Twenty-nine-year-old Moe Miller had recently been appointed managing director at M&M Pizza, a premium pizza producer in the small country of Francostan. As a third-generation director of M&M Pizza, Miller was anxious to make his mark on the company with which he had grown up. The business was operating well, with full penetration of the Francostani market, but Miller felt that the financial policies of the company were overly conservative. Despite generating strong and steady profitability of about F$100 million per year over recent memory, M&M Pizza?s stock price had been flat for years, at about F$25 per share.1

His new office, Miller discovered, had an unobstructed view of the nearby marble quarry. How wonderfully irrelevant, he thought to himself as he turned to the financial analysis on his desk. With borrowing costs running at only 4%, he felt confident that recapitalizing the balance sheet would create sustained value for M&M owners. His plan called for issuing F$500 million in new company debt and using the proceeds to repurchase F$500 million in company shares. The plan would leave assets, profits, and operations of the business unchanged but allow M&M to borrow at the relatively low prevailing market yields on debt and increase dividends per share. Committed to raising the share price, Miller felt it was time to slice up the company?s capital structure a little differently.

Francostan

The Mediterranean island nation of Francostan had a long tradition of political and economic stability. The country had been under the benevolent rule of a single family for generations. The national economy maintained few ties with neighboring countries, and trade was almost nonexistent. The population was stable, with approximately 12 million prosperous, well-educated inhabitants. The country was known for its exceptional IT and regulation infrastructure; citizens had unrivaled access to business and economic information. Economic policies in the country supported stability. Price inflation for the national currency, the Francodollar, had been near zero for some time and was expected to remain so for the foreseeable future. Short- and long-term interest rates for government and business debt were steady at 4%. Occasionally, the economy experienced short periods of economic expansion and contraction.

The country?s population was known for its high ethical standards. Business promises and financial obligations were considered fully binding. To support the country?s practices, the government maintained no bankruptcy law, and all contractual obligations were fully and completely enforced. To encourage economic development, the government did not tax business income. Instead, government tax revenue was levied through personal income taxes. There was a law under consideration to alter the tax policy by introducing a 20% corporate income tax. To maintain business investment incentives under the plan, interest payments would be tax deductible.

The Recapitalization Decision

Miller?s proposed recapitalization involved raising F$500 million in cash by issuing new debt at the prevailing 4% borrowing rate and using the cash to repurchase company shares.2 Miller was confident that shareholders would be better off. Not only would they receive F$500 million in cash, but Miller expected that the share price would rise. M&M maintained a dividend policy of returning all company profits to equity holders in the form of dividends. Although total dividends would decline under the new plan, Miller anticipated that the reduction in the number of shares would allow for a net increase in the dividends paid per remaining share outstanding. With a desire to set the tone of his leadership at M&M, Miller wanted to implement the initiative immediately. The accounting office had provided a set of pro forma M&M financial statements for the coming year (Exhibit 1).

Based on a rudimentary knowledge of corporate finance, Miller estimated the current cost of equity (and WACC) for M&M with the current no-debt policy at 8% based on a market risk premium of 5% and a company beta of 0.8. Miller appreciated that, because equity holders bore the business risk, they deserved to receive a higher return. Nonetheless, from a simple comparison of the 8% cost of equity with the 4% cost of debt, equity appeared to be an expensive source of funds. To Miller, substituting debt for equity was a superior financial policy because it gave the company cheaper capital.3 With other business inputs, the company was aggressive in sourcing quality materials and labor at the lowest available cost. Shouldn?t M&M do the same for its capital?

Questions

1. How do the financial statements for M&M Pizza vary with the proposed repurchase plan? Do the alternative policies improve the expected dividends pershare?

2. What impact does the repurchase plan have on M&M?s weighted-average costof capital?

3. What are the debt and equity claims worth under the alternative scenarios?

4. Which proposal is best for investors? What do you recommend Miller to do?

Please use some exhibit to calculate the plan.

Attached file is the Exhibit 1.

