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The Situation
Worlds largest manufacturer and distributer of chewing
gum.
The industry, branded consumer foods and candy was
intensively competitive and dominated by a few large
players.
Over the last two years, revenues grew at annual
compound rate of 10% and earnings at 9% reflecting the
introduction of new products and foreign expansion.
William Wrigley Jr. Company has a leading market share
and no debt.
n 2001,
shareholders.
Issuing Debt
If Wrigley decides to issue debt, they
will have to pay fixed future interest
payments. This will indicate to investors that
management believes the company will have
strong future cash flows.
Management will choose to issue debt
when they believe equity is undervalued.
Trade-off Hypothesis
As the debt to equity ratio increases
there is a tradeoff between the interest
Capital Structure
D+E
($
in
Millions)
D
E
D/
E/
D/E
(D+E)
Unlevered
Recapitaliz
ed
Dividend
Recapitaliz
a:on
Recapitaliz
ed
Buyback
13,10
3
- 13,10
3
13,10 3,000
3
10,10
3
0.2290
13,10
3
3,000
10,10
3
0.2290
10,10
3
3,000
7,103 0.2969
(D+E)
1
0.7710
0.2969
0.7710
0.2969
0.7031
0.4224
Buyback
Share
PV
PV
Tax
Price
Shield
(Tc
x
Debt)/Shares
Adjusted
Share
Price
56.37
56.37
56.37
5.16
5.16
61.53
61.53
232.441
232.441
61.533
Shares
(Millions)
Repurchase
Shares
Price
56.37
232.441
-
Repurchased
= (Debt /
Repurchase
Price)
Adjusted
Shares
(Millions)
48.755
Shs
232.441
232.441
183.686
Market
Equity
Recapitalized
Value
of
Unlevered
Recapitalized
Shield
Assumptions in tax shield valuation:
Debt levels are fixed (Wrigley will hold $3 billion
debt in perpetuity).
Interest rates and tax rates remain constant
PV of Interest Tax Shield = T
V alue will increase on a per share basis by:
Adjusted Share Price = Current MV SP + (TC x D)/Shares
Investment Grade
AAA
AA
A
23.4
13.3
6.3
BBB
3.9
Non-Investment
BB
2.2
B
1.0
214.2
156.6
65.7
33.6
42.2
22.3
30.6
12.8
19.7
7.3
10.4
1.5
35.0
23.4
26.6
24.0
18.1
18.1
13.1
15.5
11.5
15.4
8.0
14.7
(1.1)
21.1
33.8
40.3
53.6
72.6
5.0
35.9
42.6
47.0
57.7
75.1
Beta Calculations
Re-Levering
Unlevered
Beta
Bu
Be
= Bu
/
]
Be[1+(1-t)
=
/1+(1 Tc
/) Bu
x
No
(D/E)
Tc
Be
Be
Debt 0.75
No
-
-
0.40
0.75
Beta
Recapitalized
0.8694
0.2654
(D/E)
Bu
Debt 0.40 0.7
5
0.7500
0.40
0.7
5
0.40
0.7
5
Dividend
0.40
Recapitaliza:on
0.8694
0.2654
0.7
5
Recapitalized
Buyback
0.8804
0.2897
We need to unlever and relever Wrigleys beta to account for
the change in capital structure. The beta increases when we
take on debt and then again when we repurchase stocks
because the debt to equity ratio is increasing. The beta is a
measure of the riskiness of the firm which increases because
of the increase in debt.
0.13 0.60
v.
EBIT
Analysis
AVer
Recapitaliza:on
Before
Recapitaliza:on
AssumpAons
/
With
WorstNo Repurchase
Most
Best
Case
Case
-10%
Likely
+10%
Interest
Rate
Debt
13.0%
Dividend
AssumpAons
on
Worst
Case
-10%
Most
Likely
462,020
Debt
Debt
Pre-
-
($
in
Best
Case
+10%
513,356
564,692
-
-
462,020
184,808
Recap
513,356
564,692 Tax
Rate
($
in
000)
Tax Rate
40.0%
72,020
40.0%
123,356 174,692
205,342
in
225,877 000,
000,
Except
Except
EPS)
28,808
EPS)
49,342
69,877
OperaAng
Interest
Taxable
Taxes
Interest
Rate on
564,692
462,020
0.0% 513,356
($
in
000)
390,000
3,000,000
390,000 390,000
Debt
Income
277,212
232.44
Net
$1.19
308,014
338,815 Expense
Income
Taxable
232.44
232.44
$1.33
$1.46
Income
OperaAng
Income
(EBIT)
43,212
74,014 104,815
-
Interest
Expense
Income
232.44
Taxes
$0.19
232.44
232.44
$0.32
$0.45
($
(EBIT)
Shares
(Millions)
Earnings
Net
Income
Outstanding
Shares
Outstanding
Per Share
(Millions)
Earnings
Impact on EPS
EPS
v.
