Case 30: M&M Pizza 1. What is going on at M&M Pizza? How do the financial statements for...

Question

Case 30: M&M Pizza

1.

What is going on at M&M Pizza?

How do the financial statements for M&M Pizza vary with the proposed repurchase plan? Do the alternative policies improve the expected dividends per share?

2.

Describe the companies current WACC, and capital structure choices. It seems obvious that debt is the cheaper source of funds. Why is the company willing to pay 8% on equity when it could borrow at 4%?

3.

What impact does the repurchase plan have on M&M’s weighted-average cost of capital? Complete the table below (No Corporate Taxes). What are the debt and equity claims worth under the alternative scenarios? You may note that the present value of a perpetual cash flow stream is equal to the expected payment divided by the associated required return. Which proposal is best for investors, discuss your results in your explanation? What do you recommend that Miller do?

Income Statement		Debt = 0		Debt = 500
	Revenue	1500		1500
	Operating expenses	1375		1375
	Operating profit	125		125
	Interest payments	0
	Taxes	0		0
	Net profit	125

	Dividends	125
	Shares outstanding	62.5
	Dividends per share	2.00

Cost of Capital
	Cost of debt	4.00%		4.00%
	Beta	0.800		Levered Beta
	Cost of equity	CAPM
	WACC	= D / V * Kd (1 - t) + (1 - D/V) * Ke
Cash flows
	Debt holders		= Interest payments
	Equity holders		= Dividend payments
	Free cash flow		= Op profit

Value
	Debt	= Int payments / Kd
	Equity	= Div payments / Ke
	Total	= Sum or FCF / WACC

	Share price 1	= Equity / Shares outstanding
	Share price 2	= DPS / Ke

	Value of Firm	= Value of unlevered + Tax shield
	D/E	= D / (V - D)
	D/V	= D / V

4.

How would your analysis in questions 2 and 3 and recommendation in question 4 change if the new tax law is implemented? Please note that, with corporate taxes, the expected debt-to-equity ratio under the share repurchase plan is 0.588, and the number of remaining shares outstanding is 39.4 million. Complete the same table as in question 2 with a tax rate of 20%.

case-30-mm-pizza-questions-2-2-a4syvvj0.docx case-studies-in-finance-managing-for-corporate-value-creation-8th-edition-robert-bruner-kenneth-eades-michael-schill-z-liborg-d25p4igk-fzzbdbm5.pdf case-30-mm-pizza-questions-2-2-efxcu1hl-rukjiwpp.docx

Rochak · Accepted Answer

Answer 1: M&M Pizza recently appointed a new managing director and the new managing director while looking at the company’s financials don't hat that the financial policy at the company is overly conservative therefore, he decided to introduce debt in the company as he felt that at the current borrowing rate of 4% the company can make good use of the debt and purchase the equity to create shareholder value (Harris & Raviv 1991).
The financial statements for M&M Pizza will not vary much other than with the proposed repurchase plan, the only things which will change are:
· Book Debt: The book debt of the company will increase by F$500 million 
· Book Equity: The book equity of the company will decrease by F$500 million
· Cash: There will be not affect on cash as the cash the company will be getting from the issuance of the debt will be used to repurchase the shares
Yes, the alternative policies will improve the expected dividends per share as with the repurchase the number of shares outstanding will reduce while the dividend will remain the same and therefore there will be an increase in the dividend per share that is being paid out. 
Answer 2: The company’s current WACC with no debt which is the current state of the company is 8% which is also the cost of equity for the company. This 8% WACC has been calculated based on a market risk premium of 5% with a beta of 0.8 and a risk-free rate of 4% (Rauh & Sufi 2010).
The company is willing to pay 8% on equity because issuing equity does not bring any obligation to the company which they must pay each year, but with the debt there comes an obligation of the payment of interest every year. Therefore the 4% debt that will fetch F$500 million to the company will also cost approximately F$20 million which will reduce the overall net income of the company which could otherwise be higher when there was no debt with the company. 
Answer 3:
The impact the repurchase plan has on M&M’s weighted average cost of capital is that there is no impact on the WACC,

Case 30: M&M Pizza1.What is going on at M&M Pizza?How do the financial statements for M&M Pizza vary with the proposed repurchase plan? Do the alternative policies improve the expected dividends...

Answer To: Case 30: M&M Pizza1.What is going on at M&M Pizza?How do the financial statements for M&M...

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