Case Study: Debt Policy at UST Inc.
UST Inc. is the leading producer of moist smokeless tobacco products which manage by using the conservative debt policy and high dividend payout. Since the firm has faced the decline of the growth from year 1993, the company decided to make the recapitalization by borrowing $1 billion to repurchase their stock in order to maximize the company’s value.
By borrowing, interest charged on loan is tax-deductible which the firm can benefit from tax shield and can also reduce the cost of capital. With the combination of debt and equity financing, the company can find the optimal point that reflect the lowest cost of capital which would provide the maximum valuation. Moreover, additional debt
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In the future, the government tends to issue more new law to control over smokeless tobacco product. Now, the company is restricted for advertisement for youth and sued by their competitor. Another risk is from the competitor, since the company introduces their product as the premium and set the high price, there are small competitors to compete by setting the lower price. Moreover, the innovation for the new product and flavor of the company decreases over time. This is one of factor that affects the market share of the company to reduce continuously. Another thing that is about product diversification. The major source of UST’s income is smokeless tobacco which is more than 90% of the overall that is the company only depends on this kind of product. Since the trend of health concern increase, most of people ban the tobacco product and the smoker begin to stop smoking. This affects the demand of the tobacco to decline. Therefore, this tends to be high risk for the company in the near future and there will be the large effect to the UST as a whole. However, the company already realized this problem and reduced the risk by extend to other business such as wine, cigarette and telecommunication business but it is not seemed to generate the good result. The income and profit of these non-core operations is very small compare to the overall operation while the large capital expenditure is required to invest in each year.