Diagnosis of Problems and Evaluation of Strategies for Wrigley Jr Company - Assignment Example

Corporate Financial Policy: Diagnosis of Problems and Evaluation of Strategies for Wrigley Jr. Company of Subject Date Corporate Financial Policy: Diagnosis of Problems and Evaluation of Strategies for Wrigley Jr. Company Introduction This paper seeks to analyze the case of Wrigley Jr. Company and answer the given questions for purposes of advising the company on what is the best course of action in attaining the best financial policy for the company. The courses of action include maintaining the status quo, borrowing $ 3 billion to re-leverage the company and then either use the proceeds for dividends or for recapitalization. Question 1. In the abstract, what is Blanka Dobrynin hoping to accomplish through her active-investor strategy? Blanka is hoping to accomplish the wealth maximization objective for the shareholders of Wrigley Jr. Company by recapitalization by borrowing the amount of $3 billion through issuance of new debt and use the proceeds either to pay a dividend or to repurchase shares. As to whether the same will be successful remains to be known. On the surface, issuing debt new and using the proceeds to pay dividend or repurchase shares on will provide tax shield to the company from tax savings due to deductibility of interest expense. The downside is to increase leverage which makes the company riskier than its present financial condition. As to whether the same is justifiable must be seen in the context of attaining an optimal capital structure and the goal of maximizing the value of the enterprise and value to shareholders. Question 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: 2(a) Wrigley’s outstanding shares? When the proceeds of new debt are used for repurchase only, there will be a sure decrease of outstanding shares. Repurchase means acquiring back outstanding shares from stockholders. The repurchase shares could be place in treasury and may be reissued again should management decides to do so, or the same shares could be permanently retired and may no longer be reissued. In case the proceeds will be used for dividends, the same cannot decrease the outstanding share since it will be given to shareholders as cash. This is evidenced by Exhibit TNA1 of the case. 2(b) Wrigley’s book value of equity? It will decrease in both cases. To use the money to pay cash dividends will be charged to retained earnings which are part of the book value equity, and to use the same for repurchase will reduce the equity of shareholders. Under simply valuation in TNI the book value of equity before recapitalization is $ 1.3 billion but after it will become negative $1.7 in cases of dividends and repurchase. 2(c) The price per share of Wrigley stock? It will increase to $ 61.53 from $56.37 per share if used for repurchase since there would be less outstanding shares to be used as divisor. But it will decrease to $48.63 in case of recapitalization with dividend. See Exhibit TN1. 2(d) Earnings per share? It will decrease from $1.33 per share to $0.41 in case of recap with share repurchase and would decrease further to $0.32 per share if recap with dividend. See Exhibit TN7 of the case study. 2(e) Debt interest coverage ratios and financial flexibility? Debt interest coverage ratio will decrease because of more debts to pay with almost same income level. However flexibility will also decrease since there would less cash to use address emergencies because of the higher fixed interest expense to be paid periodically. 2(f) Voting control by the Wrigley family? It will increase or decrease depending on what part of shares is being reacquired. But since it could be assumed that the reacquisition to be evenly taken from outstanding share, there is a greater chance that it would have greater voting control or at the most there would be maintained voting control. Question 3. What is Wrigley’s current (prerecapitalization) weighted-average cost of capital (WACC)? The current WACC of Wrigley is 10.90%. Please refer to Table A below based of excerpt of Exhibit TN3 of the case study. Table A – Summary of Calculation based Exhibit TN3 of case study Question 4. What would you expect to happen to Wrigley’s WACC if it issued $3 billion in debt and used the proceeds to pay a dividend or to repurchase shares? The WACC of the company after recapitalization with repurchase stands at 10.91%, which slightly increased from 10.90% as stated earlier in the preceding question. The WACC is an estimate and there is accurate way to measure the same. It can also be estimated by using the comparative price-earnings ratio before and after capitalization, is clear that there is increase market value per share with lower outstanding shares. The recapitalization with repurchase would most likely result in increased price earning per share. The reciprocal of the price/earnings per share can be used to measure the estimated WACC of the company and since higher P/E would mean lower reciprocal there must be lower WACC as a result of recapitalization. But as estimated in the case study at 10.91%, this paper will use the same. For purposes of making a decision, the significant increase in market price per share with only slight increase in WACC, makes it already convincing to choose recapitalization with repurchase. Question 5. Should Blanka Dobrynin try to convince Wrigley’s directors to undertake the recapitalization? The only basis for doing is on whether it would increase to greater wealth for shareholders. There is basis for the recapitalization because of the increased price per share coupled with the slight increase in WACC. It is already convincing. To further verify is the almost evident choice of recapitalization with repurchase, this researcher will consider evaluating the same using the three points of view as suggest by case study # 32. From investors’ point of view, it is relevant to ask the following question: “will the re capitalization create value?” (Bruner, 1993) In Answer this researcher strongly believes that the chosen financial structure from recapitalization after new debt issue of $ 3 billion will (a) maximize shareholder wealth, (b) maximize the value of the entire firm (i.e. the market value of assets), and (c) minimize the firms weighted-average cost of capital (WACC) (Bruner, R (1993). These conditions have basis in occurring and therefore the company is making the best trade-offs, between recapitalization and not having the same. The next test is asking the question whether decision will create a competitive advantage, which is a question from competitors’ point of view (Bruner, 1993). The resulting WACC after recapitalization is only just above industry average of 9.75% as shown in Table A above. This means that the company is not yet too risky in relation to competition and such decision to have recapitalization is very strategic and will indeed maximize value of the company and shareholders’ wealth. There is evidence that it will create competitive advantage since the increase price per share after recapitalization will still not make the company to more unnecessarily risky. The next question is whether the decision will sustain senior managements vision (Bruner, 1993). The answer to this question from management’s perspective is also in the affirmative. This is being used to test internal perspective tests in determining the appropriateness of the visualized capital structure from the standpoint of the expectations and capacities of the corporation. By assessing the company’s corporate strategy and resulting possible cash requirements and resources that will be needed in the future, there is no evidence that would say that it should not be done. There is no negative information from the case facts including expected macroeconomic variations that will put the company unable to use it strength of having much flexibility to go for recapitalization. This is evident considering that before the planned recapitalization, the company is 100% and failure to recap would be at the height of failing so see the biggest opportunity that the company has The possible expected financial strains are also made part of the scenario in making assumptions to re-compute expected market value and the result was still favourable to the company. See Exhibit TN7 of the case study. In other words, there is evidence that the decision will have sustainable result in the company’s growth and cash position per period. Conclusion There is strong evidence that the best choice is to recapitalize the company since it will result to increase wealth or investor, it will create competitive advantage for the company and is consistent with internal management capabilities. The answers to the above questions clearly lead to what is best for the company that is to proceed with issuance of new debt and use the proceeds to repurchase outstanding shares. This paper has clearly shown good path on what the company should do in order to maximize value. References Bruner, R (1993). Structuring corporate financial policy: Diagnosis of problems and evaluation of strategies. Darden School of Foundation. Case Study- Wrigley Jr. Company Read More