Topics: Stock market, Stock, Finance Pages: 7 (1767 words) Published: August 21, 2010

In April 2005, Wm. Wrigley Jr. company announced plans to issue $3 billion of debt. The conundrum that it faced was whether it should use the funds to repurchase shares or pay dividends, with both options having different implications on the firm. This report provides a comprehensive analysis of the firm, both before and after recapitalisation, in order to recommend a solution. It encompasses the appropriateness of the new debt level and Wrigley’s ability to service it, while also considering the increase in the value of the firm, the level of flexibility, and the implications of the debt issue on the firm’s financial policies and objectives. It was found that through the repurchase of shares, Wrigley would better satisfy shareholders, through the increase in share price and earnings per share (EPS) as compared to paying dividends. Doing so would also afford managers more financial flexibility and decrease the weighted average cost of capital (WACC), increasing the value of the firm.

In 2005, Wm. Wrigley Jr. Company, the world’s largest manufacturer and distributor of chewing gum, announced plans for a $3 billion debt issue. The problem facing Wrigley’s was whether the company should repurchase shares or pay dividends. This report will present a thorough analysis of Wrigley’s decision to issue this $3 billion debt by assessing relevant financial factors. These factors include the use of the debt to equity (D/E) and the times interest earned (TIE) ratios to evaluate the appropriateness of Wrigley’s debt level.

Also, recommendations regarding the financial policy objectives of Wrigley’s are outlined. The report also looks at factors that influence signaling to the market, such as the EPS, as well as examines Wrigley’s level of flexibility by analysing the quick ratio. On the basis of the analysis, recommendations will be provided as to whether Wrigley should repurchase shares or pay dividends.

Debt Level Analysis
The D/E and TIE ratios will be used to analyse Wrigley’s ability to pay off their liabilities through their assets. The D/E ratio was 7.49%, which rose to 31.76% after recapitalisation, regardless of repurchasing shares or paying dividends. Before, the TIE ratio was 24.5, which fell to 8.67 after recapitalisation (Appendix G). In comparison, Hershey’s TIE ratio was 9.70 in 2005 (Inman, Haralson, Leonard, Peter and Novak, 2007), indicating Wrigley’s ability to finance their interest charges with operating income.

The WACC was 16.04%, which decreased to 15.85% after taking on debt, irrespective of paying dividends or repurchasing shares (Appendix D). The cheaper cost of debt, as compared to the cost of equity, and the tax shield on debt served to decrease WACC, increasing the value of the firm. Using Discounted Cash Flow valuation, recapitalisation increases the value of the firm by $7.13 billion (Appendix F). With a sound TIE ratio of 8.67 and the decrease of the WACC to 15.85%, the debt level is appropriate in adding value to the firm. Financial Policy Recommendations

By applying qualitative assessment criteria, three distinct objectives of financial policy are identified as potentially relevant to the future development of Wrigley’s, namely maximising stockholder wealth, voting control, and signaling to the market.

Maximising Stockholder Wealth
The objective of maximising stockholder wealth suggests targeting a mixture of debt and equity that maximises firm value. The market value of equity fell by $2.04 billion after changing the capital structure, notwithstanding the paying of dividends or repurchasing shares. However, the share price increased to $74.74 when the funds were used to repurchase shares, and dropped to $57.35 when used to pay dividends (Appendix C).

Repurchase programs convey favourable information to the market (Comment and Jarrell, 1991), increasing stock prices when announcements of share repurchases are made (Vermaelen, 1981). Although there is a...
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