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Posted: August 29th, 2022
Case Memo of The Wm.Wrigley.Jr.Company
In the case Blanka Dobynin was are trying to buy a large stake in the company and thereby force the management to reorganize the capital structure by raising the debt and using it to pay the dividends or buy back the shares. The strategy will benefit from the price appreciation from stock repurchase or dividend payment. Wrigley is a leading producer and distributor of chewing gums, and it has a advantageous position compared to the other industry players with very high brand equity and strong presence globally.
It has little business risk as the market is diversified and anti-cyclical, which was reflected in its equity beta of 0. 75 as of 2002. Wrigley has zero debt as of 2002 and therefore no financial risk. Issuing 3 billion debt will alter the capital structure and increase it WACC. The WACC before debt is 10. 11% calculated from CAPM, given the unlevered beta equals 0. 75, risk free rate equals 10 year Treasury yield which is 4. 86%, and risk premium of 7%.
After taking on the debt, the D/E ratio calculate from debt over total equity gives almost 70%, and the levered beta becomes 1. 07. Using the 13% cost of equity given in the case, the WACC after recapitalization will be roughly 9. 15%. Given 232. 441 million shares it means market capitalization of almost 13. 26 billion US dollars. The tax shield is roughly 1,200 million, which will immediately be reflected into the new share price under perfect capital market assumptions. The new share price will equals to 56. 37+5. 16 = USD 62. 23 per share.
Adding the leverage of USD 3,000 million under BB rating assumption will significantly reduce the net income of the company therefore reduce the EPS. This effect will partially be offset in case of share repurchases, since decrease of the number of shares outstanding associated with share repurchase will push EPS up. In conclusion, recapitalization through 3 billion of debt and same share repurchase will be preferable for WM. Wrigley Jr. Company shareholders, since it will in total increase their wealth by 1. 2 billion which is a fair premium for the risks associated with leveraging the company.
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