DOW CHEMICALS

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REV. AUGUST 6, 2003

GEORGE CHACKO
PETER TUFANO

Diageo plc
Ian Cray, Diageo plc’s Treasurer, looked out of his office window onto the busy streets of London in
October 2000. The London-based consumer goods company Diageo had recently announced its intention to sell its packaged food subsidiary, Pillsbury, to General Mills. Earlier in the year, Diageo also announced its intent to sell 20% of its Burger King subsidiary through an initial public offering during
2001, to be followed by a spin-off of the remainder of Burger King after December 2002. If these transactions took place, the firm would be focused exclusively on the beverage alcohol industry. As
Diageo’s business was restructured, it was an opportune time to rethink its financing mix.
On Cray’s desk lay a novel report by Ian Simpson, Diageo’s Director of Corporate Finance and Capital
Markets, and Adrian Williams, the firm’s Treasury Research Manager. Their analysis sought to quantify the textbook characterization of the tradeoff between the costs and benefits of different gearing, or leverage, policies. Built around a simulation model of the future cash flows of the company, their analysis attempted to understand the tax benefits of higher gearing versus the likelihood and severity of costly financial distress. While the analysis was still rough at points, the concepts and implementation were intriguing. Now that Diageo was rethinking its financial policies, the model could prove useful. Simpson,
Williams and Cray would soon meet to discuss its implications.

Diageo’s Business
Diageo was formed in November 1997 from the merger of Grand Metropolitan plc and Guinness plc, two of the world’s leading consumer product companies. The newly-merged firm was the seventh largest food and drink company in the world with a market capitalization of nearly £24 billion and annual sales of over £13 billion to more than 140 countries. The merger was ostensibly motivated by the

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