Bed Bath and Beyond: Capital Structure Decision (HBR Case Study)

1602 Words Apr 11th, 2014 7 Pages
Introduction
Bed Bath & Beyond (BBBY) was founded in 1971 by Warren Eisenberg and Leonard
Feinstein. BBBY held its initial public offering in June 1992, on the NASDAQ exchange. The company utilizes the “big box” retail concept and focuses its product offerings around domestics merchandise and home furnishings. Since its IPO BBBY has been favored by equity investors and long considered one of the best performing retail companies. They have never missed an earnings estimate and have experienced a fortyfold increase in stock price from the original $17 per share IPO.
The company introduced its first superstore in 1985 and have since underwent large scale expansion operating 575 stores by the end of the fiscal year 2003. BBBY also
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The most problematic key ratio on the list is BBBYʼs “operating income to sales” at roughly 14%, which is low for the industry (see Appendix one for more details), and the highest and most consistent ratio was their EBIT and EBITDA interest coverage ratios, which are considered to be the two most important ratios.
With this in mind, the default rates outlined (see Appendix one) should be a close estimate of what BBBY would face when they take on debt. Direct costs associated with financial distress are historically small. The indirect costs, such as loss of suppliers, customer, and leases can be quite substantial. Using the high side of an industry estimate, 20% of total assets, to reasonably account for what BBBY could lose due to financial distress. For the optimal D/E ratio of 0.60 we have a present value of financial distress equal to $127,432,000 and a present value of tax shield of
$400,362,000. As we move to a higher D/E ratio we see the marginal cost of financial distress and marginal benefit of the tax shield converge.

Case 2: Bed Bath & Beyond

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Repurchasing Shares
The decision to repurchase shares and take on debt is overall positive news to the shareholderʼs. They will receive a special repurchase capital gain and enjoy an increased upside on returns due to the increased beta of the company. The total capital structure of the company shifts from being totally equity funded to

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