team 14 - william wrigley

THE WM. WRIGLEY JR. COMPANY

Team 14

Constantine Brocoum

Courtney Delia

Stephanie Doherty

David Dubois

Radu Oprea

November 19th, 2009

William Wrigley Junior Page i

Contents

Objectives....................................................................................................................................................1

Management Summary...............................................................................................................................2

Item 1..........................................................................................................................................................2

Sub 1.1....................................................................................................................................................2

Sub 1.2....................................................................................................................................................2

Conclusion..............................................................................................................................................2

Item 2..........................................................................................................................................................2

Sub 2.1....................................................................................................................................................2

Conclusion..............................................................................................................................................2

Item 3..........................................................................................................................................................2

Sub 3.1....................................................................................................................................................2

Sub 3.2....................................................................................................................................................2

Conclusion..............................................................................................................................................2

Item 4..........................................................................................................................................................2

Item 5..........................................................................................................................................................2

Appendices..................................................................................................................................................2

William Wrigley Junior Page ii

ObjectivesThis report seeks to answer the following five questions about William Wrigley Jr.:

1. In the abstract, what is Blanka Dobrynin hoping to accomplish through her active-investor strategy?

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:

a. Wrigley’s outstanding shares?

b. Wrigley’s book value of equity?

c. The price per share of Wrigley stock?

d. Earnings per share?

e. Debt interest coverage ratios and financial flexibility?

f. Voting control by the Wrigley family?

3. What is Wrigley’s current (pre-re-capitalization) weighted-average cost of capital (WACC)?

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?

5. Should Blanka Dobrynin try to convince Wrigley’s directors to undertake the recapitalization?

William Wrigley Junior Page 1

Management Summary

Active Investor StrategyBlanka Dobrynin is a managing partner of the Aurora Borealis Company. The company utilizes a strategy called “Active Investor”. In this strategy, the firm looks for companies that could benefit from restructuring. Aurora Borealis then invests heavily in the company’s stock. The next step is to convince management that a restructuring will benefit the company and its stock holders. The key to Blanka’s strategy is, of course, to affect the stock price of the company they are influencing. In the case of Wrigley, they are unique in that they have virtually no debt. Many would see this as a benefit. However, taking on some debt would help to raise expenses so that cash flow can be shielded from taxes. By leveraging the firm there is an extra $156 million that can be invested to improve shareholder wealth. The value of this extra cash flow is shown as the present value of a perpetuity at $1.2 billion. This is a significant amount of value that is created due to the leveraging of the firm. The market value of a levered firm versus an unlevered firm is as follows:

As estimated in the case, a 40% tax rate can generate some significant savings if avoided.

Sub 1.1

Sub 1.2

$3 Billion in new debta. Issuing 3 billion dollars of new debt to buy back shares will reduce the number of outstanding shares,

placing those shares in the company treasury as treasury stock. Paying a dividend with this borrowed money will not affect the number of shares outstanding.

b. The net asset value or book value of a company is calculated by total assets minus intangible assets (patents, goodwill) and liabilities. So as the company issues more debt the book value is not changed since both sides of the balance sheet are increased by $3 Billion. The book value of the company should not be affected by a dividend payout.


c. The price of a share will decrease by the amount of the dividend paid per share. Repurchasing shares of the company stock will not have an effect on the share price directly. Some investors see share repurchase as a “bullish sign” for the company so the shares may appreciate on that basis.

d. Earnings per share (EPS) = Earnings After Taxes(EAT)/Outstanding Shares. If the number of outstanding shares is reduced by a buyback of shares then the EPS will increase if the EAT remains unchanged. However the EAT is reduced since there is interest expense. If the dividend payout remains the same then the dividend paid per share will increase as well. The debt interest would be 13% of $3 billion which is $390 million. EBIT in 2001 was $527,366,000. So the EBIT is $137,366,000. Then this is taxed at 40% so the EAT is $82,420,000. So by taking on more debt the EAT diminishes so the earnings per share will drop dramatically. Dividends affect next years earnings as they are taken out of the EAT.

e. The debt interest coverage ratio is EBIT/Debt Interest. The interest on the debt is $390 million as calculated above. The EBIT in 2001 is $527,366,000. So debt coverage ratio is 527,366/390,000=1.35 If Wrigley’s gets a non-investment grade rating then their financial flexibility is severely limited.

f. Issuing 3 billion dollars of new debt to pay dividends should not have any effect on the voting control of the Wrigley family. Using that money to buy back shares will have an effect on the voting right of the family. When shares are repurchased they are put in the company treasury and are no longer outstanding. Then the Wrigley family’s percent of outstanding shares would rise giving them more voting control. They also have 58% if the outstanding shares of the Class B shares which have a 10 to 1 voting advantage over the common share class. These shares are not affected by the buyback.


Sub 2.1

Conclusion

Wrigley’s current weighted-average cost of capital (WACC)?

Unlevered Levered Levered Levered

Equity Beta 0.75 (find bond beta) (find bond beta) (find bond beta)Risk free rate 4.86% 4.86% 4.86% 4.86%Expected return on market 11.86% 11.86% 11.86% 11.86%Corporate tax rate (tc) 40.0% 40.0% 40.0% 40.0%re 10.11% 14.048% 16.201% 14.300%rd (net cost of debt) 5.850% 7.800% 6.536% 7.652%debt/equity 0 1.705 1.705 1.705Wdebt 0.000 0.630 0.630 0.630Wequity 1.000 0.370 0.370 0.370

WACC (opportunity cost of capital) 10.110% 8.144% 8.462% 8.181%

Equity 1.760Debt 3.000

Net cost of debtPreatax cost of debt 13.00%Dobrynin 400 bottom 13.00% 7.80%YTM BBB debt 10.894% 6.54%

Sub 3.1

Debt Proceeds-To Pay a dividend or to Repurchase shares

The $3 billion in debt would be a liability which would be broken out as short-term debt, that which is payable within 12 months, and long term debt, which would be repayable in more than a year. If the company uses this money to repurchase shares, there would be an offset as there would be no change on the financial statements as the liabilities and equity would net each other out and assets would remain unchanged. Therefore, it would not be necessary to include the cost of debt in the weighted-average cost of capital. Similarly, if the proceeds were used to pay a dividend it would have a similar effect because they transaction would have a netted effect. The WACC of Wrigley’s would remain the same as long as the liability and equity is netted out. This can be further supported by the Flow-to Equity Method in which this method states that if a Company’s debt ratio is constant over time, the same number will result as discounting cash flows at the WACC and subtracting the debt. Therefore, the WACC will remain unchanged as the debt, dividends, and repurchase shares would all have the same effect because they will be netted against each other and WACC will be constant.


Conclusion

Item 4

Appendices


team 14 - william wrigley

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