COMPANY
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Contents
Objectives ..................................................................................................................................................... 1 Management Summary ................................................................................................................................ 2 Active Investor Strategy ................................................................................................................................ 2 Effects of $3 Billion in New Debt for Dividend or Stock Repurchase ............................................................ 2 a. b. c. d. e. f. Outstanding Shares ..................................................................................................................... 2 Book Value of Equity ................................................................................................................... 2 Price per Share............................................................................................................................. 3 Earnings per Share ....................................................................................................................... 3 Debt Interest Coverage Rations and Financial Flexibility ............................................................ 3 Outstanding Shares .......................................................................................................................... 3
Wrigleys Current Weighted Average Cost of Capital (WACC)...................................................................... 3 Debt Proceeds to Pay a Dividend or Repurchase Shares .............................................................................. 4 Wrigleys Recapitalization ............................................................................................................................ 4 Should Wrigleys directors undertake the recapitalization? ........................................................................ 5 Appendices.................................................................................................................................................... 6
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Objectives
This report seeks to answer the following five questions about William Wrigley Jr.: 1. In the abstract, what is Blanka Dobrynin hoping to accomplish through her active-investor strategy? 2. What will be the effects of issuing $3 billion of new debt and using the proceeds either to pay a dividend or to repurchase shares on: a. Wrigleys outstanding shares? b. Wrigleys book value of equity? c. The price per share of Wrigley stock? d. Earnings per share? e. Debt interest coverage ratios and financial flexibility? f. Voting control by the Wrigley family?
3. What is Wrigleys current (pre-re-capitalization) weighted-average cost of capital (WACC)? 4. What would you expect to happen to Wrigleys WACC if it issued $3 billion in debt and used the proceeds to pay a dividend or to repurchase shares? 5. Should Blanka Dobrynin try to convince Wrigleys directors to undertake the recapitalization?
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Management Summary
The analysis identifies both risks and benefits associated with undertaking the recapitalization for Wrigley. Given the reduction WACC, Wrigley should undertake the recapitalization. The conclusions reached in the following will illustrate the effects that the recapitalization will have on both equity in terms of outstanding shares, voting powers, and earnings per share. It will also illustrate the effect of WACC in a B/BB environment.
b.
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not changed since both sides of the balance sheet are increased by $3 Billion. The book value of the company should not be affected by a dividend payout.
c.
d.
e.
f.
Outstanding Shares
Issuing 3 billion dollars of new debt to pay dividends should not have any effect on the voting control of the Wrigley family. Using that money to buy back shares will have an effect on the voting right of the family. When shares are repurchased they are put in the company treasury and are no longer outstanding. Then the Wrigley familys percent of outstanding shares would rise giving them more voting control. They also have 58% if the outstanding shares of the Class B shares which have a 10 to 1 voting advantage over the common share class. These shares are not affected by the buyback.
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WACC
rD * (1-Tc) * D/V + rE * E/V Unlevered Equity Beta Risk free rate Equity Market Risk Premium Corporate tax rate (tc) re rd (net cost of debt) debt/equity Wdebt Wequity WACC 0.750 4.86% 7.00% 40.0% 10.11% 0.000% 0 0.000 1.000 10.110%
Wrigleys Recapitalization
Dobrynin estimates the Cost of Debt to be around 13%, placing it in line with the B/BB bonds. The leveled WACC was mostly calculated considering the unleveled WACC as the opportunity cost of capital (r) and estimating the cost of equity re, Modigliani and Miller prop2, as re = r + (r rd) D/E On one instance the WACC was calculated by leveraging Beta and afterwards using CAPM. l = u + u(1- Tc) D/E Wrigleys market equity after taking debt and before paying dividends was calculated using Modigliani and Miller prop 1, as Equity = Equityunlevered + Tc * D
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WACC Calculation
Unlevered Levered (BB) Levered (Dobr) Levered(Dobr) Levered (B) CAPM MM2 MM2 CAPM+lv beta MM2 Equity Beta 0.75 0.869 Risk free rate (tr) 4.86% 4.86% 4.86% 4.86% 4.86% Expected return on market 11.86% 11.86% 11.86% 11.86% 11.86% Corporate tax rate (tc ) 40.0% 40.0% 40.0% 40.0% 40.0% Cost of equity (re) 10.11% 10.762% 10.723% 10.95% 10.458% Cost of debt (rd) 5.850% 7.652% 7.800% 7.800% 8.798% Debt/Equity 0 0.265 0.265 0.265 0.265 Wdebt 0.000 0.210 0.210 0.210 0.210 Wequi ty 1.000 0.790 0.790 0.790 0.790 Wrigley's Equity (market) 13.103 11.303 11.303 11.303 11.303 Wrigley's Debt 0.000 3.000 3.000 3.000 3.000 Cost of debt 12.753% 13.000% 13.000% 14.663% Net cost of debt 7.652% 7.800% 7.800% 8.798% WACC
11% 10% 9% 8% 7% 12.753% 13.000%
10.110%
9.468%
9.456%
9.632%
9.372%
WACC/Cost of Debt
13.000%
14.663%
because this number only changes when a dividend is paid. The only negative of this transaction would be that next years earnings after taxes would drop due to the dividends. Finally, the cost of equity was 13% which is B/BB, our WACC is declining of unlevered 10.110, levered BB of 9.409%, levered (DoBr) of 9.396, and levered (B) of 9.304% support our conclusion that the board should undertake the recapitalization.
Appendices
Levered Beta Calculation
Unlevered Levered
CAPM
Unlevered Levered CAPM = .0486 +.750 (.07) = CAPM = .0486 + 0.869 (.07) = 10.110% 10.943%
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