Hill Country Snack Foods is a successful and well-managed company where all decisions focus on building shareholder value. All, that is, except one: the company’s all-equity capital structure, which does not appear to be optimal form a shareholder value perspective. Owner’s equity is larger than necessary and valuable debt tax shields are being wasted. Using cash and newly-issued debt to repurchase share would create immediate financial benefits for the company and its shareholders, but the idea of levering up the firm contradicts companies culture. It will be a challenge for external parties to convince the existing management team that adding debt and reducing equity is better for the company and better for its shareholders.
Answer the following regarding the case: Hill Country Snack and Food Co.
1. How much business risk does Hill Country face?
2. How much financial risk would the company face at each of the three alternative debt-to-capital ratios present in case Exhibit 4?
3. How much value could Hill Country create for its shareholders at each of the three alternative debt levels?