The William Wrigley Jr. Company is the largest manufacturer and distributor of chewing gum, with a well consolidated market position. Due to new products and foreign expansion, its previous revenues have grown at an annual rate of 10% and its stock price regularly outperforms the S&P 500 as well the industry index. It is a conservatively financed firm with total assets of $1.76 billion and zero debt as of 2001. The purpose of this case study revolves around how should they use a $3 billion debt issue to restructure its capital that would add the most value for the shareholders of Wrigley. The decision of how to use the debt will impact the firm’s stock price, cost of capital, debt coverage, earnings per share and voting control. The impact of these changes from the capital restructuring should be analysed to confirm that they are improving the value of the company and that they align with the company’s goals and strategic direction.
When a firm goes through recapitalisation, the share value of the firm is affected. The effects on the share value depend on the type of recapitalisation undertaken. In the case of William Wrigley Jr. Company, the two proposed types are a dividend payout and a repurchase of shares. Financial managers are very careful in handling the choice of dividend policy of the company as dividends not only influence the value of the firm but more importantly the wealth of their shareholders (Bansal, Deepak, et. al). Figures 1 and 2 below show the outcome of borrowing $3 billion worth of funds to leverage the company. Before RecapitalisationAfter Recapitalisation - DividendsAfter Capitalisation - Repurchase Market Value on Equity13.1 Billion11.3 Billion11.3 Billion # Of Ordinary Shares232.44 Million232.44 Million183.677 Million Cash ReceivedN/A3 Billion0
Share Price$56.36 $48.61 $61.52
Value to Shareholders$56.36 $61.52 $61.52
The tax rate of 40% causes the market value of equity to drop to 11.3 Billion after the loan in both the dividend payout scenario and the share repurchase scenario. In the case of the dividend payout of $12.91, which is reflected in the difference in the value of the share and the share price (dividend drop) the number of shares remain the same but the value of the share increases from $56.36 to $61.52. In the case of a share repurchase, calculations are shown below to suggest that 48.764 Million shares will have to be repurchased which causes the price of the shares to rise to $61.52. New DebtNew PriceShare Repurchase
3 BillionMV Equity + PV Debt Tax Shield = 13.1 Billion + (3 Billion x 40%) = 14.3 Billion 14.3 Billion / 232.44 Million = $61.52 per share3 Billion / $61.52 = 48.764 M Figure 2
*All calcuations viewable in Appendix 2
EPS is equal to a firm’s net income/number of outstanding shares. Pre-Recap
Wrigley’s EPS prior to recapitalisation is 1.33 and when using surplus cash, should increase or maintain the same EPS if they had decided to repurchase shares or pay dividends. The decrease in outstanding shares caused by the buying back some of its shares increases EPS and paying dividends should keep the same EPS. Dividends
There is a similar number of outstanding shares when compared to pre-recap, 232.44m and when factoring in the interest expense of $390 million this causes the EPS to decrease to 0.32. Repurchasing Shares
During the repurchase there is the same interest expense as issuing a dividend but Wrigley’s outstanding shares decrease by 48.76m. Consequently, the EPS fell significantly to 0.40.
Cost of Capital
One of the most important fundamental factors in corporate finance is building long-term value for a firm and its shareholders, thus, lowering the weighted average cost of capital (WACC) increases the chance of building this value. Value...