Diageo Plc

Case Analysis Report

I. Executive Summary

Diageo, one of the world’s leading consumer goods companies, was formed from the merger of GrandMet and Guinness. In 2000, the company announced its intention to sell its packaged food subsidiary, Pillsbury, and 20% of its Burger King subsidiary. Because of the restructuring opportunity, the company wanted to rethink its financing mix.

In this case, the tradeoff between the costs and benefits of different leverage policies will be discussed. A simulation model was created by Diageo’s director of Finance and Capital Markets, Ian Simpson, and Adrian Williams, the firm’s Treasury Research Manager, to understand the tax benefits of higher gearing and the cost of financial distress.

In this report, I will discuss the historical financial policies in Diageo. The actions of selling Pillsbury and spinoff of Burger King will be valued. And the tradeoff theory and Simpson and Williams’ simulation model will be studied and evaluated as well. Finally our conclusion is to choose interest coverage around 5.

II. The Case Decision

What recommendation would be made for Diageo’s future capital structure? Is Simpson and Williams’ simulation model reliable?

III.Facts

1. Diageo was formed from the merger of Guinness and GrandMet. It was the seventh largest food and drink company in the world.

2. The firm was organized along four business segments: Spirits and wine business, Guinness Brewing, Packaged and fast food.

3. Prior to the merger, both of the two companies had quite conservative financial policies. The bonds rating of the two companies were AA and A.

4. After the merger, management chose to retain the policies of the merged companies. The rating agencies confirmed the firm’s debt would be rated A+.

5. Diageo’s interest coverage ratio was maintained from 5 to 8.

6. Since 1997 merger, Diageo’s stock price performance had lagged...