Bed Bath & Beyond - the Capital Structure Decision

Advanced Corporate Finance  

Case: ‘Bed Bath & Beyond: The Capital Structure Decision’.

1)  Scenario 1: debt to capital ratio = D/(D+E) = 35%

Assumption: the company uses a perpetual debt policy then we can use the

following equation: Pv(interest tax shield) = τ

c

x Debt.  

To calculate the debt, we use the formula debt to capital ratio = D/(D+E) =

35%. Debt + Equity – excess cash= 2,865,023,000-400,000,000=

2,465,023,000.  

D = 0.35 x 2,465,023,000 = 862,758,000

Pv tax shield= 0,385 x 862,758,000 = 332,162,000

Scenario 2: debt to capital ratio = D/(D+E) = 85%

Assumption: the company uses a perpetual debt policy then we can use the

following equation: Pv(interest tax shield) = τ

c

x Debt.  

To calculate the debt, we use the formula debt to capital ratio = D/(D+E) =

85%. Debt + Equity – excess cash= 2,865,023,000-400,000,000=

2,465,023,000.  

D = 0.85 x 2,465,023,000 = 2,095,270,000

Pv tax shield= 0,385 x 2,095,270,000 = 806,679,000

2)  Scenario 1: to calculate the amount of shares that BBBY is going to

repurchase we first determine how many shares we can buy back with the

excess cash and debt with the old shareprice of Pold= 37.00$  

Number of shares repurchased= (excess cash + Debt)/ share price =

(400,000,000 + 862, 758, 000) / 37.00 = 34. 13 million shares

 296, 854, 000 – 34,130,000 = 262,724,000 shares outstanding after

repurchase.  

Divide the tax shield by number of shares outstanding gives : 332,162,000/

262,724,000 = 1.26 $ ΔP

So the new share price = 37 + 1.26 = 38,26$

Scenario 2: to calculate the amount of shares that BBBY is going to

repurchase we first determine how many shares we can buy back with the

excess cash and debt with the old shareprice of Pold= 37.00$  

Number of shares repurchased= (excess cash + Debt)/ share price =

(400,000,000 + 2,095,270, 000) / 37.00 = 67.440 million shares

 296, 854, 000 – 67,440,000 = 229,414,000 shares outstanding after

repurchase.  

Divide the tax shield by number of shares outstanding gives : 806,679,000/

229,414,000 = 3.52$ ΔP

So the new share price = 37 + 3.52 = 40.52 $

3)  Yes, the shareholders’ value increases with the same amount of the increase

in the share price. So for the first scenario that is 1.26$ ( 1.26/37x 100% =

3.4% increase) per share and for the second scenario that is 3.52 per share (

3.52/ 37 x 100% = 9.51%).  

The current creditworthiness of BBBY = total liabilities / capital = 874,203,000/

2,865, 023,000= 0.305 = 30.5%. with this total debt- to- equity ratio they fall in

the AA rating of Standard and Poor’s without losing any creditworthiness.

Their optimal capital structure is the upperbound of the AA scale, which is

35.9%. Because the higher the debt-to-capital ratio the more benefits of the