Tutorial 2 Answers

Tutorial 2

The Wm. Wrigley, Jr. Company (Part 1)

In the first part of the tutorial, each group will present to the class a succinct and yet comprehensive discussion of the following issues relating to Wrigley. Students who do not belong to any group will be assigned to a group in this tutorial. Intra-group discussions will be facilitated in the second part of the tutorial.

PART A

Question #1: (J1, S1, PA1, PB1)

Looking at the data provided to you in the case, without doing a detailed analysis, do you agree with Blanka Dobrynin’s view that Wrigley is not efficiently financed? Why? Discuss clearly the methods you will use to help you to arrive at your decision.

Probably the simplest way to come to a conclusion regarding the financing of Wrigley without detailed analysis is to compare the financial characteristics of Wrigley to that of other major confectionary firms.

It can be noticed initially from this data that Wrigley has 0% debt financing, whilst the other major confectionary firms all have some level of debt. It should be noted that Wrigley has levels of equity, as well as an earnings per share value roughly on par with the other major confectionary firms. The tax benefits of debt financing are great with $1 of debt adding about $0.10 to value. I therefore agree with Blanka Dobrynin’s view that Wrigley is not efficiently financed.

Question #2: (J2, S2, PA2, PB2)

What could possibly be the benefits of having more debt for Wrigley? You must refer to the literature to support your answer.

* A debt tax shield is the most obvious benefit of having more debt for Wrigley. Modigliani & Miller sum up the present value of these tax benefits for debt in perpetuity as the company’s marginal tax rate multiplied by the value of debt outstanding (TcD). As said before the benefit of debt financing is great with $1 of debt adding about 0.10 to value.

* A recapitalization can signal to the public, management’s expectations regarding...