Statement of the Problem:
The William Wrigley Company is the world’s largest manufacturer and distributor of chewing gum. Over the preceding two years, revenues had grown at an annual compound rate of 10% and earnings grew 9%, these increases are a direct result of the introduction of new products and foreign expansion. As illustrated in the graphical diagrams in Exhibit 4 (appendix), the company’s stock price had significantly outperformed the S&P 500 Composite Index, and performed slightly ahead of its industry index. At the end of 2001 The William Wrigley Company had total assets of $1.76 Billion and no debt. With all these highlights and bright spots of William Wrigley one may ask what problem a company such as this has. The answer to that question may seem odd, but the problem this company has is that it has no debt. Interest rates are at their lowest point in 50 years, but debt financing is at a decline. Many companies are missing opportunities to add value to their company, and in extreme cases such as The William Wrigley Company, mature firms may use no debt at all.
Borrow $3 Billion at a credit rating between BB and B, to yield 13%, with the intention to pay an equivalent dividend or to repurchase an equivalent value of shares.
Borrow less ($1-$1.5 Billion) and test the company’s ability to effectively leverage debt before borrowing maximum amounts. Borrow $3 Billion at a credit rating between BB and B, to yield 13%, with the intention to use the cash flows to invest in new capital projects while keeping its own cash and reserves on hand.
Continue using the current capital structure.
Analysis of Alternatives:
Alternative 1: If The William Wrigley Company where to borrow $3 Billion this action could affect the firm’s share value, cost of capital, debt coverage, earnings per share, and voting control. One benefit of leveraging debt is that the value of the firm will be increased by shielding cash flows from taxes. This in turn will add value to the unlevered firm to yield the value of the levered enterprise. Other impact of a successful levered restructuring would be on the credit rating of the company. One factor of the assumed credit rating of BB/B is probably due to the fact that company has no credit history. If the company is successful in adding value and paying interest payments in a timely fashion then the company could see an upgrade in its ratings to investment grade which would attract bigger investors, decrease its cost of borrowing, and allow the company to add value at an extremely higher pace than it can with its current structure and ratings. Finally the company could use its added cash flow from restructuring to buy back shares of the company and increase its voting control in the company so that it may have more control over the direction of the company and its assets.
Alternative 2: For a company that does not have a history of leveraging debt borrowing may seem like a big risk if one does not fully understand the full benefits of a levered restructuring. In order to smoothly phase into the process one may suggest the company borrow a smaller amount initially and then determine if they want to make this a recurring practice in the future based on the analysis of a mini restructuring.
Alternative 3: Companies are continuously looking to upgrade and expand operations but they may not want to hinder cash flows or tap into reserves in order to do so. With this being said, instead of borrowing with the intention of repurchasing shares or paying dividends, they can borrow with the intention of investing in capital projects. For a company such as Wrigley this could consist of producing new flavors of products, entering into new markets, or even investing outside of its niche without the direct use of its primary cash flows.
Alternative 4: The final alternative for the company is to of course continue using the capital structure that is in...
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