Diageo Plc

1446 Words6 Pages
1. How has Diageo managed its capital structure? Do you agree it is conservative?
Diageo was born as the result of merging Grand Metropolitan plc and Guinness plc. Since the beginning the newly formed company maintained conservative financial policies inherited from the two parent companies; and in general from the British financial management style. There are many indications that confirm that Diageo has managed its capital structure using a conservative approach. Firstly, it is worth mentioning that the company has maintained levels of debt way below its capacity to repay, maintaining the EBIT/interest ratio above optimum levels
Secondly, we can see that the credit rating of the company is A+, practically an average of what the parent
…show more content…
2. How would you apply the Equilibrium Theory to Diageo in order to determine the firm’s capital structure policy? Would this analysis result in Diageo being a firm with high or low leverage capacity?
Applying the equilibrium theory to Diageo we can segregate the scale into “benefits of debt” and the “costs of debt”. The analysis of each component of the theory is as follows:
Benefits of debt:
Tax savings – Based on the calculations provided in the case it can be estimated that Diageo has the capability to borrow more debt to some extent without losing it credit rating. This additional debt (if required) will bring additional tax savings in the future (given that Diageo will be able to maintain positive earnings). It is also important to note that the marginal tax rate of 27% will substantially contribute towards the savings.
Management discipline – Diageo’s management has maintained a strict proportion in terms of debt and equity thereby not borrowing capital aggressively to alleviate the value of company on pretense. They have paid out dividends in a regular manner in the range of 35-38% of the operating profit.
Costs of debt:
Bankruptcy cost – The financial statements of Diageo indicate that they have been able to generate steady cash flows and that revenue volatility has been low. A careful analysis of the case also

More about Diageo Plc

Get Access