case Bed, Bath & Beyond
Advance Corporate Finance - Bed Bath and Beyond Case
Questions:
You are BBBY’s CEO, Steven Temares. It is April 2004 and you are about to decide what to do with the company’s excess cash:
- Keep it?
- Pay it out and issue debt?
You structure your analysis by answering the following questions:
1. What is wrong with building up cash? Provide (at least two) reasons in favor and against keeping cash in the firm.
Against:
By paying out excess cash and issuing debt, BBBY could improve return to equity holders and raise earnings per share (by a share repurchase).
Leverage can increase a firm’s expected earnings per share. An argument is that by doing so, leverage should also increase the firm’s stock price. Because BBBY has no debt, they pay no interest, and because in perfect capital markets there are no taxes, BBBY’s earnings would equal its EBIT. If BBBY has new debt, they will have interest payments each year, so their earnings will decrease (EBIT – interest). If BBBY uses the debt to repurchase shares, the number of outstanding shares will also fall. Because of this, the earnings per share can increase with leverage. This increase might appear to make shareholders better off and could potentially lead to an increase in the stock price.
Besides this, BBBY faces the risk that the firm is not attracting investors. Investors want to maximize their returns and when the firm has a lot of cash, the investors may not be sure of the ability of BBBY to maximize the shareholder value.
Another positive point about debt is the tax deduction.
In favor:
-Leverage increases the risk of equity even when there’s no risk that the firm will default. Thus, while debt may be cheaper when considered on its own, it raises the cost of capital for equity.
-Cash can be a buffer in tough times.
-When a firm has a lot of cash, there is more money available to invest. As you can read in the case, BBBY invests in a lot of new shops and when they have a lot of
Questions:
You are BBBY’s CEO, Steven Temares. It is April 2004 and you are about to decide what to do with the company’s excess cash:
- Keep it?
- Pay it out and issue debt?
You structure your analysis by answering the following questions:
1. What is wrong with building up cash? Provide (at least two) reasons in favor and against keeping cash in the firm.
Against:
By paying out excess cash and issuing debt, BBBY could improve return to equity holders and raise earnings per share (by a share repurchase).
Leverage can increase a firm’s expected earnings per share. An argument is that by doing so, leverage should also increase the firm’s stock price. Because BBBY has no debt, they pay no interest, and because in perfect capital markets there are no taxes, BBBY’s earnings would equal its EBIT. If BBBY has new debt, they will have interest payments each year, so their earnings will decrease (EBIT – interest). If BBBY uses the debt to repurchase shares, the number of outstanding shares will also fall. Because of this, the earnings per share can increase with leverage. This increase might appear to make shareholders better off and could potentially lead to an increase in the stock price.
Besides this, BBBY faces the risk that the firm is not attracting investors. Investors want to maximize their returns and when the firm has a lot of cash, the investors may not be sure of the ability of BBBY to maximize the shareholder value.
Another positive point about debt is the tax deduction.
In favor:
-Leverage increases the risk of equity even when there’s no risk that the firm will default. Thus, while debt may be cheaper when considered on its own, it raises the cost of capital for equity.
-Cash can be a buffer in tough times.
-When a firm has a lot of cash, there is more money available to invest. As you can read in the case, BBBY invests in a lot of new shops and when they have a lot of