THE WM. WRIGLEY JR.

COMPANY:
CAPITAL STRUCTURE, VALUATION
AND COST OF CAPITAL

Group 11

ADITYA MUKHERJEE (M002-16)

ATISHAY JAIN (M012-16)
KOUNIK KUNDU (M027-16)
NEERAJ VERMA (M118-16)
Aurora Borealis LLC pursues an “active investor” strategy where they “identify opportunities for a
corporation restructure, invest significantly in the stock of the target firm and then undertake a
process of persuading management and directors to restructure.” Susan Chandler working for
Aurora Borealis LLC was asked by Blanka Dobrynin to research The Wrigley Company as a potential
investment. Under recapitalisation, Chandler must determine whether The Wrigley Company should
issue an equivalent dividend or repurchase an equivalent amount of shares in order to maximise
shareholder value.

Accordingly, Chandler listed the following findings which are critical to making the decision.

1. Market value of common equity- $13.1bn

2. Borrowing capability- $3bn
3. Credit rating of The Wrigley Company- Between B and BB
4. Yield- 13%
5. Revenue growth rate- 10%
6. Earnings growth rate- 9%
7. Total assets (2001)- $1.76bn
8. Marginal tax rate- 40%
9. Pre-tax cost of debt- 13%
10. Market risk premium- 7%
11. Shares outstanding- 232.441mn
12. Wrigley family ownership- 21% of common stock and 58% of Class B stock

We will try to find out the effect on WACC to identify the effect of leverage on the company finances

Cost of Equity (Before Recapitalization)

Market Risk Premium 7%
20 Yr Risk free rate 5.65%
Beta 0.75
Ke 10.900%

Share Price 56.37

O/S Shares (in millions) 232.441
Value of Firm (in $ billions)
Value of unlevered Firm 13.10
Debt capacity 3.00
Value of tax shield 1.2
Value of levered Firm 14.30
MV of Equity in levered firm 11.30
 Financial Ratio Value Credit Rating
EBIT Interest Coverage 1.41 B
Funds from Operations/Debt 18.82% B
Free Op CF/Debt 15.99% BBB
RoC 21.12% A
Op Income/Sales 21.32% A
LTD/Capital 70.15% BB
Tot Debt/Capital 70.15% BB

From the above table we can see that company has high chances of getting a BB or a BBB rating.
Below we try to compare the effective cost of borrowing for different ratings:

Assumed cost of Debt

Tax Rate 40%
Pre Tax cost of Debt (Rating B) 14.66%
After Tax cost of Debt 8.80%
Pre Tax cost of Debt (Rating BB) 12.75%
After Tax cost of Debt 7.65%
Pre Tax cost of Debt (Rating BBB) 10.89%
After Tax cost of Debt 6.54%

WACC (After Recapitalization)

New D/E 0.265
Levered Beta 0.87
Ke (L) 11.74%
D/V 0.210
E/V 0.790
WACC (as per BBB) 10.65%
WACC (as per BB) 10.88%
WACC (as per B) 11.12%

The above calculations show that:

 If the firm gets Credit Rating B, then it’s WACC is more than the cost of equity
 If the firm gets Credit Rating BB, then it’s WACC is almost equivalent to cost of equity
 If the firm gets Credit Rating BBB, then it’s WACC is less than the cost of equity

If the firm gets a B or BB rating then, it is not a good idea to take a loan as taking Debt is not serving
the intended purpose of reducing the WACC for the firm, while adding unnecessary risk to the
capital structure.