Diageo Capital Structure Essay

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1. What do you think about the capital structure policies Diageo has pursued in the past. Do they make sense? How does it compare to Diageo’s competitors’ policies? Which competitors would make for the best comparison? (40%) Diageo was formed from the merger of Grand Metropolitan plc and Guinness plc. Before the merge, both companies used little debt (based on the book D/E ratio and net debt to total capital in the table below) to finance themselves which helped them gain and maintain high credit rating (A and AA respectively). After the merge, Diageo wanted to take the same path by maintaining the interest coverage between 5 and 8 (through actions such as new debt issuance, share repurchase programs shown in figure 1) and having…show more content…
* Diageo’s book gearing (59%) is slightly lower than average spirits’ segment figure, higher than the average book gearing of competitors in beer and beverage industry, lower than package food and fast food industry averages. * Diageo’s market gearing (25%) is slightly lower than average spirits’ segment figure, higher than the average market gearing of competitors in beer, beverage and package food industry averages. Given its current prospects and strategy, the appropriate credit rating targeted by managers is an A. Exhibit 2 shows that spirits and wine is the best profitable business and we know Diageo’s plan to focus on this business. Let’s compare it with Allied Domecq, one of its major rivals in the alcoholic beverage industry. Allied Domecq has a way higher book gearing and a slightly higher market gearing. However, it has a credit rating of A-. With its positive and increasing net income, this could mean that Diageo may take up more debt (probably up to its competitor ratio level) without having to fear about a potential downgrade.
2. Why is Diageo selling Pillsbury and spinning off Burger King? How might value be created through these transactions? (20%)
Exhibit 2 shows that Pillsbury represents 24% of Diageo’s operating profit in FY00 while Burger King represents 10%. Spirits and wine is the biggest division (high operating margin) of the firm and also the fastest growing with sales growth of 8% for the year. Guinness was
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