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  

 

 

  1. 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?
  2. 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%.

  1. 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

 

 

  1. 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.

  1. 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

 

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