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Dandy Corporation has for many years owned and operated a national chain of retail stores specializing in low end consumer electronics. Their stores have carried
Dandy Corporation has for many years owned and operated a national chain of retail stores specializing in low end consumer electronics. Their stores have carried the name Radio Hut. Like many bricks and mortar companies in the age of the internet, Dandy has suffered through a prolonged period of stagnant sales and very slow growth. This inevitably has shown up in the performance of its common stock, which has also languished. Various strategies have been proposed inhouse to resolve this dilemma. It has been proposed that Dandy complement its low end product line with more upscale offerings that carry a higher profit margin, items such as personal computers, flat screen TVs and surround sound systems. This approach was rejected on the belief that companies like Best Buy have this market locked up Another suggestion was that Dandy should expand into Canada. This also was rejected due to the enormous expense and the highly risky nature of the proposal given the well entrenched companies in the electronics retail business already operating in Canada. Recently another strategy has been proposed, this one by the Chief Financial Officer. She believes that Dandy's market price per share can be elevated through a purely financial strategy. She proposes that the company lever its earnings by issuing bonds and using the proceeds to buy back its stock. The reduction in the number of shares issued and outstanding will raise earnings per share, allow dividends per share to increase, promote growth and cause market price per share to increase. Dandy just today paid a dividend of $ and has been experiencing growth at a rate of for many years. The recommendation made by the CFO is expected to raise that growth rate to a constant, perpetual This strategy does carry risks. The use of greater amounts of longterm debt increases the probability of insolvency and bankruptcy. This added risk should cause the firm's beta to go up The relationship between a firm's beta as an unlevered entity an all equity financed company and its beta as a levered entity is: where is the debtequity ratio, is the levered beta, and is the unlevered beta. Since its founding, Dandy has always been an all equity financed firm with a beta of The level of bonded indebtedness contemplated by the CFO would raise the debtequity ratio from zero to The market is expected to return and the riskfree rate is Will the CFO s recommended strategy cause Dandy's market price per share to increase?
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