Vrije Universiteit Amsterdam
School of Business and Economics
Advanced Corporate Finance 4.1
Case 2, Wrigley
Working Group 2, Team 5
Author:
Supervisor:
Bas Boekhout - 2655526
prof . dr. ir. H.A. Rijken
Kwame Bonsu - 2576417
dr. M.A. Dijkstra
Meine Tempels - 2623208
Anne Wezenberg - 2600722
I hereby certify that the answers to this exam are my own work and my work alone. I also certify that the
content in this document has not previously been submitted for any other exam or assignment in this course or
any other course, and that I have not copied or otherwise plagiarized the work of others.
April 1, 2021
Case 1
1
Introduction
The William Wrigley Jr. company is one of the leading companies in the production and distribution
of chewing gum. Over the last two years, the revenues and earnings of Wrigley have grown significantly
due to global expansion and the introduction of new products. Interesting is that the company has
always been conservatively financed, and until 2001 the company had no debt. However, due to the low
interest rates a leveraged recapitalization through a share repurchase or a dividend distribution could
be profitable for the Wrigley company shareholders. In this case assessment we will analyse whether a
leveraged recapitalization would be beneficial for the Wrigley family. To evaluate the effects of a leveraged
recapitalization we will analyse the effect on the company’s value, earnings per share of the company,
voting control and the credit rating of the company, and we will come up with an accurate advice for the
Wrigley family.
2
Company value
The company value is estimated by means of the adjusted present value method. In Table 1 the estimated company value before the leveraged recapitalization is compared to the company value after
recapitalization.
Table 1: Company values before and after recapitalization,
Share price
Number of shares outstanding
Debt value
Equity value
Company value
Before recapitalization
$56,4
232,411,000
$0
$13,1
$13,1
After recapitalization
$61,53
183,686,000
$3 billion
$11,3 billion
$14,3
Note: table 1 shows the company value in the situation before leveraged recapitalization and after
leveraged recapitalization in case of a share repurchase
Table 1 shows that the share price will increase and the number of shares outstanding will decrease due
to the share repurchase. The leveraging of 3 billion dollars causes a decrease of 13,7% in equity value and
an increase of 9,16% in company value. Purely based on the company value before and after leveraging,
recapitalization would be profitable, since the company value increases by 9,16%.
2.1
WACC
To compare the weighted cost of capital of Wrigley before and after a recapitalization, an unlevered beta
is implemented equal to 0,62. This is the average beta of the peers of the Wrigley company. The beta
of 0,75, which is stated in the Wrigley case seems to be very high compared to the industry beta. And
although Wrigley is the largest player in the industry, we can not find any solid argumentation for this
high beta, therefore we implement the industry average beta of 0,62 instead of 0,75. The market risk
premium is set equal to 7%. This assumption is made because the Wrigley company is an American
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Case 1
company based in Chicago, therefore the most accurate risk premium is the rate stated in the Wrigley
case, equal to 7%.
Table 2: Weighted average cost of capital before and after capitalization
Market risk premium
Unlevered β
Levered β
Re (%)
Rd(%)
Ra(%)
Before recapitalization
7%
0,62
9,2%
9,2%
After recapitalization
7%
0,62
0,72
9,9%
13%
9,5%
Note: it shows the WACC before leveraged recapitalization and after recapitalization. The distribution of dividend and the share repurchase result in the same value.
Table 2 shows the effect of leveraging on the WACC of Wrigley. Increasing debt by 3 billion will cause
the cost of equity to increase by 7%. Noteworthy is that leveraging results in a lower cost of equity, equal
to 9,9%, than cost of debt, which is equal to 13%. This implies that it is cheaper for the company to
acquire funds in the form of equity than in the form of debt which normally is not very likely.
2.2
Earnings per share
To evaluate the effect of the recapitalization on earnings per share, we have implemented 3 scenarios.
The worst case scenario reflects the situation in which there is no growth in earnings. The most likely
scenario, which reflects a 9% growth, which is equal to the growth over the previous 2 years. And the
best case scenario, in which we assume a growth of 15%. This 15% is based on an increase of 6%, which
is an increase of two third with respect to the base case. We believe the growth of the best case is in line
with the growth in case the chewing gum market in the emerging markets pick up.
Table 3: Situation before recapitalization
Operating income
Interest expense
Taxable income
Taxes (40%)
Net income
Shares outstanding
Earnings per share
Worst case
$527,366
$0
$527,366
$210,946
$316,420
232,441
$1,36
Base case
$574,829
$0
$574,829
$229,932
$344,897
232,441
$1,48
Best case
$606,471
$0
$606,471
$242,588
$363,883
232,441
$1,57
Notes: Table 3 Shows the effect on earnings per share before recapitalization. The worst case
reflects 0% growth, the most likely case reflects 9% growth and the best case reflects 15% growth.
