Q1.

Assuming Swedish Match faces a 28% tax rate on income and can issue bonds at a fixed krona
yield of 4.5%, how much will the company save in taxes for a SEK4 billion recapitalization? What is
the value of this interest tax shield?

A1. The company will save 28% of the interest paid i.e. 4.5% of 4 Billion SEK. The tax
shield would be the total present value of savings each year discounted at 4.5%

Q2. What will SMs book value balance sheet look like after it completes the debt issuance
and share repurchase?

A2.

Swedish Matchs book value balance sheet for the year 2004 post the recapitalisation:
Assuming that the debt issuance of SEK 4 billion was completely for the share
repurchase, the long term debt and hence the total interest bearing debt would
increase by SEK 4000 million. Also, the book value of equity after the share
repurchase would decrease by SEK 4000 million.

Q3. What will Swedish Matchs market value balance sheet look like:
a. Right after it announces the leveraged recap?
b. When it completes the issuance of SEK 4 billion in debt?
c. When it completes the share repurchase?

A3(a).
Swedish Matchs market value balance sheet for the year 2004 post the
announcement:
Assuming market value of equity as on year end 2004 @88.34 per share = SEK 28454
million.
The book value of equity = 5060
The company has to pay a premium when it buys back the equity. This premium i.e.
the difference between the market value and book value of equity will be accounted in
the asset side of the balance sheet as intangible assets.

Also post the announcement, the debt tax savings will be added to the market value of
equity and hence will be reflected in the intangible assets in the assets side.

A3(b). Swedish Matchs market value balance sheet for the year 2004 post the issuance of
debt:
Post the debt issuance of SEK 4 billion, the cash and short-term investments would
increase by SEK 4000 million. And the corresponding entry in the entry would be
increase in the total interest bearing debt by SEK 4000 million.

A3 (c). Swedish Matchs market value balance sheet for the year 2004 post the repurchase
of shares:
The cash and short-term investments will decrease by SEK 4000 million and
correspondingly the market value of equity will be reduced by the same amount.

Q4. Can Swedish Match afford to borrow this much money? What are the risks? Is it realistic
to expect a BBB+ rating? Should the company go ahead with a leveraged recap? If so, would
you approve a larger recapitalization?

A4.
a) Yes, the company Swedish Match can afford to borrow SEK 4 billion.
Worst case scenario:
EBITDA = SEK 1.5 billion.
Interest = SEK 266 million + 4.5% of SEK 4000 million = SEK 446 million
EBIDTA Interest = SEK 1.04 billion
So, Swedish match has sufficient cash flow to cater to the current capital expenditure and
working capital requirements.

b) Risks involved

The increased debt will lead to large part of Cash flows to be used for interest
payments will inhibit future expansion and acquisitions.
Swedish Match will be exposed to fluctuations of Bond market
Bankruptcy possibility and forced sale of assets, in case of default

c) Swedish Match would be able to maintain BBB+ rating after recapitalization.

EBITDA would be around 3 billion as expected by analysts and the interest on its pre
existing debt in 2005 would be lower than in 2004 ( pre existing debt is being rapidly
paid off)
Swedish Match has a lower interest coverage ratio and higher Total Debt/EBITDA
ratio than the average US industrial firm having a BBB +rating, (interest coverage
ratio will be higher once debt is paid off)

d) Yes, it should go forward with the recapitalization.

Swedish Match will be able to produce large and stable cash flows to add value
through tax saving returns capital to shareholders
In line with expectations of institutional investors

e) We would not recommend larger recapitalization

It would lead to lower credit rating as its cash flows are barely able to maintain BBB+
rating, a further increase of debt will increase its borrowing cost.
The additional debt would also pose a risk of default