Finance

Case: Debt Policy at UST Inc.

Executive Summary

Over the past years, UST has been a leading producer in tobacco industry, specifically the moist tobacco industry. It is widely known for its conservative debt policy and high dividend payout. Recently, the company has been considering a leveraged recapitalization plan, which is borrowing up to 1 billion debts over five years to accelerate its stock buyback program. Why would UST do that after such a long history of conservative debt policy? It primarily because UST wants to increase the firm value by having the huge tax shield provided by more leverage. But, on the other hand, the 1 billion debts would directly increase its financial distress and weaken UST’s cash flow.

This report is intended to consider whether the company should undertake the 1 billion debt policy or not by using available information provided in the case to evaluate the value of the firm with and without the 1 billion debts, and the Pro forma income statement for next year. After I conduct these methodologies, I would recommend UST to implement the 1 billion debt policy for the next five years.

Overview of UST

UST Inc. has been considered one of the most profitable companies in the U.S. in 1998. By looking at the company’s historical financial performance, UST did an exceptional job. The net sales have been growing at 9% compounded annual growth rate, and cash flows have been growing at 12% compounded annual growth rate for the past 10 years. Moreover, UST has a growing dividend payout ratio, which has increased by 14%, and the case flow is remaining at a very high level meanwhile. Although, UST has been doing very well these years and its market shares still in a comparatively dominant position, it has been actually slowly decreasing over the past 10 years. In addition, UST has faced some business risks and these risks have recently led people doubt the future profitability of UST.

Business risks

When evaluating the...