Wrigley Jr. Company

Weighted Average Cost of Capital (WACC) is the combined rate at which a company repays borrowed capital and comes from debit financing and equity capital. WACC can be reduced by cutting debt financing costs, lowering equity costs, and capital restructuring. In order to minimize WACC, companies can issue bonds by lowering the interest rate they offer to investors as well as, cutting down

WACC means weighted average cost of capital. The company has to bear on average a cost of 10.91 % to finance its operations. However it is significant to note that cost of equity is really high as compared to cost of debt this makes SanDisk a less risky company in respect of debt. But SanDisk can use leverage and geared up its operations by injecting debt as fresh blood in

The report that follows endeavors to determine an appropriate Weighted Average Cost of Capital (WACC) for the H. J. Heinz Company at the end of the 2010 fiscal year. Further, the report attempts to provide reasonable explanations for the decisions and assumptions that were made throughout the required calculations, specifically around the firm’s capital structure, cost of debt and cost of equity. Finally, the report offers an opinion on the validity of the derived WACC figure and the role it could potentially play in the decision making process at H. J. Heinz.

William Wrigley Jr. Company is exploring whether it is optimal to recapitalise with taking on $3 billion of debt. Three options are revised; borrow and repurchase shares, dividend payouts or continue to function with full equity. Debt will provide a tax shield of $1.2 billion given the tax rate is 40%, this should increase the market share price to $61.53 per share. The viable method for the company is to utilize this debt to repurchase shares. The will not only increase Wrigley’s market value, via the debt shield, but also signal to market that management believes Wrigley’s is undervalued, something the dividend payment won’t achieve.

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.

If the company chooses to pay a dividend, the Wd will be 18.63% (3,000,000/ (13,103,000+3,000,000)*100%), the WACC will be 10.32% (18.63% (1-40%)*13%+81.37%*10.9%). If the company chooses to repurchase the stock, the WD will be 22.89% (3,000,000/13,103,000), the WACC will be 10.19% (22.89% (1-40%)*13%+77.1%*10.9%). Both 10.32% and 10.19% are lower than the WACC before recapitalization, which indicates that after the recapitalization the company will have a lower minimum rate of return for the company that it needs to earn on its investments to maintain its wealth.

WACC is the rate used to discount future cash flows of a firm to their present value. By minimising WACC firms are able to increase the value of the firm. For debt to affect value, there have to be tangible benefits and costs associated with using debt instead of equity. If the benefits exceed the costs, there will be a gain in value to equity investors from the use of debt. If the benefits are less than the costs, increasing debt will lower value (Myers, 2001). Following a $3 billion leveraged recapitalisation, the investment grade of Wrigley decreases from AAA to BB/B and consequently the cost of debt increases to 13% (see appendix 9) which is greater than the post-capitalisation cost of equity of 9.84% (see appendix 8). It is for this reason that the WACC increases from 9.24% to 9.49% (see appendices 5 - 10) which results in a reduction in firm value.

Rational investors are likely to infer a higher firm value from a higher debt level. Thus, these investors are likely to bid up a firm’s stock price after the firm has issued debt in order to buy back equity. We say that investors view debt as a signal of firm value. Moreover, corporations can

the financial condition of company will affect their investment directions such as the project with product quality enhancement. So the incentives of investing can be affected by company financial conditions. In addition, the product and input market interactions also can affect company financial condition such as how the firm dealing with product recall and recovering from the recall. Maksimovic and Titman (1991) also argued that debt financing will affect their incentive in investing high quality or enhancement product because the debt financing make company more pressure on cash flow and cutting cost for getting short term profit and in case of bankruptcy. Titman (1984) also mentioned that the relationship between firms and suppliers

Modigliani and Miller were the first to theorize the issue of capital structure. In their seminal paper, ‘The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review, (June 2011), they stated their capital structure irrelevance proposition that capital structure has no predictable material effect on corporate market values in a perfect capital market. Modigliani-Miller provides the basis for modern thinking on capital structure and was for the first time introduces the concept of capital structure. Their theory states that without taxes, bankruptcy costs and systematic information and in an efficient market, the firm’s value is not affected in which way the firm is financed.

Nike has a many different segments, 62% of revenue is the main segment which includes 30% in apparel, design for sports activities. Nike sells 4.5% of non-Nike brand, which adds tiny portion of Nike’s revenue. The cost of debt RD, according to the Joanna Cohen’s calculation, she calculates the company’s cost of debt based on previous data, which will not show the Nike’s current cost of debt. According to the financial cost theory, the weighted- average cost of capital (WACC), must reflect the future interest rate because cost of capital based on book value. Cohen did not use the market value for the debt and equity weights; the reason for using the market value is to estimate the future raise of the capital in the company.

The WACC is the weighted average cost of capital. It is a calculation of the firms cost of capital taking into account the relevant weight of equity and debt as a proportion of the total. The cost of equity or KE calculated using a risk free rate example German 5yr government bond, the firm’s beta and the return on the market. The firm’s beta is a calculation of the firms exposure to the market, a beta of less than 1 indicates that the firm is not as influenced by external factors as the average firm in that market. A beta greater than 1 indicates that the firm is more heavily exposed to market factors than the average firm in that market. The formula I will be

The study generally aims to fill the gap in the literature by empirically examining the relationship between the use of debt in the capital structure of companies and the factors related to the capital structure. Specifically the objectives of this research are to achieve the following:-

In their 1st proposition they considered that the firm’s value is not depending on its capital structure. The 2nd proposition held that financial leverage incrrases to expected EPS keeping the share price constantly. The 3rd proposition concluded that an investment finance by common stock is advantageous to the outstanding shareholders only in the case that it yield exceed the capitalization rate.

Change in the capital structure of the company over the 5-year period. Reasons for the change.