BLAINE KITCHENWARE INC.

CASE STUDY REPORT

BLAINE KITCHENWARE INC. CASE STUDY REPORT

Introduction

Blaine Kitchenware Inc. (BKI) is an American company that

produces kitchen appliances such as griddles, waffle iron, blenders,

and coffee makers among others. The company started operation

solely in the United States in 1927 but by 2006 it could only boast of

10% of the American market share for kitchen appliances. The 10%

market share does not accurately reflect the status of a company

that has been in existence for the past 80. Due to the rather

unimpressive market share, the company embarked on an

expansion strategy with the intension of going global. The global

expansion was not as successful as expected. This is evidenced by

the fact that available records in the year 2006 indicate that 65% of

the company’s sales were made to wholesalers and retailers in the

United States.

In this report, we will examine a proposal that was presented

to the CEO of the company Victor Dubinski. The proposal has a

potential to “unlock” the value inherent in Blaine’s strong operation

and balance sheet. The proposal is intended to convince Victor

Dubinski and the board on the advantages of repurchasing stock and

also borrowing to add to the excess cash that the company has to

pay for the stock. The CEO needs to present this proposal to the
BLAINE KITCHENWARE INC. CASE STUDY REPORT

board. The details of the proposal are analyzed in the problem

statement below.

Problem Statement

The major issues the company faced were with respect to its

conservative nature and the effect of their organization being biased

against borrowing to raise capital for projects. This left the company

having surplus cash (over liquid) and being unlevered.

The problem with this was that, such a structure did not seek

to support the interest of the company’s shareholders. As evidenced

by the reports, the company’s dividends per share had risen only

modestly in the two years leading to 2006. Its return on equity of

11% as at 2006 was well below the industrial average of 26%.

Another problem was that by maintaining high cash balances,

they became vulnerable to the reduction in the future value of that

cash and hence the organization’s overall value. Cash was not used

appropriately as it was majorly used to satisfy the extensive

acquisition habit the company practiced. This practice of acquisition

seriously increased the company’s number of shares outstanding

which subsequently had a negative impact on the shareholders.

Most alarming of all was the fact that if the company continued

with this structure, they would be susceptible to a forced acquisition

due to the increased number of shares outstanding coupled with

BLAINE KITCHENWARE INC. CASE STUDY REPORT

reduced value of stock. This, together with the feeble structure will

entice private equity buyers to easily buy out the shares of majority

of the shareholders. A situation that would be relatively difficult if

there was a reduced number of shareholders with great stakes in the

company.

ANALYSIS OF THE SHARE REPURCHASE PROPOSAL

If the company repurchased some of its outstanding shares

and takes on some debt, it will definitely result in a secured financial

state for both the shareholders that would be left after the

repurchase and the company. This is because it will be enjoying the

benefits of being levered which include increased share price since

there will be fewer shares outstanding with increased demand. Also,

the company will enjoy tax shield due to the fact that it has debt on

its books that it is servicing.

Items in the proposal include:

 BKI to use $209 million of cash from its balance sheet and $50

million new debt at an interest rate of 6.75% to repurchase 14

million shares at $18.50 per share.

 The proposal involves paying 13.8% premium to buy back

23.7% of its outstanding shares

This was also done with the use of the tender offer strategy of share

repurchase which entailed them buying some of their outstanding

BLAINE KITCHENWARE INC. CASE STUDY REPORT

shares currently in the market at a price above the current market

price.

Assumptions made in Analysis

In preparing the above Income statement for Blaine Kitchen, we

made several assumptions due to the fact that certain information

was not given in the case. The following assumptions were made

based on professional judgment:

(1)Assume that Cost of goods sold increased by the average of

the percentages of revenue of the three preceding years.

Therefore, the cost of goods sold for the after leverage is

71.5% of revenue.
(2)Assume that Selling, General & administrative (SG&A)

expenses also increased by the average of the percentages of

revenue for the three preceding years. Therefore, (SG&A) of

the after leverage is 8.6% of revenue.

(3)Assume that other income after leverage is 4.8% of revenue.

