Blaine Kitchenware Case Study

3. Consider the following share repurchase proposal: Blaine will use $209 million of cash from its balance sheet and $50 million in new debt bearing an interest rate of 6.75% to repurchase 14 million shares at a price of $18.5 per share. How would such a buyback affect Blaine? Consider the impact on, among other things, the family’s ownership interest, and the company’s cost of capital.

After repurchasing the amount of the common stock outstanding will decrease from 59.052 million to 45.052 million, and we know that using new debt to finance would lead to the reduce of net income I*(1-t), which would be reflected in market value, hence according to the equation P1= (P0* N0- D*Rd*(1-t))/N1= (59.052*16.5-50*6.75%*(1-30.8%))/45.052, we are able to get the future price P1, 21.58 per share, going up $ 5.08, and at the same time the book value of equity, cost of capital will also change, here I assume that the market risk premium equals to 5% and Bd0=0, Bd1=1.7%/5%=0.34,and Be=(1+D/E*(1-t))*Ba-D/E*(1-t)*D/E

The more detail is shown in the table below.

As is seen in the exhibit, the D/E ratio of Blaine Kitchenware company rises significantly to 2.89% and due to the reason of issuing debt, and debt is comparatively cheaper than equity, the Weight average cost of capital lowered 0.89%, and what’s more although less than the industry average level, the ROE increases to 22.37% improving substantially, while the firm’s liquidity still remain good.

And considering the family’s ownership interest, it’s susceptible that the family members on the board would welcome such a large stock repurchase, after this activity resulting from the reducing total share outstanding amount, their percentage of ownership of Blaine will rise reversing the downside trend dating from IPO, which means they need to undertake more risk than before. And meanwhile the worrying of both the inconsistency of dividend payout ratio and the discontinuity of its acquisition makes the situation worse, given