The Addition of Debt Increases the Value of UST

Debt as Percent of Pre-

1998 Restructuring Firm Value
0% 10% 20% 30%
Operating Income $ 753 $ 753 $ 753 $ 753 Tax rate is 38%
Interest Expense $ - $ 47 $ 101 $ 165
Pretax Earnings $ 753 $ 706 $ 652 $ 588
Debt is used to buy
Taxes $ 286 $ 268 $ 248 $ 224
shares back at $30
Net Earnings $ 467 $ 438 $ 404 $ 365 each

Total Dividends $ 202 $ 189 $ 175 $ 157

Shares Outstanding 210 188.433 166.867 145.3 Dividends remain a
fixed percentage of EPS
Earnings / share $ 2.22 $ 2.32 $ 2.42 $ 2.51
Dividends as % of E $ 0.43 $ 0.43 $ 0.43 $ 0.43
Dividends / share 0.96 $ 1.00 $ 1.05 $ 1.08 Market Equity =
Total Value - Debt
Market Equity $6,470 $6,069 $5,668 $5,267
Stock Price =
Stock Price $30.81 $32.21 $33.97 $36.25 Market Equity /
# Shares Outstanding
Debt $ - $ 647 $1,294 $1,941
Bond Rating AA A BBB Debt is assumed to be
kept for perpetuity, so:
Interest Rate 0 7.30% 7.80% 8.50% PV(Tax Shield) =
Interest Coverage NA 15.95 7.46 4.57 (Tax Rate * Debt * Rd) /
Rd
 Debt is assumed to be
kept for perpetuity, so:
The Addition of Debt Increases the Value of UST
PV(Tax Shield) =
(Tax Rate * Debt * Rd) /
Rd

Value of Firm Unleve $6,470 $6,470 $6,470 $6,470

PV(Tax Shield) $ - $ 246 $ 492 $ 738 Value Levered =
Value Unlevered +
Value of Levered Fir $6,470 $6,716 $6,962 $7,208 PV(Tax Shield)
 UST Optimal Capital Structure
Costs of
$8,000 Financial Distress
( bankruptcy cost,
monitoring benefits
$7,500 of debt, issuance
cost)
Value of Firm

$7,000

$6,500

$6,000 Row 38
Value Levered

$5,500
Optimal Capital Structure
(This optimal point is for
$5,000 illustrative purposes only.
The actual optimal point for
UST may be different.)
$4,500

$4,000
0% 10% 20% 30% 40% 50% 60% 70% 80%
Debt / Value
 The Addition of Debt Increases the Value of UST

Debt as Percent of Pre-Restructuring Firm

1998 Value (mls)
0% 10% 20% 30% 40%
Operating Income (EBIT) $ 753 $ 753 $ 753 $ 753 $ 753
Interest Expense $ - $ 47 $ 101 $ 165 $ 220
Pretax Earnings $ 753 $ 706 $ 652 $ 588 $ 533
Taxes $ 286 $ 268 $ 248 $ 224 $ 203
Net Earnings $ 467 $ 438 $ 404 $ 365 $ 331

Total Dividends $ 301 $ 282 $ 260 $ 235 $ 213

Shares Outstanding 185.5 163.9333 142.367 120.8 $ 99

Earnings / share $ 2.52 $ 2.67 $ 2.84 $ 3.02 $ 3.33

Dividends as % of EPS $ 0.64 $ 0.64 $ 0.64 $ 0.64 $ 0.64
Dividends / share 1.62 $ 1.72 $ 1.83 $ 1.94 $ 2.14

Equity $ 6,470 $ 5,964 $ 5,457 $ 4,951 $ 4,445

Stock Price for Tax Shield Case $ 34.88 $ 36.38 $ 38.33 $ 40.98 $ 44.79

Debt $ - $ 647 $ 1,294 $ 1,941 $ 2,588

Bond Rating AA A BBB BBB
 The Addition of Debt Increases the Value of UST

Interest Rate 0 7.30% 7.80% 8.50% 8.50%

Interest Coverage NA
Bond Rating NA

Value of Firm (no TC) $ 6,470 $ 6,365 $ 6,260 $ 6,154 $ 6,049

PV(Tax Shield) $ - $245.86 ### ### ###

Value of Levered Firm (with Tc $ 6,470 $ 6,611 $ 6,751 $ 6,892 $ 7,033

Tax Rate 0.38

$ 6,470 $ 6,611 $ 6,751 $ 6,892 $ 7,033

0% 10% 20% 30% 40%
$ 6,470 $ 6,470 $ 6,470 $ 6,470 $ 6,470

D/E 0.00 0.11 0.24 0.39 $ 0.58

Return on Assets (rA no Tc)) 12% 12% 12% 12% 12%
Return on Equity (rE) 11.64% 12.33% 13.04% 13.71% 14.75%
 The Addition of Debt Increases the Value of UST

