M & M Pizza Solved Financial Case Solution Sample

QUESTION

 

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. What impact does the repurchase plan have on M&M’s weighted-average cost of capital? Complete the table below (No Corporate Taxes)

 

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

 

 

3. 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? What do you recommend that Miller do?
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%.

 

ANSWER

 

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?

M&M Pizza, even though is in a sound financial condition, has not been able to raise its share price. It gives out consistent dividend and makes good profit every year, and the new MD of the firm wants to rectify it. He wants to take a loan of F$ 500 million to arrange a share buyback which he hopes will increase the share price.

Currently there is 0 debt on the books of M&M but after the repurchase that debt would increase to F$500 million, and equity would reduce by the same amount. Also, as there is no debt, the interest payment is zero, and all the profit is divided amongst the shareholders.

Current DPS: F$2

Current Share Price: F$25

Total buyback amount: F$500 million

Number of shares bought back: 20 million

Number of remaining shares: 42.5 Million

Interest payments: F$ 20 Million

Profit to shared amongst the shareholders: F$ 105 Million

New DPS: F$2.47

The alternate policy improves the dividend by 23.5%.

2. What impact does the repurchase plan have on M&M’s weighted-average cost of capital? Complete the table below (No Corporate Taxes)

 

Income Statement		Debt = 0	Debt = 500
	Revenue	1500	1500
	Operating expenses	1375	1375
	Operating profit	125	125
	Interest payments	0	20
	Taxes	0	0
	Net profit	125	105
	Dividends	125	105
	Shares outstanding	62.5	42.5
	Dividends per share	2.00	2.47
Cost of Capital
	Cost of debt	4.00%	4.00%
	Beta	0.800	1.2
	Cost of equity	CAPM	0.1
	WACC	= D / V * Kd (1 – t) + (1 – D/V) * Ke	.07
Cash flows
	Debt holders	= Interest payments	20 Million
	Equity holders	= Dividend payments	105 Million
	Free cash flow	= Op profit	105 Million
Value
	Debt	= Int payments / Kd	500 Million
	Equity	= Div payments / Ke	1050 Million
	Total	= Sum or FCF / WACC	1550 Million
	Share price 1	= Equity / Shares outstanding		24.70
	Share price 2	= DPS / Ke		24.7
	Value of Firm	= Value of unlevered + Tax shield	1805.71 Million
	D/E	= D / (V – D)	.383
	D/V	= D / V	.277

 

 

3. 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? What do you recommend that Miller do?

Even though the dividend paid by the firm increases, the value of the share price goes down as the debt holders also have a claim to the share of the company. IAs the primary motive was to increase the share price; I think Miller should stick with the current capital structure.

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%.

Income Statement		Debt = 0	Debt = 500
	Revenue	1500	1500
	Operating expenses	1375	1375
	Operating profit	125	125
	Interest payments	0	20
	Taxes	0	21
	Net profit	125	84
	Dividends	125	84
	Shares outstanding	62.5	39.4 Million
	Dividends per share	2.00	2.13
Cost of Capital
	Cost of debt	4.00%	4.00%
	Beta	0.800	1.2
	Cost of equity	CAPM	0.1
	WACC	= D / V * Kd (1 – t) + (1 – D/V) * Ke	.37*.04*(.8)+(.63*.1)=7.4%
Cash flows
	Debt holders	= Interest payments	20 Million
	Equity holders	= Dividend payments	84 Million
	Free cash flow	= Op profit	125 Million
Value
	Debt	= Int payments / Kd	500 Million
	Equity	= Div payments / Ke	840 Million
	Total	= Sum or FCF / WACC	1340 Million
	Share price 1	= Equity / Shares outstanding		21.3
	Share price 2	= DPS / Ke		21.3
	Value of Firm	= Value of unlevered + Tax shield	1371.35
	D/E	= D / (V – D)	.574
	D/V	= D / V	.364