A women's apparel chain with a 10 percent debt-to-assets ratio and a times interest earned of 7.0 is concerned about the possibility of losing its independence in a raid. As part of its defense management elects to sell $100 million of new debt and to repurchase some of its common stock. This will increase the debt-to-assets ratio to 60 percent and will cut times interest earned to 2.0
a. Might this restructuring reduce the company's vulnerability to a takeover? If so, how?
b. Do you think the restructuring will create value? If so, how?
c. If the tax rate is 34 percent, the interest rate is 12 percent, and the debt will be rolled-over as it matures, (i.e., assume the debt is outstanding in perpetuity) estimate the present value of the tax shield created by the restructuring at a discount rate of 14 percent.
d. Prior to the restructuring, what percentage decline in earnings before interest and taxes could the company sustain and still cover its interest expenses? What is the comparable figure after the restructuring? If you were a well-capitalized competitor, anxious to increase market share, what do these numbers suggest might be an interesting strategy to use against this firm?