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Dunkin’ Donuts will use $43.12 million (20%) in cash towards the purchase of Krispy Kreme. Once this is completed a mixture of methods will be used to add more cash on hand for the company. The liquidity ratios (see exhibit 1) for Dunkin’ Donuts show they are currently able to meet their cash needs. Dunkin’ Donuts current and quick ratios are over 1, which indicates that the company has a greater chance of fulfilling their obligation as they become due. If a company is over 1, but not over 3, they are in good standing financially. A ratio over 3 can indicate the company is not using their assets efficiently. Dunkin’ generally collects their payables in a little over a month in 2015 and almost 2 months in 2014. They have improved their collections process.

There are a number of ways to free up cash and Dunkin’ Donuts has already done so in the past 2 years. The company has improved their activity ratios (see Exhibit 2) from 2014 to 2015. Dunkin’s accounts receivable collections have slightly increased from 2014 to 2015. This shows an improvement in collections. The company’s accounts payable payout has decreased from 2014 to 2015 showing the company has more cash on hand longer. This gives the company a bit more leverage on daily operations. Dunkin’ generally pays their payables in a little over a month in 2015, and almost by 2 months in 2014. In order to free up some cash Dunkin’ Donuts will temporarily increase the payment terms for their vendors. Increasing the payment terms allows for longer access to cash, and this will ensure the company will meet their standards.

Timely collections of monies owed, as well as increasing the monitoring of accounts will be great for the company. Dunkin’ Donuts will shorten the credit terms with customers. Although this could possibly have a negative affect for the company, it gives greater access to cash. In addition to increasing payment terms in the payables and decreasing credit terms in the receivables; Dunkin’ Donuts will look into the companies staffing technology in the event more access to cash is needed, as well as review the inefficiencies in how products are made and eliminate them.

Dunkin’ Donuts will use $43.12 (20%) million in equity towards the purchase of the acquisition. This will be in the form on stock swaps and any not swapped will be new issue stock. The stock swaps will allow for the acquisition to be settled by exercising the option of allowing Krispy Kreme’s shareholders to acquire some stakes in Dunkin’ Donuts after the takeover occurs; which allows shareholders to still be a part of the acquiring company. The shares would, thus, be valuated at agreeable figures to both parties and accurate. The accuracy allows for the determination of a fair swap ratio.

Dunkin’ Donut’s currently has shares authorized but not issued, which leaves an ideal opportunity to utilize some of those shares in acquiring Krispy Kreme. Based on the current market price of Krispy Kreme and Dunkin’ Donut’s, the swap ratio would be 2.8: 1. This indicates that shareholders of Krispy Kreme would be offered 1 share of Dunkin’ Donut’s for every 2.8 shares of Krispy Kreme they currently own. (See exhibit 3)

Dunkin’ Donut’s Share price: $51.37

Krispy Kreme Share price: $18.35

Swap ratio: 51.37 / 18.35 = 2.7995 or 2.8

Dunkin’ Donuts will issue a $129.36 (60%) million bond for the remainder of the purchase of the acquisition. According to Yahoo Finance, the current yield rate for a 2 year corporate bond is 1.36%, and the yield for a 5 year corporate bond is 2.18. The following table shows the total semi-annual interest payments due for 100,000 2 year bonds issued with a face value of $1000; and total semi-annual interest payments due for 29,360 5 year bonds issued with a face value of $1000.

The liquidity ratios, shown in Table 1, for Dunkin’ Donuts show they are currently able to meet their cash needs. Dunkin’ Donut’s current and quick ratios are over 1, which indicates that the company has a greater chance of fulfilling their obligation as they become due. If a company is over 1, but not over 3, they are in good standing financially. A ratio over 3 can indicate the company is not using their assets efficiently. Dunkin’ generally collects their payables in a little over a month in 2015 and almost 2 months in 2014. They have improved their collections process.

There are a number of ways to free up cash and Dunkin’ Donuts has already improved their activity ratios from 2014 to 2015. Dunkin’s accounts receivable collections have slightly increased from 2014 to 2015. This shows an improvement in collections. The company’s accounts payable payout has decreased from 2014 to 2015 showing the company has more cash on hand longer. This gives the company a bit more leverage on the daily operations.

