UST decides to borrow 1 billion (by issuing bonds)

1. In order to apply an APV type model we will need to estimate the interest tax shields that are a result of the new bond issuance. Therefore, we will need to have an estimate of the cost of debt that UST would face if it moved forward with this transaction. To estimate the cost of debt, begin by estimating the credit rating UST would get if it moves forward with the transaction. To do this, first calculate the following financial ratios for UST after it issues the new bonds using the data in Exhibits 5 and 8. Then using the data in Exhibit 8 to estimate the bond rating you would give UST based on these three ratios.

	Financial Ratios	Implied Bond Rating
Fund Flow/Total Debt (in %)
Free operating cash flow/Total Debt (%)
Operating income/Sales (%)

2. Based on the credit rating that you estimated for UST in question 1, estimate the cost of debt for USTs new bonds using the bond yields for 20-year bonds in Exhibit 8. Be sure to tell me which bond you are picking and why.

ZUU-UDY -Il- Exhibit 5 Summary Financial Information for UST Inc. (in millions, except per share data and Tobacco Product Manufacturers Philip North Atlantic RJR Nabisco UST Inc. Morris Trading Co. Holdingsi Tobacco Leaf Merchants Standard Commercial DiMon Inc. Universal Corp Summary Operating Data a Fiscal Year End Net Sales Gross Profit EBITDA EBITD Dec 31, 1998 $1,423.2 1,139.7 785.0 753.3 (2.2) 755.5 467.9 $429.5 $21.0 $2.52 $2.50 $1.62 64% Dec 31, 1998 $74,391.0 30,993.0 15,501.0 13,811.0 890.0 12,921.0 7.672.4 $6,076.4 $3,834.0 $3.16 $3.14 $1.68 53% Dec 31, 1998 $93.1 60.9 36.3 29.1 24.9 4.2 1.0 $14.5 Dec 31, 1998 $20,563.0 9,493.0 3,602.0 2,467.0 880.0 1,455.0 718.0 $2,016.0 $2,069.0 $2.22 $2.22 $2.05 92% June 30, 1998 $2,171.8 266.9 200.2 156.7 83.8 72.9 52.0 $52.5 $16.9 $1.17 $1.16 $0.66 56% March 31, 1998 $1,492.8 145.0 85.8 65.3 37.8 37.1 26.9 $(61.3) June 30, 1998 $4,2872 613.6 329.5 278.4 64.0 231.3 130.4 $110.2 $(16.7) $3.71 $3.68 $1.11 30% $(7.09) $(7.09) $2.18 $2.05 0% 0% Interest Expense (Income) Pretax Earnings Net Income Free Operating Cash Flow Special Charges/Non-Recurring Items (Gains) Basic Earnings per Share Diluted Earnings per Share Dividend per Share (Common) Dividend Payout Ratio Balance Sheet and Cash Flow Data Cash and Cash Equivalents Total Assets Long-Term Debt Total Debt Preferred Stock & Minority Interest Shareholders' Equity Average Basic Shares Outstanding Working Capital Capital Expenditures Stock Price Data Fiscal Year End Price/Earnings Ratio Market Equity $33.2 $913.3 $100.0 $100.0 $4,081.0 $59,920.0 $12,615.0 $14,662.0 $2.8 $260.0 $202.6 $215.6 $39.3 $(15.4) 528.2 $42.0 $0.5 $300.0 $28,892.0 $9,982.0 $10,467.0 $957.0 $7,809.0 323.9 $(259.0) $576.0 $18.7 $1,797.5 $797.0 $1,079.5 $0.5 $421.9 44.5 $706.4 $36.6 $34.1 $839.5 $197.1 $469.9 $30.3 $149.6 $79.8 $2,056.7 $263.1 $849.6 $31.7 $547.9 35.2 $328.8 $90.0 12.4 $468.3 185.5 $309.9 $35.5 $16,197.0 2,429.0 $3,851.0 $1,804.0 $219.1 $9.7 $34.88 13.8x $6,470.8 $53.50 16.9x $129,951.5 NAH NAH Nah $29.69 13.4x $9,614.4 $11.25 9.6x $500.3 $15.94 7.3x $197.3 $37 38 10.1x $1,315.2 Median Mean (excl. UST) (excl. UST) Selected Growth Rates and Ratios Sales Growth Gross Profit Margin EBITDA Margin EBIT Margin Net Margin Return on Average Equity Return on Average Assets Long-Term Debt/Capitalization Total Debt/Capitalization 1.5% 80.1% 55.2% 52.9% 32.9% 103.4% 53.8% 17.6% 17.6% 3.2% 41.7% 20.8% 18.6% 10.3% 49.3% 13.2% 43.8% 47.5% 10.2% 65.4% 39.0% 31.3% 1.1% NM 0.4% 89.4% 90.0% (0.5%) 46.2% 17.5% 12.0% 3.5% 8.4% 2.4% 53.2% 54.4% 2.2% 12.3% 9.2% 7.2% 2.4% 12.5% 2.7% 65.4% 71.9% 10.2% 9.7% 5.7% 4.4% 1.8% 22.5% 3.4% 52.3% 72.3% 4.2% 