Case 30: M&M Pizza

Case 30: M&M Pizza

1. What is going on at M&M Pizza? How do the financial statements for M&M Pizza vary with the proposed repurchase plan? Do the alternative policies improve the expected dividends per share?

2. Describe the companies current WACC, and capital structure choices. It seems obvious that debt is the cheaper source of funds. Why is the company willing to pay 8% on equity when it could borrow at 4%?

3. What impact does the repurchase plan have on M&M’s weighted-average cost of capital? Complete the table below (No Corporate Taxes). What are the debt and equity claims worth under the alternative scenarios? You may note that the present value of a perpetual cash flow stream is equal to the expected payment divided by the associated required return. Which proposal is best for investors, discuss your results in your explanation? What do you recommend that Miller do?

Income Statement	Debt = 0	Debt = 500
	Revenue	1500	1500
	Operating expenses	1375	1375
	Operating profit	125	125
	Interest payments	0
	Taxes	0	0
	Net profit	125
	Dividends	125
	Shares outstanding	62.5
	Dividends per share	2.00
Cost of Capital
	Cost of debt	4.00%	4.00%
	Beta	0.800	Levered Beta
	Cost of equity	CAPM
	WACC	= D / V * Kd (1 - t) + (1 - D/V) * Ke
Cash flows
	Debt holders	= Interest payments
	Equity holders	= Dividend payments
	Free cash flow	= Op profit
Value
	Debt	= Int payments / Kd
	Equity	= Div payments / Ke
	Total	= Sum or FCF / WACC
	Share price 1	= Equity / Shares outstanding
	Share price 2	= DPS / Ke
	Value of Firm	= Value of unlevered + Tax shield
	D/E	= D / (V - D)
	D/V	= D / V

4. How would your analysis in questions 2 and 3 and recommendation in question 4 change if the new tax law is implemented? Please note that, with corporate taxes, the expected debt-to-equity ratio under the share repurchase plan is 0.588, and the number of remaining shares outstanding is 39.4 million. Complete the same table as in question 2 with a tax rate of 20%.

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