Subject: Blaine Kitchenware Case

Introduction on Case Study:

Blaine Kitchenware Inc. (BKI) was a mid-sized appliance producer that sold most of its products
for residential kitchen use. It got its start as Blaine Electrical Apparatus Company in 1927. By
2006 the company had expanded and most of their products were small residential kitchen
appliances. They controlled just under 10% of their products market and was posting very modest
sales growth rates.The competition from mass manufacturing and cheap imported products had
begun to hurt the company. More recently Blaine has been expanding its business into foreign
markets which had definitely helped to keep them profitable, however over 65% of their
shipments were still made to customers in the U.S.
Within the small kitchen appliance industry there are 3 major segments, food preparation
appliances, cooking appliances, and beverage-making appliances. The biggest of these 3
segments were clearly food preparation appliances and cooking appliances. Blaine had their feet
in all 3 of these segments and were regarded by consumers as being a company that had a cult
following for creating appliances that always made wholesome homemade meals. Victor
Dubinski is the CEO of the company and one of the grandsons of one of the founders. He took on
this role succeeding his uncle in 1992.
The key issue in this case are whether or not the company should go forward with a large scale
buyback of company stocks. We will go through the advantages and disadvantages of making a
major move like this and give our recommendation of whether or not they should move forward
with it. We will look at their company's capital structure, payout policy, and the different views
and repercussions that come from such a move, both internally and externally. There are many
different variables to look at when deciding whether or not to make a move such as this and we
will break them all down in this write-up.
Questions for Blaine Kitchenware, Inc.
Question 1. Current Capital Structure and Payout Policy
Blaine Kitchenware, Inc. has been one of the most stable companies within their industry. With
constantly paying out dividends and growing at a modest rate of 2% every year, Blaine
Kitchenware has become a company many look to invest in. Blaine Kitchenware, compounds an
average yearly return of around 11%, though this did beat the S&P 500 of 10% growth, it was
significantly worse than its industry peers, which had a return of 16%. In the past two years the
company has also reduced the amount of cash and securities on hand from $286 to $231 million,
most of which had gone to cash considerations paid out in acquisition and dividends. In doing so,
they are issuing more and more stock to finance these acquisitions. The payout policy has become
skewed as a result, although cash spent on dividends has increased by roughly $10,000, from
$18,000 to $28,000, the dividends per share have only increased by $0.03, $0.45 per share to
$0.48 per share, thus not creating a large shareholder return on equity. Generally, acquiring more
and more companies is not the most profitable business strategy. Blaine Kitchenware could have
essentially bought something at market value, and if that company does not perform well, then
you have taken on a project with low or even a negative net present value.

The goal of any public company and the Board of Directors should be first and foremost to
increase earnings per share, lowering costs, and increase the value of the firm through positive net
present value projects. Blaine Kitchenware, Inc. has an obligation to increase shareholder wealth,
most of the time done by increasing the profitability of their own company. Blaine Kitchenware
has a capital structure that incurs no debt, and is thus one hundred percent financed by equity,
making it very inefficient. As a result, they are not catering to the obligation of increasing
shareholder wealth and growth of the company. This shows that Blaine Kitchenware has a very
inappropriate capital structure and payout policy. By being unlevered, and not including any debt,
the firm has raised their weighted average cost of capital. This makes it more expensive to go
through with projects and does not allow for a larger return on investment. By including debt into
the capital structure, Blaine Kitchenware could take advantage of an interest tax shield. This
would lower weighted average cost of capital, which would produce more projects with a positive
net present value. By taking on more of these projects Blaine Kitchenware would then raise the
value of the company, and increase shareholder wealth.

Question 2. Should Dubinski recommend a large share repurchase to Blaines board?

A move like this will obviously have a great affect on many aspects of the company. When a
company repurchases stocks it will increase its EPS, as equity lowers the total number of stocks
that are within the company increase in value. There are also tax advantages that the company
would see from the reduction in WACC. This comes from the raise of debt from both short and
long term borrowing to cover the cost of this repurchase of stocks. I Dubinski should recommend
a large share repurchase to the Blaine board.
There are many advantages that come with the repurchase of stocks. The first is the increase in
earnings per share. If their earnings indeed stay stable, and the total number of stocks is reduced
the earnings per share will obviously increase. This will lead to the price of the stock increasing
because of the increase in price per share. The second advantage involves the tax implications
that come with a share repurchase. The capital structure of a company is affected by how much a
company is leveraged by debt. This change in the capital structure will lower the taxable income
for the company. The third benefit of stock repurchase is that the stock price will increase most of
the time. When the investors in the company hear about the repurchase of stocks the stock price
will go up, which is obviously beneficial for the company. This repurchase of stocks also affects
the number of stocks that outside shareholder have, therefore decreasing float in the firm. In the
outside market it is also beneficial for the company as it alerts the outside world that cash flows
are robust.
There are also however some disadvantages that come with a company repurchasing stock. When
the repurchase is announced the stock price may increase, but when the repurchase actually
happens this increase may be short lived. Earnings can also be overstated, which will have an
adverse affect on the company as the company's value may also become overstated.
In conclusion, the repurchase of stocks can be greatly beneficial for companies that are in the
right position to do so. I believe that Dubinski should take advantage of this stock repurchase as
the company is in the position to do so, and we believe that although there are disadvantages, we
believe the advantages greatly outweigh them.
Question 3. What is the Financial Impact of Taking on Debt?
Consider the following repurchase proposal: Blaine will use $209 million of cash from its
balance sheet and $50 million in new debt at a rate of 6.75% to repurchase 14 million shares at a

