The Wm. Wrigley Jr. Company Capital Structure, Valuation, And Cost Of Capital Case Study Solution
Current WACC (Pre Re-Capitalization)
The current WACC of Wrigley’s company is 10.1% (calculated in attach excel sheet). The current capital structure of the company is entirely consisting of the equity, which indicates that the cost of the company’s equity is equivalent to WACC. However, the cost of equity is calculated by using the CAPM model. The risk free rate of 10 years US treasury is 4.860%, as mentioned in exhibit-7 of the case, used in the calculation of the CAPM. The un levered beta of the company is 75 mention in the exhibit-5 of case. The market risk premium of the company is 7% as mentioned in the case. (pg#3).(See appendix 2 for Current WACC). (A Farber, RL Gillet & A Szafarz , 2006)
Post-Capitalization WACC
After the re-capitalization, the WACC of the company is 10.3%. The Post-Capitalization structure of the company is composed of 23%of debt and 77% of equity. The pretax cost of debt is 13% as mentioned in the case. However, the tax rate is 40%,which is also mentioned in the case.After deducting the tax rate from the pretax cost of debt, the extracted cost of debt is 8%. The cost of equity is calculated by using CAPM model. The un levered beta was given in the case which is converted into levered beta. The levered beta is calculated by taking debt to equity ratio on the basis of the market value in which debt is taken as 3 billion, while equity is taken as 10.1. The levered beta of the company, after the re-capitalization is 88, while the pre-capitalization beta was 75, which shows that by adding debt in the capital structure; beta would increase as the risk level increases. The risk free rate is of 10 years US treasury is 4.86%, and the market risk premium is 7%. (mentioned in the case). The cost of equity is calculated as 11%.(See appendix 3 for post capitalization WACC)
Note: Calculation is given in excel sheet
Sensitivity Analysis
Sensitivity analysis of all the three given conditions have been performed. The result indicates different firm condition under three different scenario- worst cases, most likely and best case. All the results are consistent with the appropriate situations, such as best case shows a higher income level in all the situations. (All three tables are given in appendices section)
WACC on different debt levels
WACC on different debt levels were calculated by assuming the debt level from 0 to 3 billion. The results shows an increased WACC on minimum debt level, indicating that the higher is the WACC, the lower the firm’s value is.
Recommendations
The company should take the debt of $3 billion, because it would increase the firm’s value and lowers the cost of capital by providing tax shield.
It is recommended to Wrigley Company to re-purchase its shares, because it will increase the EPS if the profits remain the same, and it would give a hint to the shareholders about having undervalued shares.Furthermore, it will increase the net worth of Wrigley family.
Conclusion
Jr. Wrigley Company is the largest chewing gum producer, which is enjoying good profits but is also suffering from lower firm’s value and higher cost of capital because it has an equity based capital structure. The decision of re-capitalization is worth it for creating the capital a mix of equity and debt, which will increase the firm’s value and lowers the WACC.
Appendices
Appendix: 1
| Calculations: | ||||
| a. Value of Firm | Market Value | Book Value | ||
| Value of Unlevered Firm | 13.1 | 1.75 | ||
| Value of Levered Firm | 14.3 | 2.95 | ||
| b. Share Price | at Market Value | at Book Value | ||
| Unlevered Firm | 56.36 | 7.53 | ||
| Levered Firm | 79.79 | 16.46 | ||
| c. EPS | Unlevered Firm | Levered Firm | ||
| Net Income | 0.362986 | 0.362986 | ||
| no. of Outstanding Shares | 0.232441 | 0.179210237 | ||
| EPS | 1.56 | 2.03 | ||
| d. Voting Control | Common Stock | B shares | Total | |
| Current Shares of family | 58% | 21% | ||
| No. of Stocks | 0.1898 | 0.042641 | ||
| Votig Rights per share | 1 | 10 | ||
| Total Voting Rights | 0.1898 | 0.42641 | 0.61621 | |
| Total Voting Rights (Family) | 0.110084 | 0.0895461 | 0.19963 | |
| Current Voting Control | 32% | |||
| Voting Control in (Levered Firm): | ||||
| No. of Stocks Sold | 0.053230763 | |||
| Voting Rights Sold | 0.053230763 | (As Common Stocks have been sold) | ||
