Wrigley Jr. Company Essay Example for Free

Wrigley junior Company micklevas1.0 IntroductionIn June 2002 Blanka Dobrynin, a managing director of Aurora Borealis hedge fund, considers the possible gains from increasing the debt gravidization of The Wm. Wrigley Jr. Company. Blanka suggests Wrigley raise the amount of $3 billion in debt of the hoodization while Wrigley has been conservatively financed and remained no debt at the end of 2001. This report is aiming to analyze whether Wrigley should use $3 billion debt recapitalization to all pay dividends or to repurchase shargons.2.0 Current Capital StructureGenerally, devoteds can choose among various capital structures in station to growth overall market value of the company. It is proposed however, that Wrigley issues $3 billion in debt.According to the trade-off theory, the best capital structure does exist (Kraus and Litzenberger, 1973). The higher aim of debt may adjoin both bankruptcy and financial live that lead the firm to go or avoid bankruptcy. Howeve r, there are several advantages of raising debt capital. Firstly, tax-deductions which slack the cost of debt. Secondly, channelholders do not have to share the profit when the firm has excess, as debt holders are check to their fixed return. Finally, stockholders do have voting right but debt holders do not which means the stockholders are controlling the business.3.0 The Impacts of Proposed ChangesThe decision to amplification $3 billion debt capitalization of the Wm. Wrigley Jr. Company by Blanka Dobrynin is to perfect the total value of the company. Firms are often inclined to choose debt over uprightness in order to use the tax casing.As the increasing of $3 billion debt in Wrigleys capital structure, its equity value leave increase by $1.2 billion due to the tax shield. Also this proposal of recapitalization go forth help Wrigleys equity decrease by only $1.8 billion when they payout $3 billion debt, due to the offset by the $1.2 billion tax shield.According to our c alculations, through recapitalization Wrigleys total asset will be $14,459,826, which consists of $3,157,127 debt and $11,302,699 equity. In normal, firms prefer to keep a higher level of debt/equity ratio to determine larger total capital to increase the firms total value. But it is obvious that to a greater extent debt means more risk and more payout.By assessing the spreadsheet, it suggests several reasons for and against the acquisition of debt. If the Wrigleys debt increases, its credit roam will drop from AAA to BB, which leads to more cost of future financing and value of stocks.However, as debt can increase firm value up to a degree, we commend that Wrigleys find an optimal capital structure through further analysis of whether $3 billion of debt provides the smallest possible Weighted Average personify of Capital (WACC) for the firm.3.1 Flexibility and ReservesAccording to Denis (2011), financial tractability is the ability of a firm to enforce rise decisions and ha ndle problems timely. Moreover, the firm should always maximize their firm value on any unheralded changes in investment opportunity and cash flows of the firm. In addition, the firm should prudently raise their capital in the computable times to avoid stretching their capabilities too far, and in order to preserve their ability to choose to either borrow or issue equity in future times of need. Therefore, the lower level of firms debt, the more financial flexibility a firm has (Investopedia, 2014).Due to that $3 billion pertly debt existing, the financial flexibility of Wrigley will decline this financial activity leads to lower ability to borrow gold in the future if there are any profitable investment opportunities or any unexpected internal or external shocks.3.2 The Book and Market Price per ShareAs is visible from the appurtenance One, the decision of how to use the funds elevated through debt is an important one as it will extend to both the damage per share and the b ook value per share. The price per share will decrease to $48.63 if the debt raised is used to pay out a dividend (decrease in the value of equity), whereas the price per share will increase to $61.53 if it is used to repurchase shares. However, the issuance of debt can have signalling final results for investors. Generally, when firms issue debt it signals to investors that the firm is in a good financial situation as the firm is able to undertake repayments of future interest.Furthermore, the clientele effect can impact the stock price because it assumes that the investors are attracted to the company for its policies and when these change the investors will react and do their stock accordingly (Moles Terry, 2005). In addition to this, the issuance of debt and repurchase of stock could signal to investors that managers believe the stock in undervalued.Despite this change in price, the Weighted Average Cost of Capital (WACC) will give a more accurate representation of what the c hange in capital structure implies for the firm, by fetching account the costs of debt.3.3 Weighted Average Cost of CapitalBefore recapitalisation Wrigleys WACC was equal to its cost of equity (ke), which was calculated at 10.95%. After capitalisation it was found that Wrigleys WACC decreased to 10.29%. This follows the general pattern of increasing debt resulting in a lower WACC. The cost of debt (kd) rate of 13% was used later we assessed the key industrial financial ratios and comparedthem with that of Wrigleys (See Appendix 2) to conclude that it was in the range between the BB rate of 12.753% and B 14.663% (see Appendices 3 4). Although WACC has decreased, which means that every $1 that Wrigley raises in capital from investors it must pay at least $10.30 in return, its genus Beta has increased from 0.75 to 0.87. This means that Wrigleys investment is still less(prenominal) volatile than the market, but it has become more in line with the market after recapitalisation. Howeve r Beta will not in corporeal the risk of financial distress that becomes present once Wrigley have taken out the debt. 4.0 Conclusions and RecommendationsTherefore, from our analysis we know that an increase in debt can have adverse affects on flexibility and can have costs associated such as bankruptcy, agency and distress costs, however, due to the tax shield affects and the decrease in WACC we believe there should an increase in the level of debt. In addition, the share price change is not consistent with the change in WACC and it could be assumed that the distress costs associated with the increase in debt would mean the price would actually remain relatively steady to reflect the negligible change. We recommend that Wrigley issue $3 billion of debt in the form of share repurchase plan because this scenario has no formation impact upon WACC slightly decreasing from 10.95% to 10.29%, and as a companys main goal is to increase its shareholders value. Furthermore there are fewer risks in terms of clientele effect and signalling effect, while in like manner allowing the Wrigley family to maintain their control with their high portion of shares. However, we recommend further analysis to determine what is the optimal level of debt by finding the lowest possible WACC, and therefore maximising the companys value.5.0 Reference bring upDeAngelo, H., DeAngelo, L., Whited T.M., (2011) Capital structure dynamics and transitory debt. Journal of Financial economicals, 99, 235261.Denis, D J. (2011) Financial flexibility and corporate liquidity. Journal of Corporate Finance, 17(3), 667-674.Franco Modigliani Merton H. Miller . (Jun., 1958)The American Economic Review, Vol. 48, No. 3. , pp. 261-297.Investopedia. (2014). Complete Guide To Corporate Finance. Retrieved from http//www.investopedia.com/walkthrough/corporate-finance/5/capital-structure/capital-structure.aspxInvestopedia (2014). Optimal Capital Structure. ONLINE Available at http//www.investopedia.com/terms/ o/optimal-capital-structure.asp. Last Accessed 19 Aug 2014.Kraus, A. and R. Litzenberger (1973). A State-Preference model of optimal financial leverage. Journal of Finance, Vol. 28, pp. 911-922.Moles, P., Terry, N. (2005). Clientele effect. The Handbook of International Finance Terms. Retrieved from http//www.oxfordreference.com.ezp01.library.qut.edu.au/view/10.1093/acref/9780198294818.001.0001/acref-9780198294818-e-1351Myers, S.C. (2001). Capital structure. Journal of Economic Perspective, Vol. 15, pp. 81-102.Tsuji, C. (2012) A discussion on the signalling hypothesis of dividend poilcy. The Open Business Journal, 5, 1-7. Retrieved from http//benthamopen.com/tobj/articles/V005/1TOBJ.pdf