Wm. Wrigley Jr, Company Capital Structure

Topics: Weighted average cost of capital, Finance, Stock market Pages: 9 (1908 words) Published: September 3, 2013
Wm. Wrigley Jr, Company Capital Structure
Wm. Wrigley Jr, Company Capital Structure

8/23/2013

8/23/2013
EFB340 Finance Capstone
Case Study 1

Group S3
Dat Bui (N8360928)
JeongHwan KWON (N8400822)
Honghu Ye (N8106258)
EFB340 Finance Capstone
Case Study 1

Group S3
Dat Bui (N8360928)
JeongHwan KWON (N8400822)
Honghu Ye (N8106258)

Table of Contents
Abstract1
1.0 Introduction2
2.0 Analysis
Share price2
Weighted Average Cost of Capital2
Earnings per Share 3
Voting Control 3
EBIT Interest Coverage Ratio 4
Flexibility 4
3.0 Recommendation5
4.0 Reference List7
5.0 Appendix
Appendix 18
Appendix 29
Appendix 310
Appendix 412
Appendix 513
Appendix 614
Appendix 715
Appendix 816
Appendix 917
Appendix 1017

Abstract
This report examines the impacts of recapitalization of Wm. Wrigley Jr, Company which is unleveraged firm in 2002. This recapitalization with $3 billion debts increases the firm’s value and share price. On the other hand, it could be a risky strategy for Wrigley; therefore, based on our WACC analysis, the report indicates that it would be appropriate stretegy to have $2 billion debts instead of $3 billion. This examination also states that the firm needs to repurchase its share by the debts rather than pay dividend.

1. Introduction

The Wm. Wrigley Jr, Company is considering a leveraged recapitalization by raising $3 billion. It will be concerned due to the fact that the amount of debt could be account for its firm excessively comparing to its capital which is $13 billion. The debt will impact on and bring changes in the firm’s value and share price. The report will analyse and focus on the effects on the Share Prices, Earning Per Share (EPS), Weighted Average Cost of Capital (WACC) and other issues based on Modigliani and Miller (M&M) and Trade off theories. Based on the analysis, the report will justify a suitable debt level for Wrigley and provide strategies for them.

2. Analysis

Share Price
In the case of paying a dividend, Wrigley’s share price will decrease by $12.9 from $56.37 to $48.63 after the ex-dividend date. Therefore, the market value of the company will also drop 13.74% as the result of share price reduction. The share prices of share repurchase, on the other hand, increases to $61.53. Hence, its market value rises from $13.1 billion to $14.3 billion meaning that 9.16% increases in company’s market value. As the result, repurchasing share can be a better option than paying dividends as it drives up the share price and the firm’s market value. (Refer to Appendix 1)

Weighted Average Cost of Capital (WACC)
The WACC’s results in paying both dividends and repurchasing shares show how Wrigley is taking on more risks when raising 3 billion debts. In regards to dividend payments, the company’s credit rating falls from AA (9.786%) to B/BB (13%) while the cost of equity has increased from 10.11% to 10.95%. Thus, it boosts the WACC increased from 10.11% to 10.29%. A similar case is share repurchase. The WACC goes up from 10.11% to 10.25%. Consequently, the increase in WACC will make the interest rate increase that the company has to pay when it finances and hence, it will lead to a reduction of the company present value based on Discount Cash Flow (DCF) model theory (Kincheloe, 1990). (Refer to Appendix 2)

Earnings per Share (EPS)
As can be shown from appendix, the Earning per Share of Wrigley in 2001 pre-recapitalization is $1.61. Meanwhile, the figure differentiates with its expected EPS ($1.48 per share), this is because of the change in estimated tax rate (40%) and the predicted grow rate (9%) so these effects cause the EPS slightly low. The EPS for both shares repurchases and dividend payments decrease as per the requirements for interest payments so it results in a significant reduction of EPS. Consequently, the lower EPS can leave Wrigley as a less comparative to other firms which have an EPS of 1.1...

References: Achim, M., Achim, S., & Borlea, S., PhD. (2009). The use of earning per share in the analysis of a company 's market value. Journal of American Academy of Business,
Cambridge, 14(2), 344-349
Chandra, P. (2008) Investment Analysis (3rd Edition). India: Tata McGraw-Hill
Education.
Fosberg, R. H. (2010). A test of the M&M capital structure theories. Journal of Business & Economics Research, 8(4), 23-28. Retrieved from http://search.proquest.com/docview/194911822?accountid=13380
Kincheloe, S
Murali, J. Clifford P, S. & Michael S, W. (2000). Jounal of of Financial Economics. Financial flexibility and the choice between dividends and stock repurchases
http://dx.doi.org.ezp01.library.qut.edu.au/10.1016/S0304-405X(00)00061-1,
Soter, D. (1996). Of dividends and financial flexibility. Chief Executive, (116), 18. Retrieved from http://search.proquest.com/docview/212066584?accountid=13380
5
EBIT (2002) = $527,366,000 x 1.09
= $574,828,940
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