Wm Wrigley Jr. Company

Case Background-

Investment strategy of Blanka Dobrynin, managing partner of Aurora Borealis LLC focused on distressed companies, merger arbitrage, change of control transactions, and recapitalizations. 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. As a part of evaluating they wanted to find if they are inefficiently financed or not.

Under the proposed recapitalization, Wrigley would borrow $3 billion and use it either to pay equivalent dividends or to repurchase equivalent shares. Chandler, an associate in Aurora Borealis, was calculating the impact of this debt on the company. This would affect firm’s share value, cost of capital, debt coverage, earnings per share, and voting control. The debt can increase the value of firm by providing appropriate tax shields. This will give Wrigley a rating of BB/B, and as a result the interest rate charged will be 13%. Chandler knows that maximum value will be achieved when WACC is minimized and she is estimating the impact of recapitalization on cost of equity and WACC.

Management is being forced to reorganize the capital structure by raising the debt and using it to pay the dividends or buy back the shares because Blanka Dobrynin is trying to buy a large stake in the company. 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. Rather than banking on the long term investment in growth and stability of the firm, Aurora Borealis, banks on instantaneous rise and fall in stock prices

The value of the company has increased because the...