price of $18.50 per share. For the following calculations, we assumed no change from 2006
financial results other than the proposal to take on $50 million in new debt.
Repurchase of Shares:
$209 Million - Cash
$50 Million - Debt + Interest of 6.75% ($3.375 Million) = 53.375 Million
Current Shares Outstanding: 59,052,000-14,000,000
Current Shares Outstanding after buyback: 45,052,000
Calculating earnings per share of Blaine Kitchenware requires that we subtract the interest
expense from the new debt from Blaines EBT. We then take use the companys tax rate from
2006 to calculate the new net income. Based on these calculations, shareholders would see a $.23
increase in earnings per share. This is a 25% improvement in earnings per share.
EBIT: $63,946,000 - $3,375,000 (Interest Tax Shield)
Plus: Other expenses: $13,506,000 holding all other figures constant (using 2006 figures)
EBT: $74,077,000
Tax Rate 30.75%
Taxes: $22,778,677.50
Net Income: $51,298,322.50
EPS = $51,298,322.50
45,052,000
EPS = $1.14 per share
Change in EPS $1.14 - $0.91
$0.91
25.27%
Net Income:
$ 51,298,322.50
Shareholders Equity: $438,363,000.00
ROE:

11.7%

Interest Coverage Ratio: 63,946,000

3,375,000
Interest Coverage Ratio: 18.95
Total Debt: $50,000,000.00
Total Assets: $592,253,000.00
Debt Ratio: 28.98%
WACC: (833,462,000/833,462,000) * 11 + (50,000,000/833,462,000) * 6.75 * (1-.3075)
WACC = 10.64%
A stock buyback followed by taking on $50,000,000 in new debt would have a positive impact on
ROE and the the companys cost of capital. While their debt ratio would increase from 18% to
25%, this still a safe amount of debt for a company to have. Additionally, by looking at the

companys interest coverage ratio, we can see that the company generates almost 19 times the
amount of interest they need to cover the new interest expenses they will be incurring. The
family will now own 81% of the firm instead of the 62% they had before based on the expected
size of the share buyback. This means that Blaine Kitchenware can get stronger financial results
while still having a reasonable level of debt. Financial results could be improved further with
more leverage if the owners so chose.
Question 4: How will Shareholders View a Stock Buyback?
Blaine Kitchenware has two distinct types of stockholders. Family members hold 62% of Blaine
Kitchenwares stock while the remaining 38% is held by shareholders with no connection to the
firm. Family members would most likely view the stock buyback as a positive move, as this
would give them more control over the firm, assuming they held onto their shares. More
centralized control of the firm would allow for more flexibility in setting future strategy.
A stock buyback would also have advantages for the non-family shareholders. Shareholders who
are disgruntled with Blaines underperformance compared to similar companies in the industry
would take the opportunity to sell back their shares while the remaining shareholders would
benefit from the stock price appreciation. Companies typically only buy back stock when it is
undervalued, which could signal to the market that Blaine Kitchenware is optimistic about its
future growth. After the stock buyback, the remaining shareholders would see an appreciation in
Blaine Kitchenwares stock value due to the value of the firm being split between fewer
remaining shares. Additionally, a stock buyback would result in capital appreciation, which is
taxed less heavily than dividends.
Key Learnings and Takeaways about the Case Study:
After analyzing the capital structure, payout policy, and impact of a large scale stock repurchase
on the company, Blaine Kitchenware Inc., a couple of key business lessons can be learned from
this case study.
As previously mentioned above, the impact of decisions on shareholders is crucial. Ultimately a
shareholder maximizing company should aim to align its business decisions to meet the
incentives of its shareholders. In this case study, it is evident that Blaine Kitchenware Inc. was not
acting in the shareholders best interest initially when making key business decisions. This lesson
brings us to the next takeaway, the importance of capital structure on both a company and its
shareholders. The benefits of debt in the capital structure, particularly in this case, cannot be
ignored. That being said, there is no key optimal capital structure for any one company. In this
case, Blaine Kitchenware Inc. has an opportunity to increase the value of the firm through the use
of leverage. The capital structure, a combination of debt and equity, must be tailored to and
aligned with the incentives of both the shareholders and the company as a whole.