Blaine’s capital structure is not appropriate because of several reasons. The biggest of them being not using debt financing. Without debt, Blaine is not realizing its true potential. The firm would actually need plenty of capital if it wants to continue on the path of growth and make required acquisitions and expansion. Although with increasing debt, the risk also increases; but due to tax reduction on interest of debt, the cost of capital would actually be lower. By being conservative and not going for debt, Blaine is actually hurting its growth prospects which in turn affects its shareholders.
One of the examples where we can see that Blaine is not performing to its potential is its extremely low ROE in 2006 as compared to its peers (Blain ROE = 11. 0%, Mean ROE = 25. 9%). Additionally, the Payout ratio has been steadily increasing due to falling EPS and consistent dividends, which means a lot of cash is being used to pay the dividends in spite of falling EPS. Thus, we have come to the conclusion, that the capital structure of Blaine is not appropriate.
Using debt financing judiciously would make it appropriate and would help Blaine achieve its true potential. Q2 ? Should the CEO (Victor Dubinsky) recommend a large share re? purchase to the Board of Directors? What, in your opinion, are the advantages and disadvantages of this option? We believe that Mr Victor Dubinsky should recommend the share repurchase to the board, biggest reason being excess liquidity and absence of debt financing. Number of shares and Payout ratio have been steadily increasing and EPS has decreasing over the years.
A big part of Blaine’s income is utilized in paying dividends which is not an optimal situation to be in. Thus, it’s very important that Blaine repurchases some shares and lessen the dilution of ownership of the firm. This will help to improve the firm’s EPS and ROE as well. One of the disadvantages of share repurchase is that Blain might be overpaying for them. The repurchase might be done at the point when the share price is near its historic maximum. Such a repurchase might not be considered optimal.
Yet, the board should go with the repurchase, as the firm would be compensated by the tax deductible debt financing. Q3 ? Consider the following share re? purchase scheme – use $209 million of available cash along with $50 million of 6. 75% debt (payable annually) to repurchase 14 million shares @ $18. 50 per share. Make a detailed assessment of this proposal, covering inter alia, Blaine’s EPS, ROI, interest coverage and debt ratio, cost of capital, and the family’s ownership interest.
Investors and analysts might view the share repurchase as a positive move because of several reasons. Firstly, a buyback is seen as a move of confidence which usually leads to an increase in stock price. Additionally, it would lead to an increase in the ownership for the shareholders. Going forward, it would also lead to an increase in EPS and ROE. A share re? purchase scheme by using $209 million of available cash along with $50 million of 6. 75% debt (payable annually) to repurchase 14 million shares @ $18. 50 per share would have following affects: