Diageo Plc. Harvard Case Solution & Analysis

Debt Financing:

The Diageo Public Limited Corporation has debts of 58.01% just after its formation. Just before the merger of Grand Metropolitan Public Limited Corporation and Guinness Public Limited Corporation, both the merging companies have debts of 62.08% and 50.62% respectively. Debts in the capital structure of the company raises to 71.78% in the year 1999 but it falls to 67.25% in the following year. As debt is the cheapest source of finance and Diageo public limited company has debts of credit rating A+. Therefore, it is easy to find the investor to invest in the debts in the market for investment in the Diageo Public Limited Corporation. Interest payments on the debt instrument have another benefit in the financial statement of the Diageo Public Limited Company, that interest is tax deductible. Diageo would save the tax on its interest payment, if the company increases its interest payable on the bonds in its capital structure. As shown in Exhibit 1.

There is also some risk associated with over debt financing by the Diageo public limited corporation that it has to bear the financial distress cost in case of any bankruptcy or non-payment of principle to bond holder occurs. This increase in debt financing also decreases the wealth of the shareholders of the Diageo Public Limited Corporation, but increasing debt would help Diageo to reduce its weighted average cost of capital as the debt is the cheapest source of financing as compared to the equity financing or any other mode of financing.

Financial Strategies:

Diageo adopts different financial strategies to become the market leader. Diageo believes in a diversified portfolio that they have segregated divisions and product line. They are dealing in beverages, beer and fast food items across the world. Diageo is looking forward for the expansion of its product line to grab the market share specifically in the beverage market. The competitors are not so strong that they beat the Diageo but Diageo is still looking to increase its profitability and market reputation because if it fails to produce a brand name of Diageo product, the market position and brand equity would be threaten. Therefore Diageo is decided to introduce new product lines and existing products with different styles and packaging. As far as the investment decision is concern, Diageo has decided to make investment through its divisions in such a way that the return on investment should cover all the related cost of that division. Economic value addition is the estimated profits, which represents a return on the cost of an investment less all the cost incurred to generate the profit.

The analyst of the Diageo public limited corporation considering the Monte Carlo Simulation model, but the model is no more applicable with the current capital structure of the company, as Diageo has more debts in its capital structure and Monte Carlo Simulation Model does not account for the risk of liquidity in bonds.

CONCLUSION:

As per the analysis and evaluation, Diageo Public Limited Corporation is highly recommended to invest in the acquisition concern because there is a stiff competition in the market and a significant growth in the market is evaluated. In order to create a difference in the market being the market leader The Company should look forward for new markets for acquisition and integrations. Apart from the investment decision the company should also look into its capital structure that it does not affect the wealth of shareholders any more. The fact is, with the increase in debt capital, weighted average cost of capital increases and that results in decrease in wealth of shareholders consequently. The liquidity risk is another factor, Company has to consider.............................

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