Eskimo Pie’s Ice Cream Market
Unlike Reynolds Metals, whose core business had little relationship with Eskimo Pie’s ice cream market, Nestle, which already have similar subsidiaries like drumstick, was likely to eliminate Eskimo Pie’s headquarters and management staff in order to consolidate its ice cream novelty market share. Which means that once the company was acquired by the Nestle, managers of Eskimo Pie will not be able to keep their current position.
By the late 1980, the industry began consolidating by the big market, and the market growth had slowed significantly. The fastest way to increase their market share was to acquire competitors in the market. And in that perspective, Eskimo Pie is one of the leading frozen novelty brands in 1991, with the unit share of 5.3%. And further, they had good market brand which would be very valuable for Nestle.
If they acquire the firm, it will not only help Nestle to gain much more market share (by consolidation), but also will lead to less competition, which means decrease in Advertising (and maybe some price increase which will be enabled only when they get more power) And further, Nestle already had Drumstick and Carnation unit, and both units were expected to have certain amount of synergies with Eskimo Pie in the frozen novelty industry in that the Eskimo Pie was licensing their brand.
What is more, the Nestle, may be able to get tax benefits if they borrow money to purchase the company. Which may help the argument that the Eskimo company worth more to Nestle than standalone company.
3. What would the capital structure (i.e., debt ratio) of Eskimo Pie after its IPO be like if Reynolds Metals accepts the two-step transaction proposed by Wheat First?
In the first step, the firm will have to lend 2M debt, while paying 15M dividend with their excess cash. And then in the second step, the firm will return 2M debt and gain extra 2M working cash through the IPO. Therefore, the Asset will decrease by 13M, Equity will decrease by 15M(as they receive dividends), and the Liability will increase by 2M in the first phase, and then Asset will increase by 2M and Liability will decrease by 2M and the equity will increase by 4M. In this case, the summation of the change will be 11M decrease in the asset and Equity. Therefore, if we assume that there was no debt increase between the IPO and 1990 record(as there is no 1991 record given), the debt ratio (= Debt/total asset) will approximately be (29,518(Total Assets in 1990)-19,496(Shareholder’s Equity in 1990))/(29,518(Total Assets in 1990)-11,000(decrease due to the dividends + increase by IPO)+4,000(Approximate increase in net incomes in 1991 according to the text))=0.44…. while the debt ratio would have been around 0.299 if there was no IPO. Although these values are only approximation (as no solid values were given in the cases), it is apparent that the amount of debt out of total asset will be significantly larger if Reynolds Metals accepts two-step transaction proposed by Wheat First. This is because they gave dividends whose amount was almost half of the whole assets recorded in 1990 (although there was additional IPO).