Case Discussion: The Wm. Wrigley Jr. Company: Capital Structure, Valuation and Cost of Capital

1. Dobrynin plays the role of the financial entrepreneur, exploiting inefficiencies in investment valuation and corporate finance. She seeks to profit by restructuring firms with “lazy financing” or too much cash and unused debt capacity relative to the (low) risks faced by the firms. By pressuring directors and managers to adopt more efficient policies, she hopes to reap an investment gain. The larger issue is whether or not Wrigley is inefficiently financed. If so, how much capital structure change will bring it to more efficient operation?

2a. A recapitalization based on a dividend will have no effect on the number of shares
Turning to the yields by credit rating given in case Exhibit 7, one can interpolate between BB (12.73%) and B (14.66%) to obtain a cost of debt. The cost used in the remainder of this analysis is 13%, Blanka Dobrynin’s choice.[3]

Yields rise almost linearly across the investment-grade spectrum (AAA to BBB) and then rise curvilinearly at lower debt ratings—this hints at the problem that we will encounter in estimating the cost of equity.

2. Beta: You should unlever Wrigley’s current beta of 0.75, assuming the current values of book debt and the market value of equity. This gives an estimate of the unlevered beta of 0.75, reflecting the fact that Wrigley has almost no debt.[4] This beta then needs to be relevered to reflect the addition of $3 billion in debt. Using the formula produces a levered beta of 0.87. All in all, this is not much of a change. Why? The answer is twofold: first, the market value of Wrigley’s equity is so large that $3 billion more in debt does relatively little to change the debt/equity ratio. Second, the levered beta formula is a linear model that accounts for debt tax shields but not the costs of financial distress. Thus, the curvilinear relationship between risk and yield observed in case Exhibit 7 is not reflected in the estimate of the levered beta.

3. Capital weights