Diageo was born as the result of merging Grand Metropolitan plc and Guinness plc. Since the beginning the newly formed company maintained conservative financial policies inherited from the two parent companies; and in general from the British financial management style. There are many indications that confirm that Diageo has managed its capital structure using a conservative approach. Firstly, it is worth mentioning that the company has maintained levels of debt way below its capacity to repay, maintaining the EBIT/interest ratio above optimum levels
Secondly, we can see that the credit rating of the company is A+, practically an average of what the parent …show more content…
The risk of suppliers can also be considered low as Diageo mostly deals with products that need raw materials that can be traded on exchanges or OTC, therefore not relying on a limited number of suppliers. Given the nature of the businesses which Diageo is planning to divest (packaged food and restaurant) the sale of products in the other businesses (spirits and beer) should not be affected.
As stated in the case, the probability of bankruptcy for Diageo is very low in the current economic situation, which does allow the company the opportunity to borrow more debt at a lower cost owing to its good credit rating.
Agency cost – Given that Diageo has maintained steady levels of cash, a consitent dividend payout policy and its plan to acquire companies (for example Seagrams for $7-9 billion) will not be considered risky as Diageo can benefit from the synergies that the acquired businesses bring. It shouldn’t be difficult for Diageo to raise more capital for the acquisition by issuing more debt or by floating more equity of the company.
Loss of financial flexibility – Looking at Diageo’s current market situation we believe that they are in a flexible financial state wherein they can easily borrow capital through debt or equity.
Conclusion: The analysis above does give an edge to the maximization of tax shield and positive earnings over the