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Team 14 Constantine Brocoum Courtney Delia Stephanie Doherty David Dubois Radu Oprea November 19th, 2009
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Contents
Contents..................................................................................................................... ii Objectives................................................................................................................... 1 Management Summary..............................................................................................2 Active Investor Strategy.............................................................................................2 Effects of $3 Billion in New Debt for Dividend or Stock Repurchase...........................2 a. Outstanding Shares...........................................................................................2 b. Book Value of Equity.........................................................................................3 c. Price per Share..................................................................................................3 d. Earnings per Share ...........................................................................................3 e. Debt Interest Coverage Rations and Financial Flexibility...................................3 f. Outstanding Shares............................................................................................3 Wrigleys Current Weighted Average Cost of Capital (WACC)....................................4 Debt Proceeds to Pay a Dividend or Repurchase Shares............................................4 Wrigleys Recapitalization.........................................................................................4 Should Wrigleys directors undertake the recapitalization?........................................6 Appendices.................................................................................................................6
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Objectives
This report seeks to answer the following five questions about William Wrigley Jr.: 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. Wrigleys outstanding shares? b. Wrigleys 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 Wrigleys current (pre-re-capitalization) weighted-average cost of capital (WACC)? 4. What would you expect to happen to Wrigleys 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 Wrigleys directors to undertake the recapitalization?
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Management Summary
The analysis identifies both risks and benefits associated with undertaking the recapitalization for Wrigley. Given the reduction WACC, Wrigley should undertake the recapitalization. The conclusions reached in the following will illustrate the effects that the recapitalization will have on both equity in terms of outstanding shares, voting powers, and earnings per share. It will also illustrate the effect of WACC in a B/BB environment.
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as treasury stock. Paying a dividend with this borrowed money will not affect the number of shares outstanding.
b.
c.
d.
e.
f.
Outstanding Shares
Issuing 3 billion dollars of new debt to pay dividends should not have any effect on the voting control of the Wrigley family. Using that money to buy back shares will have an effect on the voting right of the family. When shares are repurchased they are put in the company treasury and are no longer outstanding. Then the Wrigley familys percent of outstanding shares would rise giving them more voting control. They also have 58% if the outstanding shares of the Class B shares which have a 10 to 1 voting advantage over the common share class. These shares are not affected by the buyback.
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Wrigleys Recapitalization
Dobrynin estimates the Cost of Debt to be around 13%, placing it in line with the B/BB bonds. William Wrigley Junior Page 4
The levered WACC was mostly calculated considering the unlevered WACC as the opportunity cost of capital (r) and estimating the cost of equity re, Modigliani and Miller prop2, as re = r + (r rd) D/E On one instance the WACC was calculated by leveraging Beta and afterwards using CAPM. l = u + u(1- Tc) D/E Wrigleys market equity after taking debt and before paying dividends was calculated using Modigliani and Miller prop 1, as Equity = Equityunlevered + Tc * D
Unlev ered L evered(B ) L B evered(D obr) L ered(D ev obr) L evered(B ) CAPM MM2 MM2 CAPM+ beta MM2 lv Equity Beta 0.75 0.869 Risk free rate (tr) 4.86% 4.86% 4.86% 4.86% 4.86% Expected return on market 11.86% 11.86% 11.86% 11.86% 11.86% Corporate tax rate (t c) 40.0% 40.0% 40.0% 40.0% 40.0% Cost of equity (re) 10.11% 10.762% 10.723% 10.95% 10.458% Cost of debt (rd) 5.850% 7.652% 7.800% 7.800% 8.798% Debt/Equity 0 0.265 0.265 0.265 0.265 Wdebt 0.000 0.210 0.210 0.210 0.210 Wequity 1.000 0.790 0.790 0.790 0.790 Wrigley's Equity (market) 13.103 11.303 11.303 11.303 11.303 Wrigley's Debt 0.000 3.000 3.000 3.000 3.000 Cost of debt 12.753% 13.000% 13.000% 14.663% Net cost of debt 7.652% 7.800% 7.800% 8.798% WAC C
11% 10% 9% 8% 7% 12.753% 13.000%
1 .1 0 0 1%
9 6% .4 8
9 5% .4 6
9 3% .6 2
9 7% .3 2
WACC/Cost of Debt
13.000%
14.663%
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Appendices
Levered Beta Calculation
Unlevered Levered
0.75 0.869
C APM
Unlevered Levered CAPM =.0486+ (.07) = .750 CAPM =.0486+0.869(.07) = 10.110% 10.943%
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