This is based on the average of the percentages of revenue of

the three previous years.

BLAINE KITCHENWARE INC. CASE STUDY REPORT

Impact on Balance Sheet

Assets: 2006 (‘000) After

Leverage(‘000’)
Cash & Cash Equivalents 66,557 21,866
Marketable Securities 164,309 -
Accounts Receivable 48,780 48,780
Inventory 54,874 54,874
Other Current Assets 5,157 5,158
Total Current Assets 339,678 130,678
Property, Plant & Equipment 174,321 174,321
Goodwill 38,281 38,281
Other Assets 39,973 39,973
Total Assets 592,253 383,253
Liabilities & Shareholders' Equity:
Accounts Payable 31,936 31,936
Accrued Liabilities 27,761 27,761
Taxes Payable 16,884 16,884
Total Current Liabilities 76,581 76,581
Other liabilities 4,814 4,814
Deferred Taxes 22,495 22,495
Debt - 50,000
Total Liabilities 103,890 153,890
Shareholders' Equity 488,363 229,363
Total Liabilities & Shareholders' Equity 592,253 383,253

Is important to note that, as a result of the stock repurchase the

cash amd marketable securities on BKI’s balance sheet has reduced

significantly from $230,866,000 to $21,866,000. That

notwithstanding, BKI will be able to operate without any significant

issues. Another point worth noting is that BKI will now have a debt of

$50 million on its books. This debt will result in BKI paying interest

expense of 3,375,000 annually. However, this debt will provide BKI

the opportunity to enjoy tax shield because of the interest expense

BLAINE KITCHENWARE INC. CASE STUDY REPORT

that it has to pay. The effect of this financial structure is that it will

ensure that forced acquisition does not occur and also, shareholders

will enjoy higher earnings per share at a share price of $18.50,

which is significantly higher than the $16.25.

Impact on Income Statement

After
Operating Results: 2004 2005 2006 (‘000’)
Revenue 291,940 307,964 342,251 352519
Less: Cost of Goods Sold (71.5 % of revenue) 204,265 220,234 249,794 252051
Gross Profit 87,676 87,731 92,458 100,468
Less: Selling, General & Administrative (8.6 % of
revenue) 25,293 27,049 28,512 30,317
Operating Income 62,383 60,682 63,946 70,151
EBIT 62,383 60,682 63,946 70,151
Plus: Other Income (expense)(4.8% of Revenue) 15,719 16,057 13,506 16,921
Less: Interest on debt 0 0 0 3,375
Earnings Before Tax 78,102 76,739 77,452 90,447
Less: Taxes 24,989 24,303 23,821 36,179
Net Income 53,112 52,435 53,630 54,268
Net Income Margin 18.2% 17.0% 15.7% 15.4%
Gross margin 30.0% 28.5% 27.0% 28.5%

Note: The “After” column shows the resulting impacts of the share
repurchase.

Financial Ratios
BLAINE KITCHENWARE INC. CASE STUDY REPORT

After
Financial Ratios 2006 Leverage

Acid test 3.7 0.99

Current
Ratio 4.4 1.7

D/E ratio
(Solvency
) -24.06 21.8
Probability

EBIT 63946 70,151

Ratios

ROE 11.00% 22.00%

ROA 9.00% 13.00%
EPS $0.91 1.13

EBIT 63,946 70,151

Tax Shield

interest
payment 0 3,375
taxable
Income 63,946 90,447
tax 23,821 36,179
Net
income 53,630 54,268

WACC Estimations
Before proposal
Outstanding Share: 59,052,000
Stock price: $16.25
Market premium: 13.8%
Unlevered beta: 0.56

Cost of Equity:
BLAINE KITCHENWARE INC. CASE STUDY REPORT

Using CAPM: rf + bu (PMR)

5.02+0.56(13.8)
12.7480
Cost of Equity 12.75%
Since Blaine Kitchen has no debt at this time, its WACC is the same
as the cost of capital calculated above.
WACC = 0+1*12.75
WACC = 12.75%