14.3% 7.7% 6.5% 3.0% 25.6% 6.5% 31.2% 59.4% 28.0% 13.4% 9.6% 2.7% 22.5% 3.1% 52.8% 65.7% 31.6% 16.7% 13.3% 3.7% 23.7% 4.8% 55.9% 65.9% 200-069 - 14- Exhibit 8 Key Financial Ratiosa Adjusted Key Industrial Financial Ratios-Senior Debt Ratings Industrial Long-Term Debt Three-Years (1996-1998) Medians Investment Grade AA A Noninvestment Grade/Speculative BB CCC AAA BBB 4.1 12.9 18.7 6.3 89.7 32.2 EBIT interest coverage (x) EBITDA interest coverage (x) Fund flow/total debt (%) Free operating cash flow/total debt (%) Return on capital (%) Operating income/sales (%) Long-term debt/capital (%) Total debt/capital (including ST debt) (%) 40.5 30.6 30.9 21.4 31.8 9.2 14.0 67.0 21.6 25.1 25.2 29.3 7.2 10.0 49.5 17.4 19.6 17.9 33.3 6.3 15.4 15.8 40.8 46.4 2.5 3.9 20.1 1.0 12.6 14.4 55.3 58.5 1.2 2.3 10.5 (4.0) 9.2 11.2 68.8 71.4 (0.9) 0.2 7.4 (25.4) (8.8) 5.0 71.5 79.4 37.0 39.2 Debt Yields-December 22, 1998 Corporate Bond Yields BBB BB+ U.S. Treasury BB/BB- BB 10-Year (%) 20-Year (%) 4.70 5.45 5.60 6.47 5.846 6.76 .126 7.05 .84 7.70 8.72 11.19 7.82 Formulas for Adjusted Key Industrial Financial Ratios EBIT Interest coverage = Earnings from continuing operations before interest and taxes/ Gross interest incurred before subtracting capitalized interest and interest income EBITDA interest coverage = Earnings from continuing operations before interest, taxes, depreciation and amortization/ Gross interest incurred before subtracting capitalized interest and interest income Funds from operations/Total debt = Free operating cash flow/Total debt = Net income from continuing operations + depreciation, amortization, deferred income taxes, and other noncash/ Long-term debt + current maturities, commercial paper, and other short-term borrowings Funds from operations - capital expenditures -(+) the increase (decrease) in working capital (excluding changes in cash, marketable securities and ST debt/ Long-term debt + current maturities, commercial paper, and other short-term borrowings EBIT + interest expense/ Average of beginning and ending year capital, including short-term debt, current maturities, long-term debt, noncurrent deferred taxes and equity Sales minus cost of goods manufactured (before depreciation and amortization), SG&A and R&D costs/ Sales Pretax return on capital = Operating income/Sales = long-term deht/Ganitalization - long-term deht/ ZUU-UDY -Il- Exhibit 5 Summary Financial Information for UST Inc. (in millions, except per share data and Tobacco Product Manufacturers Philip North Atlantic RJR Nabisco UST Inc. Morris Trading Co. Holdingsi Tobacco Leaf Merchants Standard Commercial DiMon Inc. Universal Corp Summary Operating Data a Fiscal Year End Net Sales Gross Profit EBITDA EBITD Dec 31, 1998 $1,423.2 1,139.7 785.0 753.3 (2.2) 755.5 467.9 $429.5 $21.0 $2.52 $2.50 $1.62 64% Dec 31, 1998 $74,391.0 30,993.0 15,501.0 13,811.0 890.0 12,921.0 7.672.4 $6,076.4 $3,834.0 $3.16 $3.14 $1.68 53% Dec 31, 1998 $93.1 60.9 36.3 29.1 24.9 4.2 1.0 $14.5 Dec 31, 1998 $20,563.0 9,493.0 3,602.0 2,467.0 880.0 1,455.0 718.0 $2,016.0 $2,069.0 $2.22 $2.22 $2.05 92% June 30, 1998 $2,171.8 266.9 200.2 156.7 83.8 72.9 52.0 $52.5 $16.9 $1.17 $1.16 $0.66 56% March 31, 1998 $1,492.8 145.0 85.8 65.3 37.8 37.1 26.9 $(61.3) June 30, 1998 $4,2872 613.6 329.5 278.4 64.0 231.3 130.4 $110.2 $(16.7) $3.71 $3.68 $1.11 30% $(7.09) $(7.09) $2.18 $2.05 0% 0% Interest Expense (Income) Pretax Earnings Net Income Free Operating Cash Flow Special Charges/Non-Recurring Items (Gains) Basic Earnings per Share Diluted Earnings per Share Dividend per Share (Common) Dividend Payout Ratio Balance Sheet and Cash Flow Data Cash and Cash Equivalents Total Assets Long-Term Debt Total Debt