Hill Country Snack Foods Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Hill Country Snack Foods Case Study Analysis

Evaluation of Debt Alternatives

By looking at exhibit 4, it can be seen that when the company entered 20% debt to capital ratio;its; EPS increased from $2.88 to $3.19, and the DPS increased from $0.85 to $0.95.

On the other hand, when the company entered 40% debt to capital ratio;its EPS increased from $2.88 to $3.31, which indicates that thisis a good sign for the shareholders as they normally buy shares for capital gain or dividends.

When the company entered 60% debt to capital ratio; itsEPS increased from $2.88 to $3.11, whereas its DPS increased from $0.85 to $0.93, which is a good sign for any shareholder as well as the CEO and the management, as they hold 16% of the shares.

The objective is to maximize shareholders’ wealth and to remain competitive; therefore, the best option is to keep an optimal capital structure of the company.

Financial Analysis

All of the three alternatives of debt could be evaluated on the basis of financial terms, containing the determination of value per share under each alternative by using discounted cash flow method of perpetuity. Firstly, a WACC has been calculated under all of the three alternatives, using the data given in the case and on the basis of certain general assumptions. Beta is assumed toincrease with an increase in the debt ratio. Calculations regarding WACC and value per share are given in Appendix 1 and 2, respectively, showing a high share value with an increasing trend. The share values under each case equal to $63.22, $76.79 and 76.84 respectively, which are far greater than the share price paid for stock repurchase, i.e. $47.92, $50.00 and $52.09 respectively.

Recommendations

On the basis of aforementioned analysis; the firm is recommended to adopt a higher debt ratio debt in its capital structure. Many investors are frustrated by the company’s zero debt finance policy and excess liquidity.The interest earned on cash is 0%,which has contributed almost nothing to the net income. Interest rates are currently at an unprecedented level with a market yield of 10 years, and the treasury bonds are fewer than 2% and the publicly traded ten years’ bond are being traded at 3.8% yield to maturity. In this scenario, avoidance of debt will decrease their return on equity. Therefore, to earn a high rate of return on equity; there should be more reliance on debt rather than equity.

As shown in Exhibit 4, by restructuring the debt to equity ratio became 20%,40% debt to equity ratio, 60% debt to equity ratio; the earnings per share increased from$ 2.88 to $3.19,$3.33 and $3.13. Similarly, dividend per share also increased from $0.85 to $0.96, $0.99 and $0.92. Moreover, reductions to cash increase in debt and reduction to equity will increase return on equity.

The company’s motive is to maximize the shareholders’ wealth, whereas theCEO and the management hold approximately 16% shares. Due to debt with an increase in both earnings per share and dividend per share;the performance will be in line with the objective. Along with it, there are many other advantages of having debt in the capital structure, such as:

Debt is a cheaper source of finance as compared to equity due to the contractual nature.
Interest payments are tax deductible, which results in tax savings.
Debt holders will agree at a lower rate of return, because they are secured.
Arrangement cost of debt is tax deductible.

There are several methods through which the firm can increase its debt and decrease equity in its capital structure, which include; issuance of loan notes, bonds issued, deals with debt negligently, high-interest loan, repurchase outstanding shares, increase debt obligations and issuing dividends etc...................................

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