After Proposal
The following is the situation of the firm after the proposal
rf = 5.02
Debt = 50,000,000
Equity = 229,363,000
Value =Debt + Equity =279,363,000
bu = 0.56
Weight of debt = 50,000,000/279,363,000 = 0.18
Weight of Equity = 229,363,000/279,363,000 = 0.82
Debt(D)/Equity(E) Ratio = 50,000,000/229,363,000 =0.22
Tax rate (T) = 40%.
To calculate the cost of equity after leverage, we employ the
Hamada equation
bL=bU[1+(1-T)(D/E)]
0.56[1+(1-0.40)(0.22)]
0.56*1.132
bL = 0.63
Therefore the levered beta is 0.63
Cost of equity after leverage is rf + bu (PMR)
BLAINE KITCHENWARE INC. CASE STUDY REPORT

5.02+0.63(13.8)
Cost of equity = 13.71
Cost of debt is 6.75%
Blaine kitchen’s levered WACC is calculated as follows:
= (0.18*6.75*0.6) + (0.82*13.71)
=0.7290 + 11.2422
WACC = 11.97%
Assumptions made in WACC computation:
1) Given that Blaine Kitchen has not issued debt in a very long

time and also having a strong balance sheet, it is safe to

assume that the cost of debt is the borrowing rate. This

assumption is based on the explanation provided by Ross et al.

in their book Corporate Finance: Core principles and

Applications. They reiterated on pages 378 and 379 that in

situations like the Blaine Kitchen case, the cost of debt is the

cost of borrowing. Therefore in the above calculation we chose

the borrowing rate of 6.75% as the cost of debt. Additionally,

we assumed that if Blaine Kitchen were to issue a bond,

because of its strong balance sheet, its bonds will be rated

AAA by Moody with rate of 5.88%. When the default spread of

0.86% is added to that rate of 5.88%, it will result in 6.74%.

This is only 0.05 percentage points from the borrowing rate

and therefore insignificant and immaterial for further

BLAINE KITCHENWARE INC. CASE STUDY REPORT

consideration. Based on the above, we chose the cost of debt

of 6.75%.
2) Given that Blaine Kitchen has a strong balance sheet and does

not like to take on debt, we assume that it will only take a

medium term debt of about 10 years. Therefore, we used the

risk free rate of 5.02%

3) rf= risk free rate
bu = unlevered beta
bL = Levered beta
PMR= Market risk premium.

Advantages of the Share Repurchase to Blaine Kitchenware

 Share price of the company will increase as many people will

be chasing less stock. Additionally, the fact that shares

outstanding will be reduced will give both EPS and DPS a better

value.
 There will be increased power and influence on the part of the

family (board of directors/owners) as their 62% power will

increase to about 81%.

 The power that owners now have can help them develop their

own dividend policy to situate the company in a standard for

future dividend payments

 By increasing shareholder value (share price), this program will

improve shareholder confidence.

Disadvantages of the Share Repurchase

BLAINE KITCHENWARE INC. CASE STUDY REPORT

 Utilizing the company’s cash will reduce the level of liquidity of

the company and inhibit its ability to make some capital

investments.
 A crisis could erupt from minority shareholders as they would

feel cheated or left out with the implementation of this

program.
 Less cash could also affect the ability of the company to meet

day-to-day transactions needed for operations.

Why Blaine Kitchenware Should Consider the Share Repurchase

 WACC will reduce from 12.75% to 11.97% to show that an

optimal capital structure has been attained.

 More influence for the majority stakeholders (the family) and

this will help fend off predators (i.e acquirers) from taking over

the company via shares.

 Tax shield helps reduce costs of capital. This is an encouraging

reason for them to consider it now in order to enjoy the

benefits of this tax shield.

Recommendation

Based on the quantitative and qualitative analysis and the fact

that the pros of doing the share repurchase outweigh the cons, it is

only proper to recommend that this project be accepted and

implemented because it satisfies all parties involved (the company

and its shareholders) and the future financial and budgeting

capabilities of Blaine Kitchenware Inc.

BLAINE KITCHENWARE INC. CASE STUDY REPORT