.85% interest rate on the debt (for this question). How would the recap affect the income statement? Complete the following table:

	Pre-recap	Post-recap
EBIT	63,946
Plus: Other income (or expense)	13,506[3]
Earnings Before Tax	77,451
Less: Taxes
Tax rate	40%	40%
Net income
Interest coverage ratio (times interest earned)
Return on equity (ROE)

1. By how much does the corporate tax expense decrease? How large is this amount relative to the pre-recap net income? If this annual tax saving were perpetual, what would be the present value of the future tax savings if discounted at the nominal interest rate of 5.85%. [Use the PV formula for a constant perpetuity.]

2. Estimate the present value of the tax benefits created by the recap using a back-of-the-envelope calculation based on the APV method. [No full DCF valuation needed.]

3. COFD.

1. Suppose the recap were to increase the probability of default to PrFD=10%(This is likely way too high an estimate). How large would the present value of the costs of financial distress conditional on distressi.e., PV(COFD|FD)have to be to offset the tax advantage you calculated in b?

2. Think about potential CoFDfor Blaine. (Link to Mondays discussion and the themes discussed in the module on financial distress.)

4. Do you think that the proposed recap increases the market value of the firm (to investors)?

[1] See Exhibit 3 of the case.

[2] See footnote on page 4040 of the case.

[3] This reflects the interest and dividend income from Blaines current cash and marketable securities.