Dunkin’ generally pays their payables in a little over a month in 2015 and almost 2 months in 2014. They have improved their payment process. In order to free ups some cash Dunkin’ Donuts will look into temporarily increasing the payment terms for their vendors. Increasing the payment terms allows the company to have access to cash longer. This will assist in ensuring the company will meet their standards.

Increasing the monitor of the accounts receivable can improve the amount of cash on hand also. Timely collections of monies owed will be great for the company. Dunkin’ Donuts could also look into shortening their credit terms with customers. This could possibly have a negative affect for the company. Especially for loyal long term customers, because this may affect their budget.

In addition to increasing payment terms and decreasing credit terms Dunkin’ Donuts can look into the companies staffing and technology and see if any adjustments can be made there. Reviewing the inefficiencies in how products are made and eliminating them could also free up cash.

The initial acquisition price Dunkin’ is preparing to offer Krispy Kreme is $215.6 million. Dunkin Donuts plan to use a combination of debt and equity financing to pay for this investment. 60% of this acquisition will be paid for by issuing corporate bonds; 20% of this acquisition will be paid for by engaging in a stock swap; and the other 20% of this acquisition will be paid for by bank loans. Dunkin’ will need a total of $129.36 million to cover the 60% of the price offered.

A corporate bond is a promise to pay a predetermined annual or semiannual interest payment and to pay back the principal when the bond matures. Dunkin’ has three options: they can issue the bond at par, at a discount, or at a premium.

A bond issued with coupon payments that are equal to the current market rate is considered to be issued at par. Essentially, the amount of corporate bonds issued at par, the company will in return have raised the same amount in capital.

A bond issued with coupon payments that are lower than the current market rate is considered to be issued at a discount. The bonds would most likely be issued at a discount to its par value to compensate for the lower coupon payment. Dunkin’ will get less money at initiation than it will pay to investors at maturity. In exchange it will pay a lower coupon than it would have to if the bond was issued at par. 

A bond issued with coupon payments that are higher than the current market rate is considered to be issued at a premium. The bonds would most likely be issued at a premium to its par value to compensate for the higher coupon payment. Dunkin’ will get more money at initiation than it will pay to investors at maturity. In exchange it will pay a higher coupon than it would have to if the bond was issued at par.

Dunkin’ must pay the bondholders interest every six months based on the bond’s stated interest rate and the principal amount on the bond’s maturity date. Dunkin’ best option is to issue bonds at par value if possible.

According to Yahoo Finance, the current yield rate for a 2 year corporate bond is 1.36%, and the yield for a 5 year corporate bond is 2.18. The following table shows the total semi-annual interest payments due for 100,000 2 year bonds issued with a face value of $1000; and total semi-annual interest payments due for 29,360 5 year bonds issued with a face value of $1000.

Financing the Acquisition

The purchase price for Dunkin’ Donut’s to acquire Krispy Kreme is within the range between the maximum of $1,275 million and $322 million for the absolute bare minimum (See Exhibit 6 for calculation). The difference between the two is $952 million. The initial acquisition price Dunkin’ is preparing to offer is $215.6 million. The offer was determined by taking the true value of Krispy Kreme (intrinsic value) and increasing it by the calculated rate of return of 16.5% (See Exhibit 7 for calculation). If this initial offer price is undesirable to Krispy Kreme, Dunkin’ will prepare counter offers.

Another option that is available to the board of Dunkin Donut to fund the merger would be the utilization of share (stock) swaps. The stock swaps would allow for the acquisition to be settled by exercising the option of allowing Krispy Kreme’s shareholders to acquire some stakes in Dunkin Donuts after the takeover occurs. This would allow these shareholders to still be part of the acquiring company and this could be a good mechanism for ensuring that the shareholders of Krispy Kreme agree to the deal to sell their shares to Dunkin. The shares would, thus, be valuated at agreeable figures to both parties and accurate. The accuracy allows for the determination of a fair swap ratio.

