Blaine Kitchen Inc

Do you believe Blaine’s current capital structure and pay-out policies are appropriate? Why or why
not?

BKI has a conservative capital structure, it is debt free with sizeable cash and short-term
investments. The pay-out ratios have been constantly increasing. The capital consists of equity
solely. An all equity capital structure is not the best for a publicly traded company. Due to lower EPS,
diluted share holding, Cost of capital is higher, missing out on benefit of Interest tax shield.

Lowest WACC cost structure should be taken, which gives maximum value of company

The risk v/s trade-off return needs to be considered, increasing leverage increases the cost of equity.

The company could have easily used debt to finance some of its previous acquisitions.

Also, in Pecking order hypothesis equity is the most expensive and least desirable source of funds for
expansion, since it has the highest expected returns by the investors. (higher hurdle rate)

More and more of company’s cash is being used to fund dividend pay-out.

Should Dubinski recommend large share repurchase to blaine’s board?

Yes, Blain has a huge hoard of cash and slow growth

The company will be able to have a more sustainable dividend payout.

Will also allow the founding family to increase their relative ownership.

1) Allows share price to increase

2) Higher EPS and ROE
3) Interest tax shield is available
4) Reduction in dividend payout
5) Lower WACC

consider thr following share repurchase proposal: Blaine will use $209 million of cash from its
balance sheet and $50 million in new debt-bearing interest at the rate of 6.75% to repurchase 14
million shares at a price of $18.50 per share. How would such a buyback affect Blaine? Consider
the impact on, among other things, BKI's earnings per share and ROE, its interest coverage and
debt ratios, the family's ownership interest, and the company's cost of capital.

Shares
purchased Price
14000 18.5 259000

Cash Debt total

209000 50000 259000

Interest
expense 3375

17P031 | Nihar Madkaiker

 Operating results 2004 2005 2006
Revenue 291940 307964 342251
Less: COGS 204265 220234 249794
Gross Profit 87675 87730 92457
Less: SG&A 25293 27049 28512
Operating Income 62382 60681 63945
plus: Depr. & Amort 6987 8213 9914
EBITDA 69369 68894 73859
After
pruchase
EBIT 62382 60681 63945 63945
Plus: Other Income 15719 16057 13506 13506
Earnings Before tax 78101 76738 77451 77451
Interest 3375
Less: Taxes 24989 24303 23821 22815
Net Income 53112 52435 53630 51261
Dividends 18589 22871 28345 27117

After Buy
2004 2005 2006 back
Net income 53112 52435 53630 51261
Dividends 18589 22871 28345 27117
Average shares outstanding 41309 48970 59052 45052
earnings per share 1.29 1.07 0.91 1.14
Dividend per share 0.45 0.47 0.48 0.60
Payout ratio 35% 43.6% 52.9% 0.529
Owner's holding 62% 81.27%

New ROE = 22%

Interest coverage = 3375/63945 = 19

Debt ratio = 0.13

17P031 | Nihar Madkaiker

 Cost of capital 8.4% old

Levered beta 0.644477 at 50million debt

Unlevered beta 0.56

new cost of
equity 8.9%
Cost of debt 6.75%

New cost of
Cost of capital 8.15% capital

4) As a member of Blaine's controlling family, would you be in favor of this proposal? Would you
be in favor of it as a non-family shareholders?

Yes, since the family shareholding rises to 82%

As a non-family share holder my dividend per share increases also my EPS increases.

5) Compute BKI's WACC at each of the indicated debt levels. What do your calculations imply
about Blaine's optimal capital structure? Based on these calculations, how many shares should
Blaine purchase and at what price?

Debt 0 10 20 30 40 50 60 70
Equity 100 90 80 70 60 50 40 30

Beta Unlevered 0.56 0.56 0.56 0.56 0.56 0.56 0.56 0.56
Beta levered 0.56 0.60 0.66 0.73 0.82 0.95 1.14 1.46

Cost of equity 8.4% 8.7% 9.0% 9.4% 9.9% 10.7% 11.8% 13.7%
Cost of debt (by bond
yields) 6.75% 6.75% 6.74% 7.06% 7.68% 8.42% 10.74% 12.86%

cost of capital 8.40% 8.26% 8.11% 8.03% 8.08% 8.26% 9.19% 10.35%

17P031 | Nihar Madkaiker

Optimal capital structure is 30% debt and 70% equity

Debt 86509
Equity 288363

Total repurchase 286509

Price 18.5
number 15 Million

17P031 | Nihar Madkaiker