Wrigley Case Study
The William Wrigley Jr. Company is the largest manufacturer and distributor of chewing gum, with a well consolidated market position. Due to new products and foreign expansion, its previous revenues have grown at an annual rate of 10% and its stock price regularly outperforms the S&P 500 as well the industry index. It is a conservatively financed firm with total assets of $1.76 billion and zero debt as of 2001.
The purpose of this case study revolves around how should they use a $3 billion debt issue to restructure its capital that would add the most value for the shareholders of Wrigley. The decision of how to use the debt will impact the firm’s stock price, cost of capital, debt coverage, earnings per share and voting …show more content…
Operating income in 2001 was 513,356,000 and total net sales were 2,429,246,000.
By using 513,356/2,429,246 this gives us a rate of 21%, which puts them in the A to AA range pre-recap.
To calculate the post recapitalisation credit rating the debt interest coverage ratio was used, this is a measure of the amount of cash flow available to meet annual interest and principal payments on debt and is calculated by EBIT/Debt Interest (Bruner, R. et al 2010).
By borrowing 3 billion dollars, Wrigleys will be paying an annual amount of 390 hundred million dollars interest, 3,000,000,000x.13%. The EBIT in 2001 is $527,366,000 therefore the debt coverage ratio is 527,366/390,000=1.35
After proposing the $3 billion in debt, Dobrynin assumed that a target credit rating of between BB and B should be applied, as seen in appendix 2 this debt rating spread is feasible for Wrigley given that their new position is indicative of poorer financial flexibility for the firm and future liquidity constraints.
The financial flexibility hypothesis implies that for a firm with low financial flexibility, unforeseen capital requirements often result in raising debt or equity and, consequently, intentionally moving the issuing firm away from its long-run target debt ratio (Denis et al., 2009).
Financial flexibility is expected to diminish greatly in the wake of proposed