The Wm. Wrigley Jr. Company Case Study
CAPITAL STRUCTURE, VALUATION, AND COST OF CAPITAL
Executive Summary
Aurora Borealis LLC is an activist Hedge fund. They are trying to buy a large stake in the company and thereby force the management to reorganize the capital structure by raising the debt and using it to pay the dividends or buy back the shares. The effect of restructuring on various financial parameters will be discussed in the concluding parts.
Hedge Fund Strategy
The buyback of shares would increase the EPS for the firm as a natural consequence of reduction in number of shares outstanding. The increase in EPS will signal towards a positive market sentiment, which would result in increase in share price. Also, raising debt at lower cost of debt i.e. at good credit ratings lowers the WACC due effect of the tax shield and hence the value of the firm. Aurora Borealis LLC, like any other hedge fund, banks on instantaneous rise and fall in stock prices than the long term investment in growth and stability of the firm. The hedge fund plans to short the stock at the moment it rises to the optimal level due to strong signals the hedge fund is trying to pursue.
Effect of recapitalization on WACC
The current WACC of Wrigley is 10.9%. Since it is all equity firm the WACC is same as cost of equity. Raising $3billion debt for repurchase of stock or dividend would change the capital structure of the firm. The raised debt, because of the debt tax shield under good credit ratings, would reduce WACC and hence increase value of the firm. But in our case, the WACC after including the debt structure almost remains the same (10.9 to 10.91). The reason of this change is the increase in Beta due to re-levering at new debt level, which consequently brings the beta up to the same level at relevant debt ratios. Hence although re-levering shows no effect on value of the firm, the EPS rises and the stock price rises due to the repurchase. A possible explanation for this would be the decreasing financial
Executive Summary
Aurora Borealis LLC is an activist Hedge fund. They are trying to buy a large stake in the company and thereby force the management to reorganize the capital structure by raising the debt and using it to pay the dividends or buy back the shares. The effect of restructuring on various financial parameters will be discussed in the concluding parts.
Hedge Fund Strategy
The buyback of shares would increase the EPS for the firm as a natural consequence of reduction in number of shares outstanding. The increase in EPS will signal towards a positive market sentiment, which would result in increase in share price. Also, raising debt at lower cost of debt i.e. at good credit ratings lowers the WACC due effect of the tax shield and hence the value of the firm. Aurora Borealis LLC, like any other hedge fund, banks on instantaneous rise and fall in stock prices than the long term investment in growth and stability of the firm. The hedge fund plans to short the stock at the moment it rises to the optimal level due to strong signals the hedge fund is trying to pursue.
Effect of recapitalization on WACC
The current WACC of Wrigley is 10.9%. Since it is all equity firm the WACC is same as cost of equity. Raising $3billion debt for repurchase of stock or dividend would change the capital structure of the firm. The raised debt, because of the debt tax shield under good credit ratings, would reduce WACC and hence increase value of the firm. But in our case, the WACC after including the debt structure almost remains the same (10.9 to 10.91). The reason of this change is the increase in Beta due to re-levering at new debt level, which consequently brings the beta up to the same level at relevant debt ratios. Hence although re-levering shows no effect on value of the firm, the EPS rises and the stock price rises due to the repurchase. A possible explanation for this would be the decreasing financial