Blaine Kitchenware Case

Dubinski is considering a change in the capital structure of Blaine. The essence of the case is for you to advise Dubinski on whether to pursue a change in capital structure or not.

To make the question more concrete, consider the following share repurchase proposal: Blaine will repurchase 21.5 million shares at a price of $17.25 per share. The cash required for this repurchase will come from three sources: (1) cash currently on its balance sheet; (2) cash raised by selling all of its marketable securities; and (3) cash raised by selling $170 million in new debt. To sell this debt, Blaine has engaged the services of an investment banking firm, which has determined that the debt issue would likely receive a rating of Baa from Moodys Investors Service.

How would this stock buyback affect Blaine? Consider the effects on, among other measures and concepts, EPS, ROE, capital structure, interest cover, potential financial distress, cost of capital, value of interest expense tax shield, book and market values of equity, business and financial risk, liquidity, immediate benefit to current shareholders, and the familys ownership interest and control. To determine the effect of the refinancing on Blaine, you will need to restate the 2006 balance and income statement. Think about which accounts will be affected. Big hint: On the balance sheet, three accounts will change (if we consider cash and securities as one account); on the income statement, three accounts will change as well. So as not to complicate the calculations (further), lets assume that the effective tax rate of 30.8% in 2006 will apply after the refinancing as well. Finally, in the capital structure calculations and WACC calculations, lets use the permanent financing definition (LTD/(LTD+E)) and (E/(LTD+E)).

Do you recommend the proposal or not? Justify your recommendation.

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