A New Financial Policy at Swedish Match Harvard Case Solution & Analysis

Q1). Assess the business and financial risks of Swedish Match.

Business Risk

The business risk is associated with the operations of the business. It includes the reduction in demand, increment in the cost of goods manufactured because of inflation, the increase in number of competitors, health hazard protection law and environmental change. The risk associated with Swedish Match is the risk of the reduction in profitability in the business because of health hazard.

The company is the sole distributor of tobacco products in Swedish, therefore; the company is enjoying the position of the monopolist and does not have the fear of competition. The health and regularity department hasstrict rules and regulation regarding the selling of tobacco products, therefore; it can reduce the supply of tobacco that results in the reduction in profit of the company. The government of Swedish had also implemented high tax and other duty on the tobacco products that resulted in the increase in expenses and reduction in profit. The government of Sweden has banned one of the Tobacco products of the company, if more products are banned by the government then it would increase the business risk of the company.

Financial Risk

The decision of the company to recapitalize the capital structure can also increase the business risk of the company, and if the credit rating of the company becomesworsedue to more debt, then that will result in the default of the company or bankruptcy cost will increase.

The increment in default risk reduces the capability of the company to make the raw material for credit. Hence, it would increase the business risk of the company. The company has to repay the debt in time if it wants to maintain the credit rating,otherwise, it can face the risk of default.

Q2). What are the most relevant costs and benefits of debt for Swedish Match?

In order to raise the debt from the creditors or banks, it is essential to put some collateral against the increasing debt. The bankers are more concerned about the loan security rather than the interest rate. The highly levered companies have a higher risk of default, therefore, the more the company is levered the worse the credit rating. .

The higher credit ratings for instant AAA credit rating have the lower cost of debt as compared to other interest rates. If Swedish Match increases the ratio in its capital structure then it is possible that its cost of debt will increasetherefore, it will also increase the bankruptcy cost of the company, which could result in lowering the share price of the company.

Debt Benefits

There are several benefits of the debt. The core benefit of debt is that it is tax deductible as it saves a high amount of tax, therefore; it is acheap finance source as compared to the equity financing. The debt not only increases the profit of the company, but it also reduces the Weighted Average Cost of Capital (WACC)

 It is the discount rate that is used by companies whenever it wants to make the forecasted cash flow of the business. If WACC rate is lower,thenthe forecasted cash flow net present value will be higher which will ultimately increase the enterprise value.

A New Financial Policy at Swedish Match Case Solution

IfSwedish Match increases the leverage ratio then its cost of debt will increase. On the contrary, it can save ahigher amount of tax. The company should maintain the tradeoff between the cost of debt and benefits from debt in order to save itself from bankruptcy cost.

Q3).

Performa worksheet is formed in the excel spreadsheet with the name Performa worksheet.

Q4).

It is calculated in the Excel spreadsheet with the name of spreadsheet Q4.

Q5).

(A). Right after it announces the leveraged recap?

The market value of the company will increase with respect to the tax shield. The Chief Finance Officer of the company believes that right after the leveraged recapitalization, the credit rating of the company will lie in BBB in which the cost of debt is 4.5%. It is also assumed that the probability of financial distress does not exists which results in no financial distress cost. Moreover, it is also assumed that the transaction cost does not exist. The value of the company will increase the value of tax shield.

In short, the company will save:........................

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