Preferred Stock & Minority Interest Shareholders' Equity Average Basic Shares Outstanding Working Capital Capital Expenditures Stock Price Data Fiscal Year End Price/Earnings Ratio Market Equity $33.2 $913.3 $100.0 $100.0 $4,081.0 $59,920.0 $12,615.0 $14,662.0 $2.8 $260.0 $202.6 $215.6 $39.3 $(15.4) 528.2 $42.0 $0.5 $300.0 $28,892.0 $9,982.0 $10,467.0 $957.0 $7,809.0 323.9 $(259.0) $576.0 $18.7 $1,797.5 $797.0 $1,079.5 $0.5 $421.9 44.5 $706.4 $36.6 $34.1 $839.5 $197.1 $469.9 $30.3 $149.6 $79.8 $2,056.7 $263.1 $849.6 $31.7 $547.9 35.2 $328.8 $90.0 12.4 $468.3 185.5 $309.9 $35.5 $16,197.0 2,429.0 $3,851.0 $1,804.0 $219.1 $9.7 $34.88 13.8x $6,470.8 $53.50 16.9x $129,951.5 NAH NAH Nah $29.69 13.4x $9,614.4 $11.25 9.6x $500.3 $15.94 7.3x $197.3 $37 38 10.1x $1,315.2 Median Mean (excl. UST) (excl. UST) Selected Growth Rates and Ratios Sales Growth Gross Profit Margin EBITDA Margin EBIT Margin Net Margin Return on Average Equity Return on Average Assets Long-Term Debt/Capitalization Total Debt/Capitalization 1.5% 80.1% 55.2% 52.9% 32.9% 103.4% 53.8% 17.6% 17.6% 3.2% 41.7% 20.8% 18.6% 10.3% 49.3% 13.2% 43.8% 47.5% 10.2% 65.4% 39.0% 31.3% 1.1% NM 0.4% 89.4% 90.0% (0.5%) 46.2% 17.5% 12.0% 3.5% 8.4% 2.4% 53.2% 54.4% 2.2% 12.3% 9.2% 7.2% 2.4% 12.5% 2.7% 65.4% 71.9% 10.2% 9.7% 5.7% 4.4% 1.8% 22.5% 3.4% 52.3% 72.3% 4.2% 14.3% 7.7% 6.5% 3.0% 25.6% 6.5% 31.2% 59.4% 28.0% 13.4% 9.6% 2.7% 22.5% 3.1% 52.8% 65.7% 31.6% 16.7% 13.3% 3.7% 23.7% 4.8% 55.9% 65.9% 200-069 - 14- Exhibit 8 Key Financial Ratiosa Adjusted Key Industrial Financial Ratios-Senior Debt Ratings Industrial Long-Term Debt Three-Years (1996-1998) Medians Investment Grade AA A Noninvestment Grade/Speculative BB CCC AAA BBB 4.1 12.9 18.7 6.3 89.7 32.2 EBIT interest coverage (x) EBITDA interest coverage (x) Fund flow/total debt (%) Free operating cash flow/total debt (%) Return on capital (%) Operating income/sales (%) Long-term debt/capital (%) Total debt/capital (including ST debt) (%) 40.5 30.6 30.9 21.4 31.8 9.2 14.0 67.0 21.6 25.1 25.2 29.3 7.2 10.0 49.5 17.4 19.6 17.9 33.3 6.3 15.4 15.8 40.8 46.4 2.5 3.9 20.1 1.0 12.6 14.4 55.3 58.5 1.2 2.3 10.5 (4.0) 9.2 11.2 68.8 71.4 (0.9) 0.2 7.4 (25.4) (8.8) 5.0 71.5 79.4 37.0 39.2 Debt Yields-December 22, 1998 Corporate Bond Yields BBB BB+ U.S. Treasury BB/BB- BB 10-Year (%) 20-Year (%) 4.70 5.45 5.60 6.47 5.846 6.76 .126 7.05 .84 7.70 8.72 11.19 7.82 Formulas for Adjusted Key Industrial Financial Ratios EBIT Interest coverage = Earnings from continuing operations before interest and taxes/ Gross interest incurred before subtracting capitalized interest and interest income EBITDA interest coverage = Earnings from continuing operations before interest, taxes, depreciation and amortization/ Gross interest incurred before subtracting capitalized interest and interest income Funds from operations/Total debt = Free operating cash flow/Total debt = Net income from continuing operations + depreciation, amortization, deferred income taxes, and other noncash/ Long-term debt + current maturities, commercial paper, and other short-term borrowings Funds from operations - capital expenditures -(+) the increase (decrease) in working capital (excluding changes in cash, marketable securities and ST debt/ Long-term debt + current maturities, commercial paper, and other short-term borrowings EBIT + interest expense/ Average of beginning and ending year capital, including short-term debt, current maturities, long-term debt, noncurrent deferred taxes and equity Sales minus cost of goods manufactured (before depreciation and amortization), SG&A and R&D costs/ Sales Pretax return on capital = Operating income/Sales = long-term deht/Ganitalization - long-term deht/