Swedish Match is a smokeless tobacco company that has been very profitable as compared to other companies in the same industry. It has lower debts in comparison with other companies. The CFO of Swedish Match is now looking into changing the company's financial policy.
Bo Becker; Michael Norris
Harvard Business Review (212017-PDF-ENG)
October 24, 2011
Case questions answered:
- Assuming Swedish Match faces a 28% tax rate on income and can issue bonds at a fixed krona yield of 4.5%, how much will the company save in taxes for a SEK4 billion recapitalization? What is the present value of this interest tax shield?
- What will SM’s book value balance sheet look like after it completes the debt issuance and share repurchase? (Assume share repurchase is recorded at market price).
- What will Swedish Match’s market value balance sheet look like :
a. Right after it announces the leveraged recap?
b. When it completes the issuance of SEK 4 billion in debt?
c. When it completes the share repurchase? - Can Swedish Match afford to borrow this much money? What are the risks? Is it realistic to expect a BBB+ rating? Should the company go ahead with a leveraged recap? If so, would you approve a larger recapitalization?
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Case answers for A New Financial Policy at Swedish Match
This case solution includes an Excel file with calculations.
Executive Summary:
Swedish Match is considering increasing leverage by conducting a leveraged recapitalization. To evaluate the prospects of this operation, many elements need to be taken into account mainly the tax shield generated by the leverage, the market values of each of the debt and equity before and after the operation as well as the overall feasibility of the leverage and the risks associated with the transaction.
Based on our analysis, we would recommend the Swedish Match to conduct the leveraged recapitalization as it will increase share price due to the interest tax shield and increase overall efficiency. Moreover, the company has enough liquidity to cover interest expenses. However, a large recapitalization would adversely affect the company as it will lead to a downgrade in the credit rating thus a larger recapitalization is not recommended.
To support our decision, we have done a detailed analysis of the company financials below:
1. Assuming Swedish Match faces a 28% tax rate on income and can issue bonds at a fixed krona yield of 4.5%, how much will the company save in taxes for a SEK4 billion recapitalization? What is the present value of this interest tax shield?
The company would save in taxes = Tax Rate * Interest Rate * Debt
= 0.28*0.045*4000
= 50.4 Million
Present Value of this Interest Tax Shield = (Tax Rate*Interest Rate*Debt) / Interest Rate
= 50.4/0.045 = 1120 Million
Remark: We have calculated the present value by assuming the debt has been issued in perpetuity.
2. What will SM’s book value balance sheet look like after it completes the debt issuance and share repurchase? (Assume share repurchase is recorded at market price).
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