THE WM.

WRIGLEY
JR. COMPANY
Capital Structuring, Valuation, and Cost of
Capital

Team 14

E XECUTIVE S UMMARY
Amidst the analysis of Wrigleys capital structure, we recommend that with an increase of $3 billion in
debt, Wrigley should repurchase shares at a price of $56.59. The main goal of an active investing firm like
Aurora Borealis is to find an inefficiently structured firm so that it can purchase a stake, mainly to advise
a recapitalization in the companys capital structure in hopes to maximize financial returns.
Two main valuation methods were computed to assess a $3 billion leverage recapitalization. The adjusted
present value, which is more significant in this case 1, illustrates that with a recapitalization, the firm value
will increase by almost $100 million. Likewise, a full value approach causes the firm value after
recapitalization to decrease by $1.5 billion. Both approaches have limitations in that the APV method
mainly assumes a likelihood of default, while the full value approach does not take into account an
optimal WACC.
Although it is clear that the new capital structure does not minimize the WACC, we have concluded that
the benefits of the recapitalization outweigh the drawbacks, particularly when using the debt to
repurchase shares. The cost of financing initially is 10.9%. After increasing the debt-component, the cost
of financing increases to 11.21%. This increase comes about with the addition of risk from leverage i.e. a
shift in a credit rating from AAA to a B.
Despite the increase in the Cost of Capital, a leverage recapitalization signals a number of messages to the
investors and the market. For instance, the substantial increase in debt may signal management operating
efficiently and its confidence in the operational profitabilitys ability to cover debt service payments.
Similarly, the repurchase of shares shows the public that Wrigley considers its shares to be undervalued,
and a sign for investors to reconsider the allocation of their resources. The repurchase decreases the
number of shares outstanding and leads to an appreciation in the Wrigleys share price to $56.59.
Historically, investors have preferred a share repurchase program in lieu of a special dividend given the
tax environment. Most dividends are considered as disposable income and have a marginal tax-rate (3335%) charged. On the other hand, capital gains only have a 15% rate charged, historically. 2
One of the concerns of a repurchase program is its effect on the Wrigley familys voting control. We, as
Aurora Borealis, can advise the company to only repurchase non-family common stock, or repurchase
non-family common stock and class B shares to maintain the same ratio of total common to class B. In
both cases, the Wrigley Family maintains, if not increases, its voting rights to 51% and 60%, respectively.
However, we advise to only repurchase non-family common shares, so as to avoid a higher repurchasing
premium.
As a result, this report begins by describing the concept of active investing. Subsequently, our team
discusses the market perception and the signaling of a recapitalization. Next, we analyze the impact of a
recapitalization and a special dividend on the earnings per share, balance sheet, the cost of financing, and
finally the firm value. The report concludes by advising Wrigley to repurchase shares after the leverage
recapitalization.

1 Its significant because we have a debt amount to calculate from, as opposed to obtaining a static D/E ratio and
an optimal WACC.

2 http://www.cimaglobal.com/Documents/Student%20docs/2010%20syllabus%20docs/F3/F3%20Adjusted
%20Present%20Value.pdf

ACTIVE INVESTOR STRATEGY

What is an Active Investing Strategy?
The concept of active investing implies investors that are highly involved. In contrast to passive investors
who invest in a stock when they believe in its potential for long-term appreciation, active investors will
typically look at the price movements of their stocks many times a day. Active investors primarily seek
short-term profits by purchasing shares prior to a profitable action like capital restructuring.
What is the main goal behind the Active Investing Strategy?
Through her active-investing strategy, Blanka Dobrynin tries to find companies with too much cash in its
capital structure. An abundant amount of cash signifies an inefficient use, per se. A company with extra
amount of cash could pay its investors dividends, repurchase shares (for signaling purposes), or invest in
positive NPV projects. As a result, an efficient use of cash leads to an optimal capital structure, which in
turn maximizes financial efficiency and profits. By purchasing shares prior to the change in capital
structure, Blanka hopes to make a gain as the stock price goes up when the company improves their
financial efficiency.
What are the different types of Active-Investing strategies that Ms. Dobrynin could pursue?
Dobrynins main strategy focuses on distressed companies, control transactions, and debtrecapitalizations. For distressed companies, Aurora could determine a better capital structure (mostly an
optimal) that would maximize both firm and shareholder value. In a change-of-control transaction, the
hedge fund would take majority of control of a firms voting rights, and implement improvements to the
firms financial doings.
What does Aurora and Ms. Dobrynin aim to achieve with its new target, Wrigley?
Current Market Condition: Interest rates are currently at its lowest point in 50 years, whilst the use of
debt-financing by corporations is declining. It is evident that a certain amount of debt in a companys
capital structure, leads to an optimal cost of financing, which in turn maximizes the companys
shareholder and firm value.
Wrigley and Market Conditions: A company like Wrigley has a leading market share, low-technology
business, and yet has no debt. A leverage recapitalization through a dividend or a major share repurchase
would create significant new value. That said, the two main factors that lead to Wrigley being an ideal
restructuring candidate are:
(1) Wrigleys capital structure 0% debt.
(2) Excess cash.
With a market value of $13.1 billion, and the current capital-market conditions, Wrigley could borrow $3
billion at a credit rating between BB and B, to yield 13%. There are two factors Aurora should consider
doing after recapitalizing:
(1) Repurchasing Shares
(2) Paying investor dividends
Repurchasing shares signal the investors that Wrigley considers its stock to be undervalued and moreover
rewards its investors with a capital gain. Likewise, an increase in dividend payout acts as an indicator of
the firm possessing strong future prospects.

