William Wrigley Jr Case Study

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EFB340- FINANCE CAPSTONE

Case Study 1- The William Wrigley Jr. Company: Capital Structure, Valuation, and Cost of Capital

Group: 4-4

ABSTRACT
This report examines the impact a $3 billion bond issue will have on the value of the William Wrigley Jr. Company. When analysing its various impacts, the expectations that arise as a result of the leveraged recapitalisation include an increase in the share price & cost of capital and reduced earnings per share. In essence, the potential benefits of a $3 billion bond issue are outweighed by the costs. Other potential impacts were considered and it was expected that the debt issue would lead to an increased agency cost of debt while voting control was not expected to change. The signal of a leveraged recapitalisation through a share repurchase should result in an increased share price and similarly, a recapitalisation through a dividend payout may put downward pressure on the share price when future dividend expectations are not met. Although Wrigley’s has the ability to service a $3 billion debt, it would lose financial flexibility due to interest payments. It is recommended that Wrigley’s issue $2 billion in debt resulting in an increased share price and reduced cost of capital among other benefits.

Table of Contents
1.0INTRODUCTION4
2.0OUTLINE ALTERNATIVE SOLUTIONS TO THE PROBLEM4
2.1IMPACT ON SHARE PRICE4
2.2IMPACT ON WEIGHTED-AVERAGE COST OF CAPITAL (WACC)5
2.3IMPACT ON EARNINGS PER SHARE5
2.4OTHER CONSIDERATIONS6
2.4.1AGENCY COST OF DEBT6
2.4.2IMPACT ON VOTING CONTROL6
2.4.3SIGNALLING & CLIENTELE EFFECT7
2.4.4DEBT COVERAGE & FINANCIAL FLEXIBILITY7
3.0CONCLUSION8
4.0RECOMMENDATIONS8
5.0REFERENCE LIST10
6.0APPENDICES12
6.1APPENDIX 1 – Adjusted NPV (ANPV)12
6.2APPENDIX 2 – Stock Pricing13
6.3APPENDIX 3 – Black-Scholes-Merton Option Pricing Model (Put Option)15
6.4APPENDIX 4 – Black-Scholes-Merton Option Pricing Model (Financial Distress Costs)20
6.5APPENDIX 5 – Market Risk Premium21
6.6APPENDIX 6 – Risk Free Rate22
6.7APPENDIX 7 – Beta of the firm23
6.8APPENDIX 8 – Cost of Equity25
6.9APPENDIX 9 – Cost of Debt26
6.10APPENDIX 10 – Weighted-Average Cost of Capital28
6.11APPENDIX 11 – EPS versus EBIT Analysis29
6.12APPENDIX 12 – EBIT/EPS Breakeven Analysis31
6.13APPENDIX 13 – Voting Rights32
6.14APPENDIX 14 – Debt Interest Coverage Ratio & Financial Flexibility33
6.15APPENDIX 15 – Trade-off Theory34

1.0 INTRODUCTION
The decision by William Wrigley Jr. Company to do a $3 billion leveraged recapitalisation through a dividend or share repurchase could create significant new value for the company. The purpose of this report is to analyse the impact this will have on the firm’s value, comment on the appropriateness of Wrigley’s debt level in the event of the proposed bond issue and make recommendations as to whether or not the firm should in fact follow through with the issue. The items of interest that will be analysed include: the impact on share price, cost of capital, earnings per share, agency cost of debt, voting control, signalling & clientele effect and debt coverage & financial flexibility. 2.0 OUTLINE ALTERNATIVE SOLUTIONS TO THE PROBLEM

3.1 IMPACT ON SHARE PRICE
If Wrigley issued $3 billion in debt, findings indicate that there would be a significant difference in share price movement. These calculations were modelled using the Adjusted Net Present Value (ANPV) process (appendix 1) and whilst an attempt was made to take into account the cost of financial distress with the assistance of the Black-Scholes-Merton option pricing model (appendix 3 - 4), this cost was determined to be extremely small and therefore negligible. The resulting share prices do not take into consideration the impact of signalling & clientele effect and agency costs. It was found that following...
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