Blaine Kitchenware Inc - Memo

Memo

To: BKI Board of Directors

From: John Smith

Date: March 4th, 2011

Re: Optimal Capital Structure

Recommendation

Based on the financial analysis, the firm should borrow at least $50 million to repurchase 14 million shares of stock. According to a Harvard business review, it would not be rational for a public company to be funded only by equity. It's too inefficient. Debt is a lower cost source of funds and allows a higher return to the equity investors by leveraging their money. In addition, the U.S. government encourages companies to borrow money by allowing them to deduct the interest paid on the debt from their corporate income taxes. With an increase of future corporate tax break of 34% (new tax break is 40%), it would be beneficial for the firm to deduct interest payments to pay fewer taxes. I will present two scenarios, the first one is to borrow $50 million to buy 14 million shares, and the second is to borrow $100 to buy 261,702,702 shares of stock

Analysis

Using quantitative analysis, assess the impact of the proposed repurchase on the balance sheet, leverage, ROE, and interest coverage

The balance sheet is affected in the following way:

Loan Amount $50,000,000 $100,000,000

Total Assets $383,253 $430,550

Total Liabilities $153,890 $203,890

Shareholders' Equity $229,363 $226,660

Debt/Asset 0.40 0.47

Debt/Equity 0.67 0.90

The debt to equity ratio is going to increase because you are going to use more debt and less equity to finance your business. This reduces the shareholders' risky because in the case of bankruptcy, shareholders are the first people who lose money. The cost of equity at 11% in 2006 is a more expensive way of financing than borrowing money at 6.75%. In addition,