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Case 1
Table 4: Situation after capitalization
Operating income
Interest expense
Taxable income
Taxes ( 40%)
Net income
Shares outstanding Dividend
Earnings per share Dividend
Shares outstanding repurchase
Earnings per share repurchase
Worst case
$527,366
$390,000
$137,366
$54,946
$82,420
232,441
$0,35
183,868
$0,45
Base case
$574,829
$390,000
$184,829
$73,932
$110,897
232,441
$0,48
183,868
$0,60
Best case
$606,471
$390,000
$216,471
$86,588
$129,883
232,441
$0,56
183,868
$0,71
Notes: Table 4 Shows the effect on earnings per share after recapitalization in case of a dividend
distribution and share repurchase. The worst case reflects 0% growth, the most likely case reflects
9% growth and the best case reflects 15% growth. The operating income, interest expense, Taxable
income, Taxes and net income are equal for the situation of a share repurchase and dividend
distribution.
When we look at the earnings per share of Wrigley before the recapitalization, we find that in the base
case the earnings per share is $1.48, which is slightly below the industry average of $1.65. When we model
a situation in which we have a recapitalization, we find that in the base case our EPS drops to $0.60.
This is far below the industry average and tells us that when we recapitalize, Wrigley is less profitable
than its competitors. The reason for this of course has to do with the fact that before recapitalization,
Wrigley had no interest expenses which after recapitalization brings down the net income significantly.
2.3
Credit rating
To be able to give accurate advice to the Wrigley family it is important to compare the situation before
leveraged recapitalization to the situation after recapitalization. To make this comparison, financial ratios
and the corresponding credit rating are constructed and shown in tables 5 and 6.
Table 5: Financial ratios and credit rating before recapitalization
FFO/ total debt
FOC/ total debt
Return on capital
Operating income/sales
LT debt/ capital
Total debt / capital
Worst case
2,3342
2,2460
0,2943
0,2171
0,1231
0,3042
Base case
2,4312
2,3429
0,3208
0,2366
0,1231
0,3042
Best case
2,4959
2,4076
0,3384
0,2496
0,1231
0,3042
Credit rating
AAA
AAA
AA-AAA
A-AA
AA-AAA
AA-AAA
Notes: Table 5 shows the financial ratios and credit rating before recapitalization. Since Wrigley
has no interest expense before recapitalization, there is no interest coverage ratio included for this
scenario.
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Case 1
Table 6: Financial ratio’s and credit rating after recapitalization
Interest coverage
FFO/ total debt
FOC/ total debt
Return on capital
Operating income/sales
LT debt/ capital
Total debt / capital
Worst case
1,3522
0,3274
0,2032
0,1101
0,2171
0,7383
0,7571
Base case
1,4739
0,3410
0,2168
0,1200
0,2366
0,7383
0,7571
Best case
1,5505
0,3500
0,2259
0,1266
0,2496
0,7383
0,7571
Credit rating
B-BB
BBB-A
BBB-A
B-BB
A-AA
B-CCC
B-CCC
The tables show that after recapitalization the credit ratings drop significantly. We see that apart from
the FFO to total debt and Operating income to sales all ratios have a junk bond rating. This is not
very favorable since it will be harder to attract investors as they will view Wrigley as a relatively risky
company. Especially when we compare these ratings to our peers. We find that these peers all have
investment grade ratings. This again could be another reason for investors not to invest in Wrigley. And
very important, this will complicate further leveraging of the company in the future.
2.4
Voting control
An important difference between recapitalization by means of a dividend distribution and recapitalization
by means of a share repurchase is the effect on the voting power of the Wrigley family. A dividend
distribution will not have an effect on the voting power, whereas a share repurchase could work in favour
of the Wrigley family’s voting power.
Table 7: Voting control of the Wrigley family
Common shares
Class B shares
Total shares
Common shares owned by Wrigley
Class B shares owned by Wrigley
Total votes owned by Wrigley
Voting control
before recapitalization
189,800,000
426,410,000
616,210,000
21%
58%
46,6%
Voting control
after recapitalization
141,045,365
426,410,000
567,455,356
28%
58%
50,6%
Notes: Table 7 shows the voting control in percentage of the Wrigley family before and after
recapitalization by means of a share repurchase.
Table 7 shows that due to the recapitalization the Wrigley family will gain more voting control. The
share repurchase will cause a decrease in number of common shares outstanding, 189,800,000 before the
share repurchase and 141,045,365 shares after the repurchase. This is equal to a decrease of 26% in
common shares outstanding. The decrease in total number of votes, causes the Wrigley family to have
more voting power. Their voting power increases from 46,6% to 50,6%, this is an important advantage
of a recapitalization by means of a share repurchase.
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Case 1
2.5
Merits of returning cash to the shareholders by either dividend or share
repurchase
Returning cash to shareholders by either dividend or share repurchase have both pros and cons. Pros for
share repurchase for Wrigley are: more voting control, EPS will increase, share price will go up in the
short term and dividend paid to shareholders can increase as there are less shares to split the dividend
over. Cons of share repurchase are: Investors sometimes see buybacks as a way for executives to take
advantage of their stock option programs without seeing their shares being diluted. Also, although share
repurchase has a positive short term effect on the market, in the long run investors find that the company
has done nothing to increase the value of the company and therefore share prices will drop again.
Pros for dividends are: it attracts a different kind of investor, who are most of the time very loyal and
it signals certainty about the well-being of a company. Cons of dividends is that the money used to pay
out dividends could also have been used for further growth of the company. Also, for investors dividend
payments imply that they would have to pay extra taxes, the costs of paying these taxes may sometimes
outweigh the benefits of receiving the dividend payment.
3
Advice
Throughout this research, several scenarios are investigated with respect to the issuing of debt for
WM.Wrigley Jr. company. Issuing debt affects lots of facets of the company as the capital structure
is adjusted. Since cost of debt is more expensive then cost of equity for WM. Wrigley Jr. increasing the
leverage in the company would consequently mean that the WACC would increase from 9.2% to 9.5%.
Meaning that the cost of capital for the company will become more expensive. Which is of course not
desirable.
Next, it is notable that the debt issuance affects the earnings per share. Results show a reduction in the
earnings per share from around the $1.48 to $0.48 in the base case when issuing debt. Although issuing
debt gives rise to tax advantage, as the interest on debt is tax deductible, one also needs to pay interest
on the debt. These extra interest payments severely outweigh the tax benefits. For new investors, this
might be a reason to reconsider investing in the WM.Wrigley Jr. company.
Additionally, issuing debt severely impacts the credit ratings of WM.Wrigley Jr. company. Before issuing
debt one could see that WM.Wrigley Jr. company was rated rather well. Though, when issuing debt
this rating reduced by quite a bit. Most of the ratios even entered junk bond status, going as low as
CCC-rated. This could eventually lead to a shift in investors profile as large institutional investors can
only invest in BBB and above. And this will complicate leveraging in the future, which will decrease the
flexibility of the company.
Lastly, it was observed that for the shares owned by Wrigley a share repurchase would have a positive
effect. This was also what was to be expected as they themselves would not sell shares. Their total voting
power would be increased from 46.6% to 50.6% which might come in handy when certain issues need to
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Case 1
be addressed.
As stated before there were two possible scenarios. One in which WM.Wrigley Jr. company engaged in
a share buyback. The other option was returning some of the value to the share holders, in the form
of a dividend distribution. The dividend option signals a strong belief in the future performance of
WM.Wrigley Jr. company’s cash flow and earnings. Reducing this payment, later on, gives a rather bad
signal to the market this needs to be avoided. Therefore one could also interpret the increase in dividend
payment as a sign of decreasing future investment opportunities. In the long run it is advised for W.M.
Wrigley Jr. Company to engage in increasing dividend payments. A major reason for this decision is the
fact that W. M. Wrigley Jr. Company is currently trading rather high. For this reason, a share buyback
is deemed too expensive. Also, increasing dividend signals certainty about the well-being of a company.
Lastly, the fact that most of the time a higher dividend payment attracts new, very loyal, investors should
not be overlooked.
4
Appendix
Self reflection
Due to the current situation, as a team we where forced to adapt to remote working and communicating.
The usual structure and process put to the test, spawning a new way of teamwork.
To reflect on the past weeks, we identify in which aspects we could improve as a team and going forward
as individuals. But equally important we also reflect on proceedings that lifted or helped us. Without the
usual contact events i.e. lectures and working groups, in which group members will meet, it requires more
effort to plan and realize meetings to discuss the cases. Although every group member was well-willing
to take out time. The result was more of a combination of individual efforts in a way which was not
always as time efficient as it could have been. Because the goal of these assignments is self-development,
time efficiency is not really an item. If the cases where carried out in a professional environment there is
room for improvement.
For future partnerships it might help, to hold on to the weekly meetings that the lectures and working
groups would offer, albeit via digital communication. All in all as a group we experienced a pleasant
collaboration, which is due to the general- and individual pro-active attitude. Now, it is more important
than ever to be honest, supportive and to be as open as possible.
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