EBIT
Before
Analysis
Recapitaliza:on
Per
Share
AssumpAons
Interest
Most
Best
Best
Case
Case
+10%
Likely AVer
+10%
Recapitaliza:on
Interest
With Share
Rate
on
Debt
462,020
462,020
Repurchase
513,356Debt
564,692
513,356 564,692
13.0%
($
in
000)
3,000,000
-Tax Rate
40.0%
390,000
390,000
390,000
-
0.0%
on
Rate
Debt
($
Pre-
Debt
in
Recap
Worst
Worst
Most
Case
Case
-10%
Likely
-10%
AssumpAons
-
40.0%
000)
Tax
72,020
Rate
($
OperaAng
Income
(EBIT)
Interest
in
EPS)
in
EPS)
28,808
(EBIT)
Expense
Interest
Taxable
Income
Taxable
Income
Taxes Taxes
Net
Income
Net Income
Shares
Outstanding
Shares
(Millions)
(Millions)
Earnings
Per Share
Earnings
43,212
183.69
$0.24
462,020
123,356
184,808
49,342
277,212
513,356
174,692
205,342
69,877
74,014
308,014
104,815
183.69
232.44
183.69
232.44
$1.19
$0.40
564,692
000,
000,
225,877
OperaAng
338,815
Expense
232.44
Outstanding
$1.33
$1.46
$0.57 Per Share
Except
($
Except
Income
-
Repurchase
AVer
Share
Class
Stock
Common
Ownership
%
Wrigley All
Family
Share
Others
Shares Family
(Millions)
Shares
58%
42%
Held
(Million
21%
79%
s)
Wrigle All
y
Class Family
Others Total
Common
Common
Stock
24.7
Total
42%
79%
100%
100%
Shares
Held
(Millions)
Wrigley All
Family
Others
Common
Stock
Total
Wrigley All
Family
17.9
Others
Total
149.9
Total
-
10.2
189.8
64.6
Held
Others
58%
21%
42.6
39.9
Ownership
%
Wrigle All
y
167.9
38.5
48.8
38.5
48.8
10.2
232.4
24.7 B 17.9
Stock
29.6 -111.4
141.0
54.4
183.7
129.3
42.6
Votes
Votes
Class
B
Common
Stock
Common
Stock
Total
Per
Share
Votes
(Millions)
Wrigley
Votes
Wrigley All
Family
Per
Share
Family
10
Others
Total
10
247.3
247.3
179.1
426.4
29.6
111.4
141.0
276.9
290.5
567.5
1
1
VoAng
Interest
%
VoAng
287.2
Interest
Class
29.1%
Common
Wrigley
Wrigley
Family
Family
B
%
All
All
Others
Others
Common Stock
69.2%
43.6%
Stock
30.8%5.2%19.6%
Total
100.0% 48.8%
Total
Total
40.1%
31.6% 75.1%
6.5%
24.9%
51.2%
24.3%
46.6% 53.4%
100.0%
Financial Distress
Leads to decrease in customers, decrease
in skilled employees and a reduction in R&D.
The threat of financial distress will cause
managers to purse certain strategies.
Agency costs are much higher when the
firm is close to bankruptcy.
Signaling
Capital Structure decisions are complicated
due to signaling.
Wrigleys managers have more information
about the firms business and finances and can
try to manipulate signals.
Dividend Signaling
Asymmetric information
Stocks price will generally increase
when the firm announces an increase in
dividends.
Thus, increased dividends cause the
stockholders to increase their
expectations of future earnings and cash
flows.
More flexibility
Offset to dilution
Repurchase as investment
Tax advantage
Executive compensation
2003
2004
2005
2006
Wrigley
0.3847 0.3842
0.4535
1.014
0.952
Hershey's
1.5374 2.4862
1.7992
3.194
5.0834
Tootsie Roll
0.2266 0.2399
0.4237
0.3179
0.2552
Questions?