Chandler knew that the maximum value of the firm was achieved when the weighted average cost of capital was minimized. Thus she intended to estimate what the cost of equity and the wacc might be if wrigley pursued this capital structure change. The projected cost of debt would depend on her assessement of wrigley’s debt rating after recapitalization and on current capital market rates.

WACC before recapitalization

Wrigley’s pre recapitalization WACC is 10.9%, the cost of equity assumes a risk free rate of 5.65% for 20 years US treasuries in the case exhibit 7; a risk premium is assumed 7% (or 5%), and uses Wrigley’s current beta of 0.75 (case Exhibit 5).

4. WACC after recapitalization

The increase in leverage will affect Wrigley’s WACC in at least three ways:

1. Cost of debt: Wrigley’s debt rating will change from AAA (consistent with no debt) to a BB/B rating reflecting the higher risk. The postrecapitalization credit rating is a matter of judgment. It is highly instructive to guide students through a rating exercise for Wrigley’s pro forma recapitalization. This requires computing the range of measures included in case Exhibit 6 and determining where in the ratings range the firm would fall. Comparing Wrigley’s projected results to the benchmarks given in case Exhibit 6 suggests that BB/B is a reasonable call.

Turning to the yields by credit rating given in case Exhibit 7, one can interpolate between BB (12.73%) and B (14.66%) to obtain a cost of debt. The cost used in the remainder of this analysis is 13%, Blanka Dobrynin’s choice.

Yields rise almost linearly across the investment-grade spectrum (AAA to BBB) and then rise curvilinearly at lower debt ratings—this hints at the problem that we will encounter in estimating the cost of equity. 2. Beta: You should unlever Wrigley’s current beta of 0.75, assuming the current values of book debt and the market value of