Prof. Ian Giddy, New York University
The Monster Garage Proposed Restructuring
Monster Garage, Inc., is the largest independent retailer of truck transformation products in the South. The company opened its first store in Baton Rouge in 1987 and now has stores in Mississippi, Louisiana, Arkansas and Tennessee.
Jesse James, the CEO of Monster Garage, is considering options for a change in the company's financial structure. Banks are willing to lend him additional money, but only if they are protected by an "EBIT interest coverage" ratio of at least 2.6. Since the company now has good stable prospects, Jesse is considering paying a substantial one-shot dividend to himself and fellow shareholders. Another alternative is to expand through acquisitions, but as there are no immediate prospects the money would be held as cash until an opportunity arose. He has asked your advice, and provided the following information:
A consultant has estimated the value of the firm at $30 million.
Long-term US Treasury bonds currently yield 4.5%, and the long-run "market
equity premium" is estimated at 5.5%. The consultant figured the company's
"beta" was about 1.7, and the spread over Treasuries for its borrowing was
about 2%, based on an estimated ratings
1. What is Monster Garage's weighted-average cost of capital?
2. What is the company's borrowing capacity?
3. What should they do? Raise more debt? Pay a special dividend? Expand through acquisitions? What effect would these have on shareholder value?