Incense Statement Revenue 1,500 Operating expenses 1,375 Operating pret 125 Net ineame 125 Dividends 125 Shares autstandjng 62.5 Dividends per share 2.00 Balance Sheet Current assets 450 Fixed assets 550 Tetal assets 1,000 Beak debt 0 Bank equity 1,000 Tetal capital 1, Landi Lu Finance 4596 Section 001 M&M Case Grade =65 Your exhibits Thetax numbers for implemented. the debt and taxes are wrong. You cannot buy back shareareatconfusing. $25 after the has been The writing is just reporting and comes to strange conclusions that are not justified. This is very poor and not accomplished the task set out for this analysis. You report but without analysis Executive Summary Given the fact that there was a law under consideration to alter the tax policy by introducing a 20% corporate income tax. The feasibility of the proposed repurchase plan may vary under the alternative scenarios. The change of financial policy and tax policy will directly have an impact on M&M Pizza's net income, dividends, cost of equity, stock price, market share and other financial data. Therefore, the outcome of the different scenarios will be analyzed by calculating the related financial data. Introduction Miller, the third generation managing director at M&M Pizza is planning to recapitalizing the company by raising a new debt of F$500 million in cash since he believes that the financial policies of the company were conservative. Given the supportive financial policies in Francostan, Miller thinks that it is entire possible for the shareholders in the company to be better off by the recapitalization plan. To be more specific, the short- and long-term interest rates for government and business debt are steady at 4% in Francostan, making it possible for M&M Pizza to raise a debt in a relatively low cost. Besides, currently the government levies no tax on business income. Therefore, the company is able to use the cash raised by the new debt to buy back some of the company share and pay more dividends to the remaining shareholders at the same time. Because the number of shares will decrease due to the repurchase policy, the dividend paid per share will accordingly increase, benefiting the remaining shareholders. Analysis No tax on business income: Scenario 1 is based on the current financial policy and tax policy in which the company does not raise the debt and the government does not levy tax on business. Under this circumstance, the net income is the highest (125 million) among the four scenarios and the market value at this time is 1562.5(Exhibit 7) calculated by multiplying the stock price and share outstanding. At this time, the stock price is 25(Exhibit 6) and the cost of equity is 8%(Exhibit 5). Scenario 2 occurs when Miller implements the recapitalization plan by raising a F$500 million's debt at 4% interest rate. At this time, the tax policy remains the same, which means there is no tax on business income. As a result, the share outstanding decreases from 62.5 million to 42.5 million by repurchasing the shares with cash, leading to a higher dividend per share which is 2.47(Exhibit 3). Under Scenario 2, the stock price remains 25(Exhibit 6) while the cost of equity increase to 9.88%(Exhibit 5). 20% Tax on business income: Scenario 3 is based on the assumption that the government will levy a 20% tax on business income and the company will keep the current financial policy. Therefore, the net income of the company will be lowered from 125 million to 100 million (Exhibit 2), causing a lower dividend received by shareholders. Finally, the lowered dividend per share which is 1.6 (Exhibit 3) will bring a shrink of market value of 1250. Scenario 4 includes debt as well as tax which will lower the net income by 20% and increase the interest rate by 4%. The net income is 84 million (Exhibit 1) and the stock price will be lowered to 21.6 (Exhibit 6) under this circumstance. The cost of equity (9.51%) at this time will be much higher than the current rate which is only 8% and will reach the top. Besides, the market value will be lowered to 883.7, which is the lowest value among the four scenarios. Conclusion After calculating the financial data under four different scenarios, it can be seen from the calculation that the company will generate a relatively high net income, a highest dividend per share with the highest stock price. Therefore, it is advisable for the company to raise debt in order to increase its stock price and benefits its shareholders as long as the government doesn't levy the 20% tax. However, if the government starts to levy tax on business income, the M&M Pizza is supposed to keep its current financial policy. Exhibit: Running head: RECAPITALIZATION 1 Recapitalization Student Name Institution RECAPITALIZATION 2 Question The thought changing the financial analysis through recapitalizing varies from the financial statements of the M & M. It varies because there is a change of the assets, profits, and operations of the business contrary to his expectations according to the exhibit of the previous statement. It did not allow to borrow at a relatively low prevailing market yields on debt hence increasing the dividends per share (Nasr et al. 2015). Factors affecting the recapitalizing lead to the government bid to encourage economic where a law is altering the tax policy of a 20 % corporate income tax hence the interest payments being deductible. The financial statements recorded a decrease of value of the net income in general as the economy experienced short periods of economic expansion and contraction which was contrary to the expectations (Philippon et al. 2013). The alternative policies did not improve the expected dividends per share as the price per share did not rise due to a dividend policy of returning all company profits to equity holders in the form of dividends which has a relatively lower rate of 2 dividend per share (Nasr et al. 2015). Weighted-average cost of capital Weighted average cost of capital is a calculation of a firm's cost of capital in which each category of capital is proportionally subjective. All sources of capital such as common stock, preferred stock, bonds and any other long-term debt compute the WACC calculation. The cost of capital signifies a rate that a corporation must attain before it can generate value. The Cost of equities carefully calculates as the share value does not technically have an exact value. The cost of capital is essentially the amount that a company must spend to maintain a share price that will satisfy its investors (Philippon et al. 2013). RECAPITALIZATION 3 WACC is a very useful reality used to check for investors although it is a challenging computation as the cost of equity is not consistent values due to various reasons. In this case, the rate of return on investment is low as in the exhibit where the book debt value rises due to the less number of outstanding shares. Thus making the weighted average cost of capital to decrease. The repurchase plan of M & M reduces the WACC thus denoting an increase in valuation and risk. WACC is an indicator of whether or not an investment is worth pursuing. M & M Company's return is less than WACC thus showing a loss of value (Nasr et al. 2015). Worth Debt and Equity Claims. There are worth claims on the debt and equity shift in the case where the debt contract is not negotiable preserves the financial value of both debt and equity. Therefore, taxpayer transfers are necessary to carry out a restricting plan where the debt holders see the value of their claim go up as shipments of the debt to equity varies depending on the scheme of the organization. The level of transfers reflects how much debt holders benefit from the restructuring. Most options are equivalent to a pure recapitalization. Restructuring involving asset sales turns out to require more transfers than recapitalization (Philippon et al. 2013). Recommendation I would advise investors to employ various restricting options in the bid to solve the multifaceted problems as the rescue plans in determining how surplus value from restructuring benefits the debt holders, equity holders, and taxpayers. Therefore, Miller should be careful in RECAPITALIZATION the option he employs as results vary according to the various parties as best overall strategy involves both asset- and liability-side interventions before making a decision. Miller should not substitute the capital due to its less value as it would not be give out surplus value is divided among the debt holders, equity holders, and taxpayers (Nasr et al. 2015). 4 RECAPITALIZATION 5 References Nasr, N. Z., Thurston, M., Haselkorn, M., & McConky, S. (2015). Technology Insertion for Recapitalization of Legacy Systems. ROCHESTER INST OF TECH NY. Philippon, T., & Schnabl, P. (2013). Efficient recapitalization. The Journal of Finance, 68(1), 142