Hill Country Snack Foods Co
Questions
1. Explain the benefits/advantages and the risks/costs of adding debt to the capital structure
of Hill Country.
2. Build Pro Forma 2011 Income Statements (Exhibit 4) for the three Alternative Capital
Structures, assuming
a. Debt is issued and added to the capital structure and the proceeds are used to
repurchase common stock;
b. Common stock is repurchased at a premium to the market price of $41.67 per
share. The premium increases as the size of the recapitalization and repurchase
increases. The recapitalization that increases the debt-to-capital ratio to 20% is
assumed to require a 15% premium to repurchase the required shares; the 40%
debt-to-capital ratio is assumed to require a 20% premium; and the 60% debt-to-
capital ratio is assumed to require a 25% premium.
c. The minimum cash balance is assumed to be $126.1 million, equal to 9.2% of sales,
which is 1.5;
d. The corporate income tax rate is 35.5%;
e. The quality of the debt issued by Hill Country decreases and the interest rate on
this debt increases as the amount of debt issued and the size of the
recapitalization increases, according to the current Interest Rates and Bond
Ratings Information:
Exhibit 3 - Current Interest Rates and Bond Ratings Information
a
Interest rates on U.S. Treasury bonds
Yield to maturity on 10-year maturities 1.8%
Bond Rating
a
Interest rates on corporate bonds AAA AA A BBB BB B
Yield to maturity on 10-year maturities 2.5% 3.2% 3.8% 4.4% 6.1% 7.7%
Bond Rating
Standard & Poor's medians for 2011 AAA AA A BBB BB B
Debt-to-capital ratio (book value) 13.8% 29.6% 33.8% 40.4% 47.0% 62.3%
Interest coverage (times) 64.7 15.8 9.6 4.1 2.4 1.3
a
Market interest rates during January of 2012
Sources: Standard & Poor's, Compustat, Datastream, and U.S. Department of Treasury
3. How much value could Hill Country create (in terms of total taxes savings and impact on
profitability ratios) for its shareholders at each of the three alternative debt levels?
4. What debt-to-capital structure would you recommend as optimal for Hill Country?
Notes:
1. Be aware there isn’t a “correct answer” to the case. You will have to make some
assumptions that should be clearly justified to improve your final mark.
2. Your case solution should be sent by e-mail (which should include a pdf or word file and an
excel file with the calculations used to solve the case) until the end of October 28.
([email protected]).
3. I am available to help you regarding any doubt you will have during your work.
Good work!
