M&M Pizza Harvard Case Solution & Analysis

ANALYSIS

In this analysis, the detailed analysis and evaluation has been performed on the M&M Pizza. The detailed discussion has been made on the company and the county’s issue. Finally, the detailed discussion has been made regarding the weighted average cost of capital of M&M before the debt issue and after the debt.

M&M Pizza is based in Fran cost an and is a premium pizza producer in the market of pizza over there. Fran cost an is a politically and economically stable country; there is still the benevolent rule of a single family. The people over there are ethical and well educated with a stable population of approximately 12 million. However, the relationship of Fran cost an is not so good with the neighboring countries, which is a big drawback for this country as there is very less trade between these county. The import and export has a very big impact on the economy of the country as a general. Fran cost an can take the advantage of its IT, as the county is known for its IT infrastructures and experts, to grow its economy.

M&M Pizza is operating in a full penetration where price is a war between suppliers of pizza. Any company can maximize its profits and ultimately the wealth of its shareholder through two ways. One is that the company can increase its revenue to increase the business and profits. Other one is that the company can maintain a cost structure in a way that lowers the cost. Over herein the case of M&M, they are trying to cut down their cost to maintain strong profits and beat the rivals.

Moe Miller recently appointed managing director at M&M Pizza. He is considering the reduction in cost through the reduction in the weighted average cost of capital. Currently, the company is fully equity funded and the cost of equity is always higher than the cost of debt. Therefore,Miller is looking to exploit this opportunity through raising the funds of $ 500 million in the debt market and repurchasing the shares from the market of the same amount. M&M is currently a low risk company and therefore, it will enjoy a lower cost of debt. The debt can also give the tax benefits to the company, whereas the equity does not give any tax benefits. Although currently Fran cost an has no tax for the companies but is considering imposing a 20% tax on companies,there forein this analysis the tax impact has been taken.

The cost of debt of Fran cost an is 4%, which is the risk free rate on government risk free securities. Currently there is no tax for corporations; however, the individual tax is much higher and M&M currently paying the full earnings as a dividend. With this approach, there are two disadvantages. One is that the company does not retain any of the reserves so that if a profitable project emerges, then M&M can take that project without resistance of funds. The other disadvantage is for the investors, as they have to pay the individual tax on dividends. The dividends reduce the share price;therefore M&M can increase the share price by decreasing the payout ratio from 100% to for example 60%.

M&M Pizza Case Solution

The WACC of M&M has been calculated in the EXHIBIT and a detailed discussion has been performed over here. The current WACC of the M&M is 8%, although this is the cost of equity but because there is no debt therefore,this cost of equity is equal to WACC. To calculate the WACC, the risk free rate of 4% and the market premium of 5% have been taken. The beta of the company is 0.8, note that this is un levered beta; un levered beta means that it does not contain any debt impact (Tirole, 2010).

After raising the funds of $ 500 million in the debt market, the WACC of the M&M would be 7.5% as this is the reduction in the WACC by 0.5%. In order to calculate the WACC after debt, first of all, the levered beta has been calculated by Miller & Modigliani formula, which is beta = un levered beta * [1 + (1 - t) * D/E], where itis the corporate tax, D is the debt value and the E is the equity value.In addition,the remaining calculation for WACC is the ordinary (Luigi, n.d).

M&M Pizza is an aggressive company to source its quality materials and labor at the lowest available cost. Considering this policy, the company must have a look to incorporate the debt in its capital structure to take the advantage of the lowest cost of capital..................

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