Assume that Wrigley’s managers want to evaluate the benefits and costs of the debt issue
recommended by Blank Dobrin in an informal way, without carrying out any precise calculations
at this stage.
To this end, they want to understand which information and variables contained in the
case study are relevant to analyze Wrigley’s likelihood of financial distress once the debt issue has
taken place. You should help Wrigley’s managers by creating a list of the most important variables
to consider. For each variable, explain in general terms why it could be relevant and how it should
have an impact on financial distress. Also, what additional information not included in the case study
would you gather to improve your analysis? [Word limit: 400 words]
Blank Dobrin is convinced that Wrigley could borrow $3 billion at a credit rating between BB
and B and with an interest rate of about 13%. However, a firm’s cost of debt is often hard to estimate
and different analysts can consider alternative methods that can generate a wide range of estimates.
Produce your own estimates of Wrigley’s cost of debt assuming that it borrows $3 billion. Overall,
would you agree with Blanka Dobrynin that Wringley should be able to raise such amount of debt at
an interest rate of around 13%? [Word limit: 300 words]
Blanka Dobrynin’s recommendation is for Wringley to boost leverage by raising $3 billion through
a debt issue and return an equivalent amount of cash to shareholders.
In contrast, a rival hedge fund is making a more radical recommendation which would entail a debt
issue of $5 billion with a contemporaneous cash distribution to shareholders of the same amount.
Evaluate the two alternative recommendations above by using as many methods as possible and in
consideration of what could be considered Wringley’s optimal level of leverage. Which of the two
recommendations is preferable? Why? [Word limit: 800]
Assume that after considering the recommendations of the hedge funds described in the previous
question, Wrigley’s managers are convinced that leverage should be increased over time. The
company is evaluating the following alternative options that should cause a similar increase in
leverage over the next year or so:
– A debt issue together with an incremental dividend payment of the same amount;
– A debt issue together with incremental stock repurchases of the same amount;
– A debt issue together with incremental cash distributions to shareholders (a mix of a dividend
payment and stock repurchases) of the same amount;
– A larger debt issue in comparison with the other options above without any contemporaneous
incremental cash distribution to shareholders.
Comment on the options above and analyze their costs and benefits considering their effects on the
market value of the firm. [Word limit: 500 words]