1) Overview / Introduction
Diageo was created when Grand Metropolitan, plc and Guiness, plc merged in 1997. While the Diageo name is not well known to consumers, its brands are among the most famous including Guinness, Smirnoff, Johnnie Walker and Cuervo. The company recently decided to focus on a strategy to grow through its spirits, wine and beer businesses and divest of its Pillsbury and Burger King subsidiaries. This case study will focus on the proposed capital structure decisions of Diageo.
2) Is Diageo’s current capital structure appropriate to its new business? It believes that it has traditionally had a conservative debt policy. If so, is that policy still appropriate? Has Diageo’s capital structure been as conservative as it believes? (What interest rate coverage ratio has it been targeting? How does it look relative to its competitors?) Diageo’s capital structure has not been as conservative as it believes. Although their capital structure in FY 2000 has been as conservative as it has targeted, it is less conservative compared to other companies in related industries. The interest rate coverage ratio that it has been targeting is between 5 and 8 x and they currently have a ratio of 5 (Exhibit 4). This ratio is low compared to the average Alcohol (8), Beer (10), and Beverage (13) segments. Below is Diageo’s current interest coverage ratio compared to its competitors:
Also, since the mergers Diageo’s book value of equity divided by total assets is considerably lower than the average British firms (42%). See table below:
FY '97 PF
Book Value of Equity
In addition, their...
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