Preview

THE WM. WRIGLEY JR. COMPANY - Valuation

Powerful Essays
Open Document
Open Document
2215 Words
Grammar
Grammar
Plagiarism
Plagiarism
Writing
Writing
Score
Score
THE WM. WRIGLEY JR. COMPANY - Valuation
The William Wrigley Jr. Company
Case Report

Ying Suan Lo
Julianne Mills
Nick Lim
Vinson Chen
Glen Hamilton

Table of Contents

1.0 1.0 Introduction

Identifying opportunities for corporate financial restructuring was typical for Blanka Dobrynin, a managing partner of the hedge fund Aurora Borealis LLC. In 2002, with the then debt free William Wrigley Jr. Company (Wrigley) in her sights, she asked her associate Susan Chandler to conduct research on the impact of a $3 billion debt recapitalisation on the company. This case report aims to make an informed recommendation on whether Wrigley should pursue the $3 billion debt proposal.

2.0 Optimal Capital Structure

According to Miller and Modigliani’s (1958) first proposition, the value of a firm is independent of its capital structure, assuming no corporate taxes. It was later demonstrated that the existence of debt in the capital structure creates a debt shield that increases the value of the firm by the present value of the tax shield (Miller & Modigliani, 1963). This line of reasoning implies that debt financing adds significant value to the firm and an optimal capital structure occurs with 100% debt. However, this is an unlikely outcome in reality with restrictions imposed by lending institutions, bankruptcy costs and the need for preserving financial flexibility implying that management will maintain a substantial reserve of borrowing power (Miller & Modigliani, 1963). These imperfections have since been discussed as additional factors when determining an optimal capital structure.

The trade off theory suggests that an optimal capital structure may be achieved by determining the trade-off between tax shields and the costs of financial distress (Kraus & Litzenberger, 1973). The presence of tax shields means that the optimal capital structure decision is unique for each firm (DeAngelo & Masulis, 1980). High levels of debt can lead to



References: Armitage, S. (2005). The Cost of Capital: Intermediate Theory. Cambridge, UK: Cambridge University Press. DeAngelo H., & DeAngelo, L., (2006) Capital Structure, Payout Policy, and Financial Flexibility, University of Southern California working paper. DeAngelo, H., & R.W. Masulis. (1980) Optimal Capital Structure under Corporate and Personal Taxation. Journal of Financial Economics 8, 3-29. DeAngelo, H., DeAngelo, L., & Whited T.M., (2011) Capital structure dynamics and transitory debt Denis, D J. (2011) Financial Flexibility and Corporate Liquidity. Journal of Corporate Finance, 17(3), 667-674. J.R. Graham, & C.R. Harvey., (2001) The theory and practice of corporate finance: evidence from the field. Journal of Finance and Economics 60, 187–243. Jensen, M., & Meckling, W. (1976). Theory of the firm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics 3, 305-360. Johnson, H. (1999). Determining Cost of Capital: The Key to Firm Value. London: FT Prentice Hall. Kraus, A., & R.H. Litzenberger. (1973) A State Preference Model of Optimal Financial Leverage. Journal of Finance (September), 911-922. Modigliani, F., & M.H Modigliani, F., & M.H. Miller. (1963). Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Review 53 (June), 433-443. Pratt, Shannon P., & Roger J. Grabowski. (2008) Cost of Capital: Applications and Examples. Hoboken, NJ: Wiley.

You May Also Find These Documents Helpful

  • Satisfactory Essays

    References: Parrino, R., Kidwell, D. S, & Bats, T.W. (Author) (2012). Fundamentals of Corporate Finance (2nd ed) Hoboken, NJ: Wiley: Cost of Capital [Video file]. Available from University of Phoenix website: http://edugen.wiley.com/edugen/courses/crs6420/simulations/Videos/Concept_Review_Video/cost_of_capital/cost_of_capital.html…

    • 452 Words
    • 2 Pages
    Satisfactory Essays
  • Best Essays

    The Walt Disney Company (DIS) has a long and prestigious history in the entertainment business covering a period of greater than 75 years. The DIS objective is to be the world leader in production of entertainment using their diversified portfolio to differentiate its brands including Walt Disney Parks, ESPN, PIXAR, MARVEL, and ABC. The financial goals are to maximize cash flow, maximize earnings, and capital profits that will drive longer-term shareholder value (The Walt Disney Company, 2012). The DIS conglomeration offers brand recognition although DIS faces high sunk costs including updates of their parks. Although DIS is faced with a number of industry competitors, it remains the industry leader with a solid debt to equity ratio of 38.16 choosing internal trade off financing rather than issuing outside debt. Currently DIS can cover their liabilities with a current liquidity ratio of 1.11 demonstrating their ability to pay debts with short-term assets (Google Finance, 2012). DIS currently maintains an industry low total debt to equity of 38% reducing the overall risk associated with financial growth. DIS demonstrates weak returns with a three-year average of 17% (Table 4) while others in the industry such as Viacom shows a one-to-one ratio DIS shows a two percent increase in 2011 to 19% in Table 4. YET, DIS continues to show a modest three-year return on equity of 17.9%. The DIS bond weight is 11.42% while the stock weight is 88.58%. Using this information and a large number of calculations show DIS as a good investment making smart decisions to remain the industry leader. Investors should invest in DIS as it has a proven, steady, and stable profitability and returns.…

    • 4477 Words
    • 18 Pages
    Best Essays
  • Powerful Essays

    Modigliani, F., & Miller, M. H. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review, 48(3), 261-97.…

