TN34 the WM Wirgley Jr Company Capital Structure Valuation and Cost of Capital
The Wm. Wrigley Jr. Company: capital structure, valuation, and cost of capital
Teaching Note
Synopsis
In June 2002, a managing director of an active-investor hedge fund was considering the possible gains from increasing the debt capitalization of the Wm. Wrigley Jr. Company. Wrigley had been conservatively financed and at the date of the case, carried no debt.
The tasks for the student are to:
Estimate the potential change in value from relevering Wrigley using adjusted present value analysis.
Assess the impact on the weighted-average cost of capital, earnings per share, the credit rating of the firm, and voting control of the Wrigley family.
Consider the merits of dividend or share repurchase as a means of returning cash to shareholders.
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.
Suggested Questions for Advance Assignment
1. In the abstract, what is Blanka Dobrynin hoping to accomplish through her active-investor strategy?
2. What will be the effects of issuing $3 billion of new debt and using the proceeds either to pay a dividend or to repurchase shares on:
a. Wrigley’s outstanding shares?
b. Wrigley’s book value of equity?
c. The price per share of Wrigley stock?
d. Earnings per share?
e. Debt interest coverage ratios and financial flexibility?
f. Voting control by the Wrigley family?
3. What is Wrigley’s current (prerecapitalization) weighted-average cost of capital (WACC)?
4. What would you expect to happen to Wrigley’s WACC if it issued $3 billion in debt and used the proceeds to pay a dividend or
Teaching Note
Synopsis
In June 2002, a managing director of an active-investor hedge fund was considering the possible gains from increasing the debt capitalization of the Wm. Wrigley Jr. Company. Wrigley had been conservatively financed and at the date of the case, carried no debt.
The tasks for the student are to:
Estimate the potential change in value from relevering Wrigley using adjusted present value analysis.
Assess the impact on the weighted-average cost of capital, earnings per share, the credit rating of the firm, and voting control of the Wrigley family.
Consider the merits of dividend or share repurchase as a means of returning cash to shareholders.
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.
Suggested Questions for Advance Assignment
1. In the abstract, what is Blanka Dobrynin hoping to accomplish through her active-investor strategy?
2. What will be the effects of issuing $3 billion of new debt and using the proceeds either to pay a dividend or to repurchase shares on:
a. Wrigley’s outstanding shares?
b. Wrigley’s book value of equity?
c. The price per share of Wrigley stock?
d. Earnings per share?
e. Debt interest coverage ratios and financial flexibility?
f. Voting control by the Wrigley family?
3. What is Wrigley’s current (prerecapitalization) weighted-average cost of capital (WACC)?
4. What would you expect to happen to Wrigley’s WACC if it issued $3 billion in debt and used the proceeds to pay a dividend or