Bed Bath and beyond BBBY Harvard Case Solution & Analysis

40% debt in capital structure

In the forty percent capital structure criteria, debt is generated around 636 million & the interest coverage time is near to 22% which means it has moderateEBIT to cover the interest expense. This would affect the financial leverage which means that earning per share will increase to $1.41 as compared to actual EPS.  Present value of tax shield indicates the value in thousand which is 16009 that shows the additional benefit for implementing the debt. The return on capital shows 24 percent which is moderate for the company. If the debts will increase it would lower the return on capital but improve the return on equity. The analysis of the 40% debt is mentioned in the excel sheet and also stated in the “Exhibit 2”

bbby case solution

bbby case solution

60% debt in capital structure

Now moving toward the60% structure of the capital. In this criterion the debt createdis near to 954 million & coverage of interest time is getting lower as increase in the debt percentage which is 15.1 times. This means that the EBIT has been weakenedbecause of the interest factors.This would affect the leverage of company with respect to the EPS which is increased to $1.43 as compared to the lower increase of the debt. This shows better income,however it would create lower EBT.  Present Value of Tax shield represents the 24014 rounded off to thousand which could be an extra benefit for opting the more debt percentage in the enterprise. ROC depicts21 percent which shows the declining position of the company. If they increase the debt then it wouldaffect the return on capital but increases the ROE.The credit rating will fall to the B category which is not good sign for the company. The reason is company has been known as debt free company through out its history and now suddenly this new change would affect negatively. The analysis of the 60% debt isstated in the excel sheet and also point out in the “Exhibit 3”

80% debt in capital structure

The last debt criterion is the 80% and through this the debt generated is 1270 million which is already stated in the case material. For this criterion the interest coverage time will be 11.8% which means that EBIT is badly affected by the interest cost. This would affect the leverage of the company with respect to the EPS which would increase up to $1.44 as related to the current year’s earning.The consequence of the earning is good but it adversely affects income before tax. This affects the company to gain the advantage of the tax shield and the present value of tax shield is 31592 in thousands and ROCexpressed as19.5% which would be getting lower as the debt increases but it would be beneficial in terms of the return on equity. The decision for this increase in the debt shows the bad position which affect the gearing of the company and which adversely affect the image of the company. Furthermore, the credit rating would fall to B category. This decision from both ends is supporting the criteria of the business.The analysis of the 80% debt are mentioned in the excel sheet and also mentioned in the “Exhibit 4”

Assumption Criteria

The alternatives are based on the certain assumptions for evaluating the company’s capital structure. The reason for these alternativesis to maintain excess cash with adequately financial leverage ratios. This alternative analysis contains the in depth analysis of the challenges faced by the enterprise. The following assumptions are given below for evaluating the best criteria for the company.

  1. 20% debt is assumed to be½ of the 40% and 60% is assumed as 1.5 of the 40% financial leverage ratio.
  2. Cost of tax shield is assumed to 4.5% which is given in the case material.
  3. Bond rating of the 20%, 40%, 60% and 80% is fall in the AA and B category in which AA is related to 20% and 40%& B category is related to the 60% and 80%.
  4. Tax rate is 30.85%
  5. There is no dividend paid to the shareholders.
  6. The price of the repurchase is assumed to be $37 per shares which is also mentioned in financial of the company.

These are the main assumption points which the company has to follow, to face the challenges of revised capital structure and the financial leverage. The company should alsoemphasize on the qualitative features of the capital structure.

Leases do play an important role in the case, as a (hybrid) debt contract.

Enterprise capital valuation could be affected by the operating leases but it does not affect on interest cost.The accounting difference between the capital and operating lease may look rational but it doesn’t have any reason to look rational from the financial point of view. To maintain the difference it comes to the point of estimating the operating income, capital and profitability...................................

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