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

Introduction

Swedish Match has a long historywith number of failures and success. By 2005, Swedish Match became theworldwide leader in the smokeless tobacco products. Swedish Match gained this position by becoming the monopoly in the business. The statusof monopoly is acquired by merger and acquisition of the local companies.

Swedish Match was able to capture Sweden, Norway and the US market. In EU, Swedish Match Suns was banned and was not allowed therefore,it was unable to gain access in theEU market. Swedish Match was a growing and the most profitable company.

Analysis

Merger and accusation require huge amount of money. Swedish Match also requires a lotof money which will finance the accusations and mergers. Swedish Match is considering raising finance from the European market of approx. 300 million Euros or equivalent of 3 Billion Swedish krone through bond issue. Such an issue would be knownEuro Bonds because Swedish Match is issuing in another currency.Coupon rate on bond will depend on the credit ratings of the company which it is expected that it will be stable at BBB+. The proceeds raised from the bond will be used to finance growth of the company and buy back of the equity.

Amount of debt is always considered good as it is a cheap source of finance due to thefact interest is tax deductible and there is reduction ofcost of capital which increases the value of the company.

Business Risk

Business risk includes the possibility that Swedish Match will perform worse and will show less profit or loss. Business risk includes several factors such as increased regulatory environment, input cost, overall climate change and competition.

As Swedish Match has gained monopoly status therefore,competition will play no role in the risk. Increased regulatory environment will have moreimpact on Swedish Match because tobacco related products are always considered as risk to health and Government often.Inorder to discourage the use of tobacco, taxes and other duties should be implemented.

EU hasalready ban one product of Swedish Match, if other countries also take such steps thenthere will be increased business risk for the Swedish Match. In most of developed countries there isanti-monopoly regulation which preventscompanies to hold majority of market share. As Swedish Match market is based on monopolies therefore,there could be a market risk.

Swedish Match can also face market risk by recapitalization. If Swedish Match incorporates heavy debt in its financials, then credit rating of the Swedish Match can be deteriorated over time and creditors will demand more interest rates to offset their risk.

Financial Risk

Financial risk includes many risks related to the finance of the company such as risk of default. Risk of default can occur when the company is making continuous losses and its cash flow from operating activities is also negative. In the case of Swedish Match, it is borrowing loan through Euro bonds therefore,financial risk will increase. Swedish Match’s gearing will increase as its interest payments will increase. There is also an increase of credit ratings if Swedish Match was not able to service its debt on time.

Cost of Debt

Cost of debt will include many consequences. Before taking out loan, creditors might ask for the security. Swedish Match might offer mortgage of its asset that is necessary in case of default creditors will have claim on the assets.

Interest rates will also depend upon the credit rating of the company. Higher credit ratings means there will be lowers cost of debt, lower credit rationing of the company will have higher interest rate.

A New Financial Policy at Swedish Match Case Solution

In case if Swedish Match isunable to service its debt for any reason then there will be financial distress,ascreditors will for full amount to be repaid while interest rates will also be increased. In case of Default, thecompany’sshare price will decline significantly and the ones who will be more affected will be Swedish Match’sshareholders as they will get nothing. Creditors will have their claims on the asset of the company which was mortgaged before the loans.

Benefit of Debt

There are multiple benefits of debt such as reduced cost of capital and tax savings. Debt is always considered as a cheap source of finance and its interest is tax deductible. Equity is always expensive as required rate of return is high and divided is not tax deductible.

Debt finance also reduces the weighted average cost of capital of the company. WACC is used to evaluate the project andit is used in discounting in order to thelower cost of capital, which would lead tohighest value of the projects.Thus, firm’s value will also be increased by lower WACC...........................

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