Essay About Stock Price And Tax Shield Effect Of More Debt

Goodyear
GoodyearGoodyear largest tire producer in worldGoodyear known as a fierce competitor- The Gorilla Spent $1.5 billion modernizing over 1975-1986.Before 1983 about 10% of sales from Aerospace divisionBasic Industry Conditions 1980-1988Mature or declining industryOvercapacityPrice warsShrinking marginsRobert Mercer new CEO in December 1982Acquired Celeron (natural gas transmission) for $825 million in stock in February 1983Start $1.5 billion pipeline in November 1983Failed bids for helicopter firms in 12/83 and 7/85Results of diversification programStock market did not like diversification movesSold gas transmission part of Celeron in 8/85. Spent proceeds on oil and gas properties!Stock price from $32.75 in 10/86 to $48.25 by late 11/8610/28/86-James Goldsmith announces holds 11.5%Goldsmith offers to buy all shares at $49 per shareGoodyear’s ReactionRepurchases Goldsmith’s shares @ $49.50 ($621 million total)        Repurchases 40 million shares from public @ $50Everything but tire assets and $1.4 billion dollar pipeline sold by August 1987$4 billion credit facility/term loan arrangedDebt from $1.1 billion 1985 to $2.8 billion 1986 to $3.6 billion by end of 1987Management and organization consolidatedSmaller board and staggered electionsCapital expenditures cutTotal 1985-$1623m, 1986-$1131m, 1987-$666m Tires 1985-$438m, 1986- 532m, 1987-406m,1988-500 mil∙ EPS up from $1.16 in 1986 to $12.73 in 1987Stock price up to $76 in October of 87 What is the source of this value gain?-Tax shield effect of more debt (positive NPV project)?-Transfer of wealth from debt to equity (existing debt becomes riskier)?-Signal effect of stock repurchase (managers think stock is undervalued)?-Management incentives to work hard (agency costs of equity financing)?Highlights of income statements198519861987Sales8,3419,1039,905Costs of goods sold        -6,550 Selling, gen. & admin. Expenses        -1,380-6,993-1,601-7,374-1,634Unusual items Discontinued operations-21185-22823+135257Taxes-133-137-266Interest-101-134-282Shares outstanding10710760.6