Case 35: Stock Repurchase Program Recommendation

Memo ToRajat Singh, managing theatre director at Hudson Bancorp From Date08/01/2002 ReStock Repurchase Program testimonial The purpose of this memo is to examine whether high-minded Corpo proportionalityn should growth borrowings to salvation stocks. After considerable digest of the companys financial position, we pr to each sensation(prenominal) that voluptuary Corp. to borrow up to $1. 023 billion to buy back 34,175 sh bes. In order to achieve this, Deluxe will need to lower its hold fast rate from A rate to BBB , which results in a decrease in WACC from 11. 47% to 9. 5%. By doing this, Deluxe s WACC is minimized, yet the seize rating is still at investment grade rating plus, the home will have a financial flexibility of $872 million, and an summation in its rightfulness cheer per plowshare by $35. 34. This memo explains in dot the calculation of the real WACC, the period intrinsic equity determine, the unused debt readiness at different ratings, and the re commended WACC as well as the estimated increase in equity value with attentiveness to the new WACC at the recommended debt borrowing level.Current WACC found on our calculation, the current WACC is 11. 47% as of August 01, 2002. In this calculation, for the borrowing rate, we use 5. 70% regarding Deluxes link rate A from Exhibit 8. The marginal tax rate is is projected to be 38%. We use 5. 41% for the risk set-apart rate of return with respect to the 20 years U. S Treasury bond. The equity risk amplitude and beta are given at 6% and . 85, respectively.Since the beginning of 2002, Deluxe had retired all of its long term debt, we calculate the contribute debt by adding the short-run debt and the long-term debt due within one year to arrive at $151 million for the total equity, we multiply the number of shares outstanding which is given in the companys 2001 Financial Summary, by the market adjusted make full price per share which we look up in yahoo finance to get to $1,568 mi llion. For the small stock risk premium, we use 1. 73% as Deluxes total equity is surrounded by $1. 05 billion and $1. 6 billion. Current intrinsic equity valueDeluxes intrinsic equity value as of August 1, 2002 utilise a discounted cash flow analysis and the current WACC of 11. 47% has a premium of $2. 38 over the current market value. We estimate the terminal value growth rate to be at -2% we make this assumption by taking the average of the exertions annual decline growth rate between 1% and 3%. The free cash flows for 2002-2006 are taken from the companys Financial Forecast and, to calculate the terminal years free cash flows, we grow it by -2% and divide it by the difference between the WACC and the long term growth rate.Since August 1st is our evaluation date, there is still 5 months left for 2002, the cash flow to be authoritative for 2002 is calculated by taking the total cash flow propagation 5/12, and for the remaining years, the cash flow to be received is tint to the total cash flows. And, final examinationly, for the midyear factor ,we also take same watchfulness that t are 5 months left to receive cash flows, and payments are made semiannually . Thus, our mid-year factor for 2002 is 5 over 24, and (5+6) over 12 for 2003, and for the remaining years we add 1 to the prior years midyear factor.Flexibility by rating Our analysis of the flexibility in allowed debt to a lower place each bond rating provided us the maximum allowable unused debt for each rating. We calculated this figure by considering both the interest coverage symmetry as well as the leverage ratio, and then using the smaller of the two figures. We calculated the maximum allowable debt using the leverage ratio by multiplying the five-year EBITDA average times the required leverage ratio under each credit rating. The lower the credit rating the larger the allowable debt becomes.By choosing the lower of the two calculations, the maximum allowable debt under credit rating AAA is 278. 9 million and ranges up to 2,456. 6 million for bond rating B. In order to maintain an investment grade rating, Deluxes maximum allowable debt would be 1,023. 5 million. Recommended WACC In collusive the WACC for each bond rating, we altered several components for each. First, the borrowing rate increases as the bond rating decreases. These figures were provided in Exhibit 8. Second, we recalculated beta taking into flier the changes in the debt/equity capitalization structure using.The re-levered beta was calculated using the levered and unlevered information. Third, as ratings declined their debt/equity ratio increased and altered their weighted be of debt. Fourth, their equity/debt ratio decreased as their bond rating declined. Our final calculations of the WACC for each bond rating went from 11. 47% at AAA hatful to 9. 95% at BBB and back up to 11. 02% at a B rating. We recommend using the debt level allowed under the BBB rating since it maintains our status as inve stment grade bonds and also provides the lowest possible WACC. Estimate increase in equity valueTo sink the number of shares to be redemptiond in the approaching repurchase program, we used the maximum allowable debt under the BBB bond rating and subtracted our current debt to determine the total funds to be used to repurchase shares. In order to determine the number of shares that could be repurchased, we divided the total allowable debt by the current market per share price. This resulted in a recommended repurchase of 34,175 shares. Next, we conducted a free cash flow analysis to determine the intrinsic endeavour value of Deluxe mess.This analysis is similar to the one conducted for the Current intrinsic equity value. However, we lowered the WACC to reflect our recommended credit rating. In estimating the total increase in shareholder value from this repurchase program, we took enterprise value minus the maximum allowable debt at the BBB rating. This gave us the equity value of Deluxe Corporation. Then, we divided the equity value by the current outstanding shares net of the repurchase program. This gave us equity per share value of $63. 24. In comparing this to the old equity per share value, we found an increase of 127%.This is a highly favorable move for the shareholders of Deluxe Corporation. Concluding passport We believe Deluxe Corporation should borrow funds in the criterion of $872 million for the stock repurchase program. By borrowing these funds, Deluxe Corporation will be able to increase their equity value per share by 127% while still maintaining investment grade status. Deluxe is aiming for a flexible capitalization structure, and by borrowing more debt we believe they bum achieve this due to the high cost of equity. If you have any head teacher or concern, please feel free to contact us via emails