Case Assignment- UST
The CEO of UST would like you to prepare a three--to--four page case memo 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 that the debt would be 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 memo 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?
(Hint: use the growing perpetuity formula, !! = !! !!! - ! , and solve for ! to infer UST's long-- term growth rate. You will need to use the CAPM to find !!!, and assume that !! = !!× 1 + ! . )
5) Comment on the financial performance of UST relative to other tobacco companies.
6) Create a pro--forma income statement for fiscal year 1999 under the assumption that the debt is investment grade, and then under the assumption that the debt is below investment grade. Under each assumption, 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. Comment on possible changes in value due to other market frictions such as bankruptcy costs, information signaling, or other market frictions that you feel are applicable.
8) 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 memo should be three to four pages with any useful tables or graphs attached. The memo should be presented in a professional manner, and with a logical flow, so that the CEO of UST can easily understand your main points. If you need to make any assumptions, make them clear. Calculations should be relegated to an appendix. A memo that consists of a mess of calculations and numbers would not be acceptable. The memo can be worked on in groups of up to five people.
The case presentation should be about 30 minutes in length. It should also be presented in a professional manner, and with a logical flow, so that the CEO of UST 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.