SIGNALLING OF RECAPITALIZATION
Wrigley is one of the worlds largest manufacturers and distributor of chewing gum. The firms industry,
branded consumer foods and candy, was intensely competitive and was dominated by only a few larger
players. 3 Over the preceding two years, revenues had grown at an annual compound rate of 10% while
earnings at 9%. The dynamic growth has come about from various expansionary methods like mergers,
acquisitions, organic expansions, and globalization. Amidst its strong competitive position, a leverage
recapitalization leading to share repurchase or dividend could signal various messages to the market. The
possible indications would be as follows:
(1) Leverage financing signals that Wrigleys shares are undervalued: Various academic studies
indicate that the market reacts favorably to share repurchase announcements. When a company
repurchases its own shares, it assumes that the stock is undervalued in the market. Whenever the
market price falls below this warranted equity value per share the company would repurchase
its own shares. The warranted equity value is calculated by discounting cash flows to equity using
the equity cost of capital. A gap between warranted value and market price, therefore usually
triggers repurchases.
(2) Leverage financing signals Wrigleys strong operating profitability: The use of debt financing
implies that the company has a strong operating profitability, allowing it to meet the encumbrance
of debt service payments including interest and principal.
(3) Leverage financing signals a less complacent management: Amidst the use of debt,
management will be less complacent. The management ought to be more efficient with its use of
debt in order to secure and maintain their executive positions in Wrigley. Likewise, since the
increase in debt leads to a higher probability of default, this signals the commitment of the board
and the management to efficiently use Wrigleys resources and caution not to default.
(4) Leverage financing signals that Wrigley has run out of positive NPV projects: The use of
debt to repurchases shares or to issue a special dividend signals to the investors that Wrigley is in
the maturity stage of its life cycle. Since the debt will not be used to invest in positive NPV
projects, this signals that there is very little growth potential within the consumer product
industry. Companies in this stage of the life cycle usually grow at the same rate as the economy,
and may only achieve average returns.

3 The Wm. Wrigley Jr. Company: Capital Structure, Valuation, and Cost of Capital, Case, Exhibit 1
4

EFFECT OF RECAPITALIZATION: BALANCE SHEET

A leverage recapitalization of $3 billion impacts Wrigleys balance sheet. An addition of $3 billion
directly causes book value of assets and total capital to increase by $3 billion. The market value balance
sheet also increases its figure by more than $3 billion. The market value balance sheet comprises of a
debt-tax shield and a financial distress component. The two concepts are explained below.
FINANCIAL DISTRESS & CREDIT RATING: Financial distress occurs when a company cannot
meet nor pay off its financial obligations to its creditors. Wrigleys cost of borrowing additional capital
will thus increase its risk, and as a result, its cost of capital.
The cost of bankruptcy is divided into two components:
(1) The direct bankruptcy cost: The direct bankruptcy cost is 20% of the firm value. A direct
bankruptcy cost is the easier component to calculate. It is generally between 20% 30% of the
firm value, according to empirical probabilities over time. Since Wrigley is one of the more
dominant players in the market and is in the maturity phase of its life cycle, a lower probability of
direct bankruptcy is chosen.
(2) The indirect bankruptcy cost: This is a more difficult component to calculate partly because the
cost is difficult to come by. These probabilities are backward looking and are mainly based upon
the empirical examination of firms within each ratings class and its corresponding default risk. A
debt-reiteration was computed using Ms. Dobrynins initial rate of 13%. Upon calculating the
initial interest expense, an Interest Coverage Ratio was computed. The ICR came to 1.352 4,
giving the debt a rating of B. In addition to the interest coverage ratio, an Operating Income/Sales
ratio, a long term debt/capital ratio, and an OCF/Total Debt ratio were calculated. All the ratios
were then compared to the Key Industrial Financial Ratios by S&Ps Credit Rating 5, which in turn
confirmed a credit rating of B.
(3) With a B rating, Wrigleys likelihood of defaulting is 45%.6 This rate is