Ust case assignment | FIN 320

The CEO of UST would like you to prepare a three to four page case report discussing UST’s current

financial situation and the implications of increasing leverage in UST’s capital structure. The firm is

considering a $1 billion increase in long-term debt. Assume that the debt would be taken on

immediately and held in perpetuity. The $1 billion would be used immediately to repurchase shares.

Also assume that the top marginal tax rate is 38 percent. The following questions should be addressed

when preparing the report for the CEO:

1) Provide an overview of UST’s business operations. In your presentation, feel free to provide

visual detail of the type of products UST sells to its customers.

2) Compile a list of factors that a credit analyst or potential bondholder would take into account

when evaluating UST’s proposed recapitalization. Discuss the important factors.

3) Why is UST considering a leveraged recapitalization after such a long history of conservative

debt policy?

4) Comment on the past and future financial performance of UST. What is the stock market’s

assessment of UST’s long-term growth rate?

a. Hint: use the growing perpetuity formula, ????0 = ????1⁄(???????????? − ????), and solve for ???? to infer

UST’s long-term growth rate. You will need to use the CAPM to find ????????????. (You may want

to do some online research of comparable tobacco companies to figure out the

approximate beta you should use for the CAPM.) Assume that ????1 = ????0 × (1 + ????).

5) Comment on the financial performance of UST relative to other tobacco companies.

6) Create three pro-forma income statements for fiscal year 1999 under each of the following

assumptions: (1) the $1B in debt was not issued; (2) the $1B in debt was issued and is

investment grade; (3) the $1B in debt was issued and is below investment grade. For the latter

two cases, can UST afford to make the interest payments based on the respective pro-forma

income statement?

In answering this question, the CEO only wants a simplified pro-forma income statement that

takes the following form:

SALES

EBIT

INTEREST EXPENSE

PRE-TAX NET INCOME

TAX

NET INCOME

7) Calculate the change in UST’s value due to the tax shield benefits of the additional debt. For this

question, it would be useful to create a table containing the following information: value of the

tax shield, value of the firm, value of the debt, value of the equity, number of shares

repurchased, number of shares outstanding, and stock price. The table should cover the same

three cases as Question 6. Assume that the $1B in debt is used to repurchase $1B in shares.

8) Comment on possible changes in value from the recapitalization due to other market frictions

such as bankruptcy costs, information signaling, or other market frictions that you feel are

applicable.

9) UST has paid uninterrupted dividends since 1912. Will the recapitalization hamper future

dividend payments? Consider, in particular, the dividend paid per share in 1999, with the

assumption that UST will try to maintain a constant dividend payout ratio.

The case report should be three to four pages in length (use the default spacing in Microsoft Word) with

any useful tables or graphs attached. A one-paragraph executive summary should be included at the

beginning of the report. The report should be presented in a professional manner and read as a cohesive

document so that the CEO can easily understand your main points. If you need to make any

assumptions, make them clear. Calculations should be relegated to an appendix. A report that consists

of a mess of calculations and numbers or a series of random paragraphs pasted together would not be

acceptable.

The case presentation should be about 20-30 minutes in length. Similar to the report, it should also be

presented cohesively and in a professional manner so that the CEO can easily understand your main

points. The presentation should be informative, concise, and should keep the listener engaged. The

presenter should also be prepared to answer questions from the audience. A maximum of two people

from your group should present your findings.

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