Diageo

Executive Summary Diageo, which is a London based company, has the production and distribution of Spirits and Wine, with highly recognized brands all around the world such as Johnny Walker and J&B, as its main business activity. Furthermore, the firm is engaged in the package food and fast food industry with Pillsbury and Burger King respectively. The corporation was formed in 1997 through the merger of Guinness Plc. and Grand Metropolitan. Diageo follows the norm of British Corporations of using debt as a main source of financing, conforming to a more conservative financial policy. Since Diageo relied more on equity as a source of financing its corresponding credit rating is “A+” meaning that it can borrow funds with favorable terms and easily. The firm’s conservative financial policy can be summarized by the statement in the merger announcement that the group’s policy will to manage the capital structure so as to keep the interest cover ratio between 5 and 8. The firm can retain a lower coverage ratio with no further unfavorable implications in each corresponding credit rating compared to other industries due to the stable nature of Diageo’s portfolio of brands. The firm’s main intention is to sell the packaged food subsidiary (Pillsbury) and 20 per cent of Burger King with a subsequent spinoff of the remainder of the subsidiary after December 2002. Referring to the capital structure of Diageo, we can mention that applying the trade -off theory we found that the firm had a higher debt than the optimal one suggested by the theory. This conclusion was enhanced by the Monte Carlo Simulation used by the firm’s executives in order to identify the capital structure to identify the coverage ratio that minimizes the taxes paid and the financial distress costs. When constructing the model we believe some of the assumptions were unrealistic. The model should have been adjusted to include factors such as the fact that the credit spreads for different