Return on Assets (rA with Tc) 11.64% 11.40% 11.16% 10.93% 10.71%

Return on Equity (rE with Tc) 11.64% 11.84% 11.95% 11.88% 12.00%
 The Addition of Debt Increases the Value of UST

50% 60% 70%

Value of Firm (no TC) Val
$ 753 $ 753 $ 753 $7,600
$7,000
$ 294 $ 353 $ 480 $7,400
$6,000
$ 459 $ 400 $ 273 $7,200
$ 174 $ 152 $ 104 $5,000
$7,000
$ 285 $ 248 $ 169 $4,000
$6,800
$3,000 $6,600
$ 183 $ 160 $ 109 $2,000 $6,400
77.6666667 56.1 34.5333333
$1,000 $6,200

$6,000
$ 3.66 $ 4.42 $ 4.91 $-
1 2 3 4 5 6 7 8
1 2

$ 0.64 $ 0.64 $ 0.64

$ 2.36 $ 2.84 $ 3.16 D/E
1.80 $2,000
1.60 $1,800
$ 3,938 $ 3,432 $ 2,925 1.40 $1,600
$1,400
1.20
$ 50.71 $ 61.17 $ 84.72 1.00
$1,200
$1,000
0.80
$800
$ 3,235 $ 3,882 $ 4,529 0.60
$600
BBB BBB BBB 0.40
$400
0.20 $200
0.00 $-
1 2 3 4 5 6 7 8 1 2
 $1,200
1.00
$1,000
0.80
$800
The Addition of0.60
Debt Increases the Value of UST
$600
0.40
$400
9.10% 9.10% 10.60% 0.20 $200
0.00 $-
1 2 3 4 5 6 7 8 1 2

Return on Assets (rA no Tc)) R

$ 5,944 $ 5,839 $ 5,733 14% 12.00%

13% 11.50%
$ 1,229.30 $ 1,475.16 $ 1,721.02
13% 11.00%

12% 10.50%
$ 7,173 $ 7,314 $ 7,454
12% 10.00%

11% 9.50%

11% 9.00%
1 2 3 4 5 6 7 8 1 2

Return on Equity (rE)

$ 7,173 $ 7,314 $ 7,454 20.00%

50% 60% 70% 18.00%

$ 6,470 $ 6,470 $ 6,470 16.00%

14.00%

12.00%

10.00%
0.82 1.13 1.55
8.00%
13% 13% 13%
6.00%
15.61% 17.20% 17.07% 4.00%

2.00%

0.00%
1 2 3 4 5 6 7
 10.00%

8.00%
The Addition of Debt Increases the Value of UST
6.00%

4.00%

2.00%
10.50% 10.30% 10.11% 0.00%
1 2 3 4 5 6 7

11.65% 11.66% 9.34%

 The Addition of Debt Increases the Value of UST

Value of Levered Firm (with Tc)

$7,600

$7,400

$7,200

$7,000

$6,800

$6,600

$6,400

$6,200

$6,000
1 2 3 4 5 6 7 8

PV(Tax Shield)
$2,000
$1,800
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$-
1 2 3 4 5 6 7 8
$1,200
$1,000
$800
The Addition of Debt Increases the Value of UST
$600
$400
$200
$-
1 2 3 4 5 6 7 8

Return on Assets (rA with Tc)

12.00%

11.50%

11.00%

10.50%

10.00%

9.50%

9.00%
1 2 3 4 5 6 7 8

Stock Price for Tax Shield Case

$70.00

$60.00

$50.00

$40.00

$30.00

$20.00

$10.00

$-
1 2 3 4 5 6 7
$40.00

$30.00
The Addition of Debt Increases the Value of UST
$20.00

$10.00

$-
1 2 3 4 5 6 7