The Wm. Wrigley Jr. Company: capital structure,
valuation, and cost of capital
In June 2002, a managing director of an active-investor hedge fund was considering the possible gains from increasing the debt capitalization of the Wm. Wrigley Jr. Company. Wrigley had been conservatively financed and at the date of the case, carried no debt.
The tasks for the student are to:
Estimate the potential change in value from relevering Wrigley using adjusted present value analysis. Assess the impact on the weighted-average cost of capital, earnings per share, the credit rating of the firm, and voting control of the Wrigley family. Consider the merits of dividend or share repurchase as a means of returning cash to shareholders.
The case’s central teaching objective is to explore the financial effects of the capital structure change. Significant here is the trade-off between the tax benefits of debt and the associated costs in the form of financial distress and loss of flexibility. Related issues include signaling to investors, clientele effects (control considerations for the Wrigley family), and incentives created for directors and managers. Finally, the case affords a comparison of dividends and share repurchases.
Suggested Questions for Advance Assignment
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. Wrigley’s outstanding shares?
b. Wrigley’s 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 Wrigley’s current (prerecapitalization) weighted-average cost of capital (WACC)? 4. What would you expect to happen to Wrigley’s 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 Wrigley’s directors to undertake the recapitalization?
Depending on the preparation of the students, the instructor could add further guidance when approaching the analysis regarding the levering and unlevering of betas, and when using adjusted present value analysis or the Modigliani-Miller theory of capital structure and value. The Appendix to this note contains a brief exposition of levered betas suitable for use with students.
Possible Supporting Materials
The instructor may find it useful to assign this teaching note’s Appendix as background reading on leverage and corporate valuation. In addition, the “Technical Note: Structuring Corporate Financial Policy,” (Case 32) summarizes a range of practical considerations. Numerous textbooks in finance present the conceptual foundations for capital structure analysis. One example is Brealey, Myers, and Allen, Principles of Corporate Finance, (8th edition), (New York: McGraw-Hill/Irwin, 2006), Chapters 17, 18, and 19.
The Microsoft Excel spreadsheet file (Case_34.xls) supports student preparation of the case analysis. Also, TN_34.xls supports instructor preparation—please do not share the contents of this teaching note or the instructor model with the students. Suggested Teaching Plan
This teaching plan presumes that students already have some exposure to basic capital structure theory. The following questions give an overview of an 85-minute class.
1. In the abstract, what does Dobrynin hope to accomplish with her active-investor strategy? 2. What is the nature of Wrigley’s business? Is this a healthy, growing company? What would a major recapitalization of Wrigley signal to investors? 3. What will be the effect of issuing $3 billion in new debt and using the proceeds to pay a dividend or to repurchase shares on: a. Wrigley’s market value per share?
b. Wrigley’s number of outstanding shares?
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