    • 8377 Words
    • 34 Pages
    Powerful Essays
  • Powerful Essays

    David Jones analysis

    • 3184 Words
    • 13 Pages

    Graham, John R. and Campbell R. Harvey. “The Theory and Practice of Corporate Finance: Evidence from the Field,” Journal of Financial Economics, 60, 2001, pp. 187-243.…

    • 3184 Words
    • 13 Pages
    Powerful Essays
  • Better Essays

    References: Ross, S. A., Westerfield, R. W., & Jaffe, J. (2008). Corporate finance (8th ed.). New York: McGraw-Hill Irwin.…

    • 1331 Words
    • 6 Pages
    Better Essays
  • Good Essays

    This article mainly discusses the cost of capital, the required return necessary to make a capital budgeting project worthwhile. Cost of capital includes the cost of debt and the cost of equity. Theorist conclude that the cost of capital to the owners of a firm is simply the rate of interest on bonds.…

    • 1323 Words
    • 6 Pages
    Good Essays
  • Powerful Essays

    Hatfield, G. B. (1994). The Determination of Optimal Capital Structure: The Effect of Firm and Industry Debt Ratios on Market Value. Journal of Financial and Strategic Decisions, Volume 7, Number 3.…

    • 1625 Words
    • 7 Pages
    Powerful Essays
  • Powerful Essays

    The case’s central teaching objective is to explore the financial effects of the capital structure change. Significant here is the trade-off between the tax benefits of debt and the associated costs in the form of financial distress and loss of flexibility. Related issues include signaling to investors, clientele effects (control considerations for the Wrigley family), and incentives created for directors and managers. Finally, the case affords a comparison of dividends and share repurchases.…

    • 6139 Words
    • 22 Pages
    Powerful Essays
  • Better Essays

    This Report investigates the financial effects on Wrigley’s with the issuance of $3bn debt. It explores two alternate means of allocation for the funds; pay out a one-time dividend or carry out a share repurchase. Both methods are analyzed in regards to an optimal capital structure and maximizing share holder value (value of the firm). A compilation of historical data and future predictions were used for the basis of this report, and recommendations.…

    • 2798 Words
    • 10 Pages
    Better Essays
  • Better Essays

    Capital Structure

    • 2014 Words
    • 6 Pages

    In finance, the term “capital structure” refers to the way a firm finances its assets. Generally speaking, there are two main forms of capital structure: debt financing and equity financing (Cumming 52; Myers, 83). Each type has its own advantages and disadvantages, and an essential task for the successful manager of a firm is to find an optimal capital structure in terms of risk and reward for stockholders. When making decisions that affect capital structure, managers must be aware of the impact capital structure has on the firm’s potential for future success, as well as the advantages and disadvantages of debt versus equity financing.…

    • 2014 Words
    • 6 Pages
    Better Essays
  • Good Essays

    Capital Structure

    • 1020 Words
    • 4 Pages

    References: H. Kent Baker and Gerald S. Martin, Capital Structure and Corporate Financing Decisions – Theory, Evidence and Practice, 2011, Wiley…

    • 1020 Words
    • 4 Pages
    Good Essays
  • Powerful Essays

    Sheridan Titman McCombs School of Business Department of Finance University of Texas at Austin Austin, TX 78712-1179. Sergey Tsyplakov Moore School of Business Department of Finance University of South Carolina Columbia, SC 29208…

    • 24563 Words
    • 99 Pages
    Powerful Essays
  • Powerful Essays

    8. Haugen, R. A., and Wichem D. W. (1974). The Elasticity of Financial Assets, Journal of Finance (29)12, 29-4 9. Hill N. C. and Stone B.K.(1980). Accounting Betas, Systematic Operating Risk and Financial Leverage: A Risk Composition Approach to the determinants of Systematic Risk, Journal of Financial and Quantitative Analysis, 595-633 10. Hittle, L. C., Haddad, K., and Gitman (1992). Over the counter firms, asymmetric information and financing preference, Review of Financial Economics, 2(1), 81 81-92 11. James, C. (1987). Some evidence on the uniqueness of bank loans, Journal of Financial Economics, 19(2), 217-235 12. Kane, E.J., Marcus A. J. and McDonald R.L. (1985). Debt Policy and the Rate of Return Premium to , Leverage, Journal of Financial and Quantitative Analysis, (28)2, 479-500 479 13. Klapper, Leora & Tzioumis, Konstantinos, 2008. "Taxation and capital structure : evidence from a evide transition economy," Policy Research Working Paper Series 4753, The World Bank. 14. Miller, M.H. (1977). Debt and Taxes. Journal of Finance, 32(2), 261-275 261 15. Modigliani, F. and Miller, M (1958). The cost of capital, Corporate finance, and the theory of investment, American Economic Review 48, 261-297 261 16. Myers, S.C. (1984). The capital structure puzzle. Journal of Finance, 39(3), 575-592 575 592 17. Myers, S.C. (2001). Capital structure. Journal of Economics Perspectives, 15(2),81 15(2),81-102…

    • 3748 Words
    • 15 Pages
    Powerful Essays
  • Powerful Essays

    Capital Structure and the Cost of Capital: TheoryChapter 13 :Financial Theory and Corporate Policy (Copeland and Weston)…

    • 4180 Words
    • 17 Pages
    Powerful Essays
  • Powerful Essays

    Chen, N. and F. Zhang (1998), `Risk and Return of Value Stocks ', Journal of…

    • 9094 Words
    • 59 Pages
    Powerful Essays