HEC Lausanne

Corporate Finance
Prof. Theodosios Dimopoulos
Case: Blaine Kitchenware, Inc.: Capital Structure.
Due: Beginning of Lecture 6.
Instructions:
Fearing an impending hostile takeover bid, the management of Blaines Kitchenware has decided
to distribute all excess cash as a dividend. Even though all of the management team has
unanimously agreed on this dividend, opinions are divided regarding a proposed
recapitalization plan according to which, the firm will hold permanently debt with market value
$300 mil on its balance sheet. This is especially controversial, since the first signs of a mortgage
crisis have lead management to revise its revenue growth expectations. In particular, it expects
that revenue will decline by 4% in each of the years 2007-2009, before growing permanently at
rate 2% after that. A consultant has already provided information on credit spreads and trailing
coverage ratios (EBIT(t-1)/MV(Debt(t)), which will help the firm evaluate the consequences of
levering up:

Coverage ratio
>
to
-100000 0.199999
0.2
0.649999
0.65
0.799999
0.8
1.249999
1.25
1.499999
1.5
1.749999
1.75
1.999999
2
2.2499999
2.25
2.49999
2.5
2.999999
3
4.249999
4.25
5.499999
5.5
6.499999
6.5
8.499999
8.5
100000

Rating

Spread

Default
probability

D
C
CC
CCC
BB
B+
BB
BB+
BBB
AA
A+
AA
AAA

12.00%
10.50%
9.50%
8.75%
6.75%
6.00%
5.50%
4.75%
3.75%
2.50%
1.65%
1.40%
1.30%
1.15%
0.65%

90.00%
30.00%
20.00%
9.90%
7.00%
5.20%
3.00%
2.10%
1.00%
0.40%
0.30%
0.20%
0.15%
0.05%
0.01%

Please use APV to assess how the proposed recapitalization plan will affect enterprise value, after
excess cash has been distributed, using the following assumptions:
Tax rate (linear)
Unlevered cost of capital
Risk-Free Rate
Market Risk Premium
Perpetual growth rate of revenues
MV Debt (permanent)
Bakruptcy cost as % of unlevered firm value
Recovery of debt in case of default

40%
8.7%
5.02%
5.00%
2%
$300,000
20%
41%