Essay on Wrigley Case Study

2283 WordsApr 3, 201210 Pages
Introduction The William Wrigley Jr. Company is the largest manufacturer and distributor of chewing gum, with a well consolidated market position. Due to new products and foreign expansion, its previous revenues have grown at an annual rate of 10% and its stock price regularly outperforms the S&P 500 as well the industry index. It is a conservatively financed firm with total assets of $1.76 billion and zero debt as of 2001. The purpose of this case study revolves around how should they use a $3 billion debt issue to restructure its capital that would add the most value for the shareholders of Wrigley. The decision of how to use the debt will impact the firm’s stock price, cost of capital, debt coverage, earnings per share and voting…show more content…
The cost of capital is calculated dependant on what capital structure or debt to equity ratio the firm wishes to employ. In Wrigley’s case, prior to re-capitalization, it was purely equity funded therefore the cost of equity, (ke = 10.9%), is the total WACC. Due to the tax shielding benefits, the incorporation of debt into Wrigley’s capital structure would result in not only an increased firm value, but a lower WACC (Arzac & Glosten 2005). With all revenue streams remaining equal prior to re-capitalization, the value of the firm has to increase as the cost of capital has now been lowered. Table 1 below illustrates the introduction of 22.9% debt into Wrigley’s actually lowers the WACC to 10.83%, (down from 10.9%). The benefits of cheaper capital far outweigh the negatives of being over leveraged in a market downturn in the case of Wrigley’s. Chewing gum is an item of very low technology and the invention of a replacement to gum is very unlikely as would be a decrease in product revenue during a recession. Before Re-capitalization After Re-capitalization Weight of Equity 100% 77.10% Weight of Debt 0% 22.90% Pre-tax Cost of Debt N/A 13% Beta 0.75 0.869 Cost of Equity 10.90% 11.74% WACC 10.90% 10.83% Table 1. *Calculations in Appendix 1 Debt Ratings Before recapitalisation, Wrigley’s had zero debt and, thus, an AA – AAA credit rating was approximated. Prior to

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