Bed Bath & Beyond: The Capital Structure DecisionBed Bath & Beyond: The Capital Structure Decision

Questions:

You are BBBY$\text{'}$s CEO, Steven Temares. It is April $2004$ and you are about to decide

what to do with the company's excess cash:

Keep it$?$

Pay it out and issue debt?

You structure your analysis by answering the following questions:

Consider the case in which BBBY uses its $$400$ million excess cash and

borrowed funds $($interest rate: $4\mathrm{.}5\%)$ in a share repurchase program. Corporate tax

is $38\mathrm{.}5\%.$ Consider two scenarios for the debt to capital $($Book$)$ ratio: $13\%$ and $87\%.$

Calculate the present value of tax shield under each scenario. Assume that

the company uses a perpetual debt policy.

Estimate the number of shares BBBY can repurchase under each scenario and at

what price.

Evaluate the decision from the perspective of BBBY$\text{'}$s shareholders: does the

proposed repurchase program increase shareholder value $($provide calculations to

illustrate your answer$)?$ Assuming there are no bankruptcy costs, what is the

optimal capital structure if BBBY$\text{'}$s creditworthiness is not affected $($i$.$e$.,$ borrowing

costs do not change$)?$ Calculate the number of shares it can repurchase under

the optimal capital structure.

For the following questions consider exhibit $9$ for interest rates and assume for BB: $6\%,$

B: $7\%$ and CCC: $8\%.$

For both scenarios $(13\%$ and $87\%$ debt to capital $($Book$)$ ratios$),$ estimate BBBY$\text{'}$s

bond rating. Does levering up deteriorate the company's creditworthiness?

Assuming there are no bankruptcy costs, what is the optimal structure if BBBY$\text{'}$s

creditworthiness does change $($that is$,$ borrowing costs do change$)?$ Calculate

the number of shares it can repurchase under the optimal capital structure.

Suppose now BBBY faces bankruptcy costs if its credit rating falls below

investment grade. What would be the optimal leverage ratio that results in an

investment grade credit rating? Calculate the number of shares it can repurchase

under this capital structure. Perform a sensitivity analysis $($i$.$e$.,$ how your results

change$)$ with respect to BBBY$\text{'}$s leverage ratio.