Blaise Pascal Mekouy Corpo

• CASE STUDY BLAISE PASCAL MEKOUY CORPO

1. Do you believe Blaine’s capital structure and payout policies are appropriate? Why or why not?  

The goal of any public firm should be to increase EPS, lowering costs and increase company’s value with positive NPV projects. Blaine Kitchen has a capital structure that incurs no debt, and is thus 100% financed by equity.

As a result, they are not catering to the obligation of increasing shareholder’s wealth and growth of the company.  It shows that they have a very inappropriate capital structure and payout policy. By being unlevered, Blaine has raisded their weighted average cost of capital, which makes projects more costly and does not allow for large return on investment.

By including debt, they would take advantage of the interest tax shield which would lower the WACC and allow for more positive NPV projects.

1. Should Dubinski recommend a large share purchase to Blaine’s board? What are the primary advantages and disadvantages of such a move?  

Dubinski should recommend a large share repurchase to the board of directors. Blaine is a prime candidate for recapitalization due to its cash hoard and slow growth. A repurchasing program of one form or another can help the company lessen the impact of past stock acquisitions on future financial performance. It could also allow the company to have a more reasonable and sustainable dividend payout, while allowing the founding family to increase their relative ownership levels.

Although it runs counter to the company’s financially conservative culture, there are a number of advantages. First, there is the opportunity for the share price to increase. All else being equal, two ways that a repurchase, including debt, can contribute to the value of a firm by causing some of its financial ratios to improve, such as EPS and ROE, and the benefit of the present value of the interest tax shield, as presented below. Blaine’s projected tax rate (tC) for 2007 is estimated to be 32%.

Second, a large share repurchasing will help the company reduce the annual cash drain of paying dividends, while being able to maintain them for the shares that remain. However, the cash savings would more than make up for it. Third, a repurchasing program would give shareholders the control on whether to retain ownership in the firm or decide to take capital gains and incur taxes. Last, the addition of debt to the capital structure will lower the weighted average cost of capital and the debt to market value of equity ratio will be small enough that it shouldn’t have a significant impact on the cost of equity.

Other considerations that Blaine’s board must entertain include the possible signaling effects of a repurchasing program. It could be perceived positively as a company perception that the stock is cheap and possibly cost the stock price to increase. Even if the board doesn’t want to do a one-time large repurchase, the company could certainly afford to annual repurchases of several million dollars worth of stock without hurting its cash levels and keeping its capacity to make future acquisitions.

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