The Wm. Wrigley Jr. Company: Capital Structure, Valuation, and Cost of Capital

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Before Recapitalization

After Recapitalization - Dividend

After Recapitalization - Repurchase

Market Value Equity

13.1 Billion

11.3 Billion

11.3 Billion

# of Outstanding Shares

232.441 Million

232.441 Million

183.677 Million

Add. Cash Received

N/A

3 Billion

0

Share Price

$56.36

$48.61

$61.52

Value to Shareholders

$56.36

$61.52

$61.52

P/E ratio

42,38

147,3

153,8

The effect from the recapitalization

Borrowing $3 billion to recap will generate an amount of $1.2 billion in equity value due to tax effects. This effect is calculated with the assumption that Wrigley commits to maintain their debt in perpetuity. A net adjusted value per share is then $ 61,5210.

As a result of the large payout the Book Equity will become negative, since the amount of treasury share will rise with $ 3 billion. The market value of equity will decline by (11.3 – 13.1) 1.8 billion, which is to some extent offset by the gain of the debt tax shield. The accounting values will not give any indication of the tax shield.

The reduction in outstanding shares might create influence to some control groups if the shares with the voting rights were changed. We assume that the shares which was trading and repurchased was only the common shares, since the investors that hold the voting shares are not so willing to sell.

Inexperienced investors often look only at book values as determining the value of a company. Before recapitalization the equity of Wrigley did account for 72 % of Wrigley’s book value of capital and the book value per share is ($1,276,287 / 232,411) $5.49, which is less than 10 % of Wrigley´s share price, $56,3584, before the recapitalization. This huge difference comes from that book values are backward looking and they therefore ignore essential financial considerations.

2.2 Impact on Debt Rating

Wringley is assuming a debt rating between BB and B for the 3 bilion dollar debt. Various key industrial financial ratios could be used to measure if the debt rating is correct for the company (exhibit 6):[3]

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With a 1,5 interest coverage or lower a company’s ability to meet interest expenses may be questionable, although the company still have good chances to cover the interest. Only an interest coverage below 1 indicates the company is not generating sufficient revenues to satisfy its expences.

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A 6,87 % FFO to debt ratio shows Wringley’s current position to pay its debts from operating income; the higher ratio the stronger position. Need to be said here is that other resources than funds from operations must be considered when repaying debt; Wringley might for example take out an additional loan, sell assets or issue new stock to raise funds in the future.

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Wringley’s 4,94 % FOCF/total debt ratio shows the company’s ability to cover total debt with its yearly cash flow from operations.

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Return on capital indicates how effective a company is at turning capital into profits. Comparing Wringley’s ROC with its cost of capital (WACC) reveals whether invested capital was used effectively. In Wringley’s case the ROC of 23,4 % does cover the cost of capital of 10,82 % (before recapitalization). In capital following is included: total current liabilities, total-noncurrent liabilities without the bank loan since it hasn´t financed the operations, total equity excluded from Treasury stock.

[pic 18]

If only looking at operating marning when deciding on credit rating Wringley would in qualify for an AA rating. This means the company has a great portion of revenue left over after paying for variable costs. This is an important factor for Wringley because a healthy operating margin is required to be able to pay for fixed costs, such as interest on debt capital.

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By using this ratio we see the company’s risk exposure. As debt financing could be considered riskier than equity financing, Wringley’s 67% leverge ratio shows the amount of risk exposure when only looking at this ratio.

AAA

AA

A

BBB

BB

Wrigley

B

Interest Coverage

23,4

13.3

6.3

3.9

2.2

1.32

1

FFO/Total Debt

241,2 %

65.7%

42.2%

30.6%

19.7%

6.87%

10.4%

FOCF/Total Debt

156,6 %