*Numbers taken from SEC.gov directly from the 10K of Krispy Kreme.

Outstanding Liabilities Assumed $85 million

Total Bare Minimum Purchase Price $323 million

Krispy Kreme’s Market Value ($1,275 million)

Max Purchase Price $1,275 million

Difference between Max & Min Price $952 million

Intrinsic Value = $185.1 million

Rate of Return = rf + b(fm - rf)

Risk free rate (rf) (10 year treasury constant maturity rate) = 2.20%

Beta (b) = 2.69

Market return (fm) = 7.5%

Required rate of return = (2.20% + 2.69(7.5% - 2.20%) = 16.5%

Offer Price Intrinsic Value * (1 + Rate of Return) $185.1 million * (1.165) = $215.64 million

Stock Swaps

A stock swap occurs when shareholders' ownership of the target company's shares are exchanged for shares of the acquiring company as part of a merger or acquisition. Stock swaps allow one company to take over another without having to pay cash for the whole operation. This is exactly with Dunkin’ is looking to do in the acquisition of Krispy Kreme. Instead, it uses its own stock as currency. During a stock swap, each company's shares must be accurately valued in order to determine a fair swap ratio.

Swap ratio is an exchange ratio used in case of mergers and acquisitions. It is the ratio in which the acquiring company offers its own shares in exchange for the target company's shares. The difference in their share prices and the number of shares outstanding then have to be factored in, and the acquiring company may need to throw in a little extra to get the target company's board of directors and shareholders to play ball. The result might be a nice clean ratio, such as 2-for-1 or 1-for-3, or it can be a lot more finessed.

Dunkin’ Donut’s currently has shares authorized but now issued and this would be an ideal opportunity to utilize some of those shares in acquiring Krispy Kreme. Since a majority of the financing will come from a bond issuance the options for Dunkin’ will be to offer a stock swap with current shareholders of Krispy Kreme stock. This makes the most sense to provide shareholders with the opportunity to acquire shares in Dunkin’ Donut’s and based on the current market price of Krispy Kreme and Dunkin’ Donut’s the swap ratio would be 2.8 : 1. This indicates that shareholders of Krispy Kreme would be offered 1 share of Dunkin’ Donut’s for every 2.8 shares of Krispy Kreme they currently own (See Exhibit 1 for Calculation).

Exhibit 1

*Share price pulled from googlefinance.com

Dunkin’ Donut’s Share price: $51.37

Krispy Kreme Share price: $18.35

Swap ratio: 51.37 / 18.35 = 2.7995 or 2.8

Synergies and opportunities will be created when Dunkin’ Donut’s acquires Krispy Kreme. The potential financial benefits that can be achieved through the combination between these two companies are extraordinary. Revenues and share prices will increase, which will make shareholders’ happy. Depreciation expense will increase due to a large increase in assets. The acquisition will create a chain reaction that will drive up the firms’ market and book value. Other benefits directly related to the acquisition of Krispy Kreme by Dunkin’ Donut’s are the cost of reduction of weeding out competitors in the market. Costs will also be reduced because Dunkin’ Donut’s will be able to gain better suppliers and raw materials, as well as better production techniques. The company will also benefit largely from the combined talent of employees and technology.

Dunkin Donuts is able meet the asking price that Krispy Kreme shareholders will approve. The company has weathered some difficult business conditions coupled with among other factors increased competition and bad weather. However, the decline is sales has not stopped the revenue growths that the company has experienced. In addition, the increase in profits and per share translates to the company’s ability to match the asking price of Krispy Kreme. Dunkin Donuts is definitely bound get value for its premium as Krispy Kreme has lately been very profitable and the acquisition would ensure that the Dunkin Donut has a larger network of stores to work. Dunkin Donuts expects to get a large increase in sales volume and revenue too. The company will be able to break-even after the acquisition and make some accounting profits.

References

Yahoo Finance. (2015). Krispy Kreme Doughnuts, Inc. Profile. Retrieved July 20, 2015, from http://finance.yahoo.com/q/pr?s=KKD+Profile

Yahoo Finance. Composite Bond Rates. Retrieved August 18, 2015 from: