The investment banker commented that Blaine was “over-liquid and under-levered” due to the fact that Blaine was debt-free and also held $231 million in cash, a 39% of its total assets. The pros of this type of capital structure are that it gives the company more freedom when making business decision and disturbing its cash. And the company with more liquidity reacts quicker under an economic or industry hardship. The cons of this type of capital structure are that it is wasting the potential of expanding its business by leveraging/borrowing. Too large of a cash position also signal waste as the funds are generating very little return as well as make the company a takeover target. The shareholders generally expect the company …show more content…
A. The tax shield of the interest expense on the debt per year is: 3,375,000*30.8% = $1,039,500.
The PV of the tax shield is: 1,039,500/6.75%=$15,400,000
The PV of the tax shield on a per share basis is: 15,400,000/45,062,000=$0.34 < $2.25
The $2.25 premium is not justified based on the PV of the tax shield of the interest expense.
B. The tax reduction in interest income is: 13,506,000*30.8%=$4,159,848
The PV of the above tax reduction is: 4,159,848/6.75%=$61,627,378
The PV of the above tax reduction on a per share basis is: 61,627,378/45,062,000=$1.37
The PV of the total tax changes on a per share basis is: 1.37+0.34=$1.71 < $2.25
The $2.25 Premium is not justified based on the PV of the total changes in tax.
C. I don’t consider this an issue. The higher premium gives the shareholders incentives to sell their shares instead of holding them so as to accelerate the repurchase process. The company has excessive cash. And if they choose to distribute the cash back to shareholders, it’s better to distribute it though one-time event such as a stock repurchase instead of to raise dividend and to maintain the level of