Case Discussion: The Wm. Wrigley Jr. Company: Capital Structure, Valuation and Cost of Capital
1. Dobrynin plays the role of the financial entrepreneur, exploiting inefficiencies in investment valuation and corporate finance. She seeks to profit by restructuring firms with “lazy financing” or too much cash and unused debt capacity relative to the (low) risks faced by the firms. By pressuring directors and managers to adopt more efficient policies, she hopes to reap an investment gain. The larger issue is whether or not Wrigley is inefficiently financed. If so, how much capital structure change will bring it to more efficient operation?
2a. A recapitalization based on a dividend will have no effect on the number of shares
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Equity accounts for 89% of Wrigley’s book value of capital before the recapitalization. But the book value per share is $5.49,[1] less than one-tenth of Wrigley’s current share price of $56.37. This huge disparity is the possibility that book values are backward-looking and ignore important economic considerations, such as the value of brands, intellectual property, and customer franchise as well as the debt tax shields.
In contrast, finance theory and best practice rely on the firm’s current market value as a guide to compute the capital weights. Before the recapitalization, Wrigley’s market value of equity accounted for 99% of its capital. And, after the recapitalization, that ratio fell to 78%. The increase in leverage will imply a change in Wrigley’s cost of capital.
WACC before recapitalization
Wrigley’s prerecapitalization WACC is 10.9%. The cost of equity assumes a risk-free rate of 5.65% for 20-year U.S. Treasuries (case Exhibit 7), a risk premium is assumed 7% (or 5%), and uses Wrigley’s current beta of 0.75 (case Exhibit 5).
4. WACC after recapitalization
The increase in leverage will affect Wrigley’s WACC in at least three ways:
1. Cost of debt: Wrigley’s debt rating will change from AAA (consistent with no debt) to a BB/B rating reflecting the higher risk. The postrecapitalization credit rating is a matter of judgment. It is highly instructive to guide students through a rating exercise for Wrigley’s pro forma recapitalization. This
Andrea Winfield considered issuing bonds was not a good option for financing the acquisition. She was particularly concerned about the increasing long-term debt and annual cash layout of $ 6.25 million for 15 years. We believe that her concerns are justified, because the Company had already significant amount of debt that could result in higher risks and stock price
The cost of equity was found using CAPM, with the given market risk premium of 5%, a beta of .88, and risk-free rate of 4.03%. The beta was found by running a regression of Southwest’s percent change in stock price versus the S&P 500’s percent change in stock price for two years (June 28, 2000 to June 28, 2002). The risk-free rate was the return on a ten-year treasury note issued on June 28, 2002, according to the U.S. Treasury’s website. The tax rate of 39% was used to account for tax savings from leverage. In order to calculate the firm’s leverage, the market value of equity was found from the price per share on July 24, 2002 (Yahoo Finance) and the shares outstanding on the balance sheet of the July 10-Q report, as shown in Exhibit X. The debt value was approximated at the book value since data could not be found regarding its market value. This analysis resulted in a debt weight of 11.74% and equity weight of 88.26%. The final approximation for the weighted average cost of capital was 8.64%.
The purpose of this memo is to provide Target Corp. senior management with an evaluation of the company’s weighted average cost of capital (WACC). Since the 2010 financial information is not yet to be finalized, the analysis will use the most currently published financial data to evaluate each component of the WACC, including the company financial structure, cost of debt, and cost of equity.
However, the Walgreens’ capital structure is similar to its stronger competitor CVS’ capital structure that I defined as the benchmark. CVS has a total liabilities and shareholders’ equity of $54,721.90, where total debt is $23,400 representing the 42.76% and total equity is $31,321.90 which represents 57.24%. Moreover, if we compare 2006 results to 2007, I realize that capital structure
- A firm has a market value equal to its book value. Currently, the firm has excess cash of $1,200 and other assets of $10,800. Equity is worth $12,000. The firm has 750 shares of stock outstanding and net income of $775. What will the new earnings per share be if the firm uses its excess cash to complete a stock repurchase?
The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).
In order to find the WACC, we need to find the cost of the components of the capital structure and their proportion in the total capital.
in which wd is the proportion of Southwest’s assets financed by debt, ws is the proportion of Southwest’s assets financed by equity, rd is the required return on debt, rs is the required return on equity, and T is Southwest’s marginal tax rate.
At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable
The Coca-Cola Company is a beverage company which owns more than 500 nonalcoholic brands. Its product is known by customers all over the world. The company has market capitalization of $185.88 billion (Google finance, Oct 2015). In addition to equity capital, the company also issues corporate bonds to finance its operation. Both stocks and bonds of the company is traded in The New York Stock Exchange (NYSE). To calculate WACC of The Coca-Cola Company, we need to obtain some information about its debt
The statement of cash flows outlines some of the changes to the capital structure. The company added $164.5 million in a consolidated loan facility, and it paid out $138.1 million in dividends. There were no share buybacks during the year. The company states in the annual report (p.4) that it intends to maintain a conservative gearing ratio. The company in this section attributes its increased borrowings to projects and opportunities on which it has embarked. These investments lie within the integrated retail, franchise and property system. One of the
Torres’ common-size financial statements also show the changing composition of Costco’s financing structure over time. The fact that interest expense consistently fell over the five year span from -0.35% of net sales in 1997 to -0.09% in 2001 demonstrates Costco’s ability to reduce its overall amount of debt during these years. Exhibit nine’s balance sheet portion supports this reduction, documenting an increase in total current liabilities from 35.86% of total assets in 1997 to 40.76% in 2001 and an increase in accounts payable from 25.46% of assets in 1997 to 27.03% in 2001. This signifies that the company’s debts or obligations due within one year increased, further corresponding with the fact that short-term borrowing increased from 0.46% of assets in 1997 to 1.93% in 2001. With an increase in short-term borrowing it is logical to expect to see a decrease in long-term borrowing. The income statement proves that this is indeed the case, documenting a decrease in long-term debt from 16.74% of sales in 1997 to 8.52% in 2001. This relates back to the decrease in Costco’s interest expense on the income statement, representing the company’s decision to switch to short-term and away from long-term methods. Furthermore, the decrease in long-term debt helped account for a decrease in total liabilities from
The effect of financial leverage on the cost of equity is prevalent in the Modigliani-Miller capital structure theory. Since the financial leverage increases the cost of equity, it can be considered one of the disadvantages of borrowing. As shown in Appendix A, the cost of equity, at each debt to capital ratio, increases by 0.1% as the financial leverage increases by 10%. With a higher
and the sale of noncore assets were common. Moreover, in anticipation of sluggish sales in the
Already in 1958, Modigliani and Miller have pointed the discussion of capital structure towards the cost of debt and equity. According to their first proposition, in a world of no corporate taxes and with perfect markets, financial leverage has no effect on a firm’s value. In their second proposition, they state that the cost of equity equals a linear function defined by the required return on assets and the cost of debt (Modigliani and Miller, 1958).