| Voting Rights (Family) UL | 0.1996301 | |||
| Voting Rights (Family) L | 0.146399337 | |||
| Total Voting Rights Levered | 0.562979237 | |||
| Voting Control Family in Levered Firm | 26% | |||
Appendix: 2
| Pre Capitalization WACC: | |
| Beta | 0.75 |
| RF | 4.86% |
| Risk Premium | 7% |
| Cost of Equity | 10.1% |
| WACC | 10.1% |
Appendix: 3
| Post Capitalization: | |
| Beta Unlevered | 0.75 |
| Beta Levered | 0.88 |
| Pre Tax Cost of Debt | 13% |
| Cost of Debt After Tax | 8% |
| Cost of Equity | 11% |
| RF | 4.86% |
| Risk Premium | 7% |
| Weight of Equity | 77% |
| Weight of Debt | 23% |
| Tax Rate | 40% |
| WACC | 10.30% |
Appendix: 4
Pre-Recapitalization (Status Quo)
| Scenario Summary | |||||
| Current Values: | Worst case | Most Likely | Best case | ||
| Changing Cells: | |||||
| EBIT | 513356 | 214000 | 514000 | 814000 | |
| Result Cells: | |||||
| TAXINCOME | 527,366 | 228,010 | 528,010 | 828,010 | |
| TAXES | 164,380 | 71,071 | 164,581 | 258,091 | |
| NETINCOME | $ 362,986 | $ 156,939 | $ 363,429 | $ 569,919 | |
| EPS1 | $ 1.56 | $ 0.68 | $ 1.56 | $ 2.45 | |
| shares | 232,440 | 232,440 | 232,440 | 232,440 | |
Appendix: 5
Post-Recapitalization (Share Repurchase)
| Scenario Summary | |||||
| Current Values: | Worst case | Most Likely | Best case | ||
| Changing Cells: | |||||
| EBIT1 | 513356 | 214000 | 514000 | 814000 | |
| Result Cells: | |||||
| INTEREST_EXP | (390,000) | (390,000) | (390,000) | (390,000) | |
| TAX_INCOME | 137,366 | (161,990) | 138,010 | 438,010 | |
| I_TAX | 54,946 | (64,796) | 55,204 | 175,204 | |
| NI | 82,420 | (97,194) | 82,806 | 262,806 | |
| REPUR_OUT_SHARES | 179,213 | 179,213 | 179,213 | 179,213 | |
| EPS2 | 0.460 | -0.542 | 0.462 | 1.466 | |
| debt_EBIT | 382599 | 382599 | 382599 | 382599 | |
| debt_yeild | 0.1711 | 0.0713 | 0.1713 | 0.2713 | |
| SHARE_PRICE | 79.79 | 79.79 | 79.79 | 79.79 | |
| MKT_VALUE | 14.3 | 14.3 | 14.3 | 14.3 | |
Appendix: 6
Post-Recapitalization (Dividend Payout)
| Scenario Summary | |||||
| Current Values: | Worst case | Most Likely | Best case | ||
| Changing Cells: | |||||
| EBIT1 | 513,356 | 214,000 | 514,000 | 814,000 | |
| Result Cells: | |||||
| NI | 82,420 | (97,194) | 82,806 | 262,806 | |
| I_TAX | 54,946 | (64,796) | 55,204 | 175,204 | |
| TAX_INCOME | 137,366 | (161,990) | 138,010 | 438,010 | |
| INTEREST_EXP | (390,000) | (390,000) | (390,000) | (390,000) | |
| Debt_EBIT | 382599 | 382599 | 382599 | 382599 | |
| Debt_yeild | 0.1711 | 0.0713 | 0.1713 | 0.2713 | |
| Out_shares | 232,444 | 232,444 | 232,444 | 232,444 | |
| EPS3 | 0.355 | -0.418 | 0.356 | 1.131 | |
| SHARE_PRICE | 79.79 | 79.79 | 79.79 | 79.79 | |
| MKT_VALUE | 14.3 | 14.3 | 14.3 | 14.3 | |
Appendix: 7
WACC on different debt levels
| Stock Price ($) | 56.36 | 56.36 | 56.36 | 56.37 | 56.37 | 56.37 | 56.38 |
| Number of shares (Million) | 0.232441 | 0.232432128 | 0.232423256 | 0.232414385 | 0.232405513 | 0.232396641 | 0.232387769 |
| MV Equity (or Firm) | 13.1 | 13.1002 | 13.1004 | 13.1006 | 13.1008 | 13.101 | 13.1012 |
| EBIT ($ Million) | 514 | 514 | 514 | 514 | 514 | 514 | 514 |
| Tax Rate | 40% | 40% | 40% | 40% | 40% | 40% | 40% |
| Beta | 0.75 | 0.75 | 0.75 | 0.75 | 0.75 | 0.75 | 0.75 |
| Risk Free Rate | 4.86% | 4.86% | 4.86% | 4.86% | 4.86% | 4.86% | 4.86% |
| Risk premium on the Market | 7% | 7% | 7% | 7% | 7% | 7% | 7% |
| Debt ($ Million) | 0 | 0.5 | 1 | 1.5 | 2 | 2.5 | 3 |
| MV | 13.1 | 12.6002 | 12.1004 | 11.6006 | 11.1008 | 10.601 | 10.1012 |
| D/MV | 0 | 0.0397 | 0.0826 | 0.1293 | 0.1802 | 0.2358 | 0.2290 |
| Yield | 0 | 1028 | 514 | 342.6666667 | 257 | 205.6 | 171.3333333 |
| Interest (INT) ($ Million) | 0 | 0.065 | 0.13 | 0.195 | 0.26 | 0.325 | 0.39 |
| EBIT/INT (Coverage) | 0 | 7907.692308 | 3953.846154 | 2635.897436 | 1976.923077 | 1581.538462 | 1317.948718 |
| Levered beta* | 0.75 | 12.09 | 6.20 | 4.23 | 3.25 | 2.66 | 2.27 |
| Cost of equity | 10% | 89% | 48% | 34% | 28% | 23% | 21% |
| After Tax Cost of Debt | 7.80% | 7.80% | 7.80% | 7.80% | 7.80% | 7.80% | 7.80% |
| Weight in Equity | 100% | 96% | 92% | 87% | 82% | 76% | 70% |
| Weight in Debt | 0% | 4% | 8% | 13% | 18% | 24% | 30% |
| WACC | 10.1% | 86.2% | 44.9% | 31.0% | 24.0% | 19.8% | 16.9% |
| Interest Rate | 13% | 13% | 13% | 13% | 13% | 13% | 13% |
| Tax Sheild | 0 | 0.026 | 0.052 | 0.078 | 0.104 | 0.13 | 0.156 |
| PV of Tax Sheild (Perpetuity) | 0 | 0.2 | 0.4 | 0.6 | 0.8 | 1 | 1.2 |
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