The Wm. Wrigley Jr.

Company

Ericka Lopez

David Bruner

Curtis Chan

Matthew Vu

Dr. Paul Sarmas

August 13, 2015

FRL 440
 In 2002, Blanka Dobrynin from Aurora Borealis LLC took notice of Wm. Wrigley Jr.
Company’s performance above the market indexes without the use of any debt. She used an
“active-investor” strategy to capitalize on companies that she felt could improve their returns if
they restructured their capital structure. Her researchers had to analyze the effects of Wrigley
assuming $3 billion in debt to either buy back outstanding shares or use the money for a dividend
payout. They also needed to analyze the cost of debt factored into the cost of capital calculation
to see if the debt could maximize the value of the firm. If the analysis does conclude that buying
back shares is the best use of the debt, then the Wrigley family would have even more control of
the company through its voting power. Another important issue to address is the final credit
rating that Wrigley would be assigned after incorporating debt into their capital structure.
Dobrynin would have to successfully persuade the Wrigley Company that the capital restructure
would be beneficial if she wants to implement her strategy.

1. In the abstract, what is Blanka Dobrynin hoping to accomplish through her active-
investor strategy?
Blanka Dobrynin is a financial entrepreneur who plans to use her active-investor strategy
to help increase revenue for firms. By using her strategy, Dobrynin can identify opportunities for
corporations to restructure and invest significantly in shares of the target firm. In addition,
Dobrynin can engage in the process of persuading management and directors to adopt more
efficient policies to earn an investment gain.

2. What will be the effects of issuing $3 billion of new debt and using the proceeds either
to pay a dividend or to repurchase shares on:

A. Wrigley’s outstanding shares?

The effect of issuing $3 billion in new debt and using the proceeds to pay a dividend will
have no effect on the shares outstanding at 232.44 million. However, if Wrigley’s decides to
repurchase its shares, the common shares outstanding would decrease to 183.69 million as seen
by the following equation:
232,440,000-(3,000,000,000/61.53)=183.69 million
B. Wrigley’s book value of equity?
The effect of issuing $3 billion in new debt and using the proceeds to pay a dividend will
cause the book value of equity to decrease from $1,276,000,000 to $-1,724,000,000. We
calculated this by subtracting the book value of equity from the total long term debt
($1,276,000,000-$3,000,000,000=-$1,724,000,000). If Wrigley’s decides to repurchase its
shares, it will cause the book value of equity to decrease from $1,276,000,000 to $-
1,724,000,000. We calculated this by subtracting the book value of equity from the total long
term debt ($1,276,000,000-$3,000,000,000=-$1,724,000,000). 

C. The price per share of Wrigley stock?

The effect of issuing $3 billion in new debt and using the proceeds to pay a dividend will
cause the price per share of Wrigley’s stock to decrease from $56.37 to $48.63 per share. We
calculated this by dividing the market value of equity by the common shares outstanding based
on the dividends payout (11,303 million/232.44 million=$48.63). If Wrigley’s decides to
repurchase its shares, the stock price would increase from $56.37 to $61.53 per share. We
calculated this by using the new price stock formula to determine the new amount of shares
outstanding (11,303 million/183.69 million=$61.53).

D. Earnings per share?

The effect of issuing $3 billion of new debt and using the proceeds to pay a dividend will cause
the earnings per share to decrease as seen below:

Dividends Worst Case Most Likely Best Case

Current EPS $1.13 $1.33 $1.72

After Recapitalization $0.12 $0.32 $0.72

If Wrigley’s decides to repurchase its shares, the earnings per share will decrease as seen below:
Repurchase Worst Case Most Likely Best Case

Current EPS $1.13 $1.33 $1.72

After Recapitalization $0.15 $0.40 $0.91

E. Debt interest coverage ratios and financial flexibility?

If the Wrigley company issues $3 billion in debt, the company would be obligated to pay
an interest payment of 13.00% of the amount borrowed which is $390 million. Using the EBIT
of $527,366 from the end of year 2001, Wrigley Company would have a Debt interest coverage
ratio of 1.35, which indicates that the company would be able to meet its debt obligations.
Regardless of whether the company repurchases shares or pays a dividend with the $3 billion,
their credit rating would fall from AAA to BB/B in response to issuing the new debt, which
restricts its financial flexibility. Although the company’s performance is stable, the new credit
rating reflects the increase in risk for the company, so it may be more difficult to find investors.

F. Voting control by the Wrigley family?

The Wrigley family currently holds 21% of the Wrigley Company’s 189.8 million shares
of outstanding common stock and 58% out of the 42.641 million class B shares. The Wrigley
family’s voting control would not be affected by distributing a dividend payout with the $3
billion in proceeds from the recapitalization. The recapitalization would however increase the
Wrigley family’s voting control if the $3 billion was used to repurchase outstanding shares. The
total shares outstanding would decrease to 183.69 million, which would increase the family’s
voting control of common stock and increase the advantages of having 58% of the 10-to-1 voting
rights from the class B stocks. 

3. What is Wrigley’s current (pre-recapitalization) weighted- average cost of capital

(WACC)?
The Wrigley Company has no debt and the firm is currently financed with equity only.
Wrigley’s current pre-recapitalization WACC is equal to its CAPM at 10.90%. To calculate the
current pre-recapitalization, we used the formula 5.65%+.75(7%) =10.90%, where 5.65% is the
risk free rate, .75 is the beta and 7% is the market risk premium. 
4. What would you expect to happen to Wrigley’s WACC if it issued $3 billion in debt
and used the proceeds to pay a dividend or to repurchase shares?
We expected Wrigley’s WACC to decrease if it issued $3 billion in debt. Issuing $3
billion in debt would cause Wrigley’s credit rating to drop from AAA to BB/B. In addition,
issuing $3 billion in debt would lever the company causing its beta to increase, thus increasing
its cost of equity. We calculated the levered beta using the unlevered beta and the following
equation:
.75*(1+(1-40%)*27%) =.87
We then used this levered beta of .87 to calculate the new cost of equity using the following
equation:
5.65%+.87*7%=11.74%
Wrigley’s pre-tax cost of debt is expected to be 13%. Therefore, when using a 40% tax rate,
Wrigley’s after-tax cost of debt is calculated to be 7.8%. Taking these new figures into account,
we were about to determine the post-recapitalization WACC using the following equation:
(13%*21*(1-40%))+(11.74%*79%) =10.91%
As a result of our calculations, we were able to determine that our initial expectations
were wrong. Issuing $3 billion in debt to pay a dividend or repurchase shares would have
virtually no effect on the WACC. As seen from above, the pre-recapitalization WACC was
10.90% and the post-recapitalization WACC is 10.91%.

5. Should BlankaDobrynin try to convince Wrigley’s directors to undertake the

recapitalization?
Blanka Dobrynin should try to convince Wrigley’s directors to undertake the
recapitalization. The recapitalization will virtually have no effect on the firm’s WACC as it only
changes from an unlevered 10.90% to a levered 10.91%. The firm’s EPS will dramatically drop
regardless of whether Wrigley’s decides to pay a dividend or repurchase shares, but this sharp
decrease can be easily explained away by the increase in interest expense that the company will
be paying. Therefore, shareholders will need to be informed of this.
All things considered, if the firm does decide to undertake the recapitalization, they
should invest the borrowed funds in a share repurchase as opposed to paying a dividend. A share
repurchase will cause the company’s stock price to increase from $56.37 to $61.53, thus creating
value for shareholders, while paying a dividend will cause the stock price to decrease to $48.63.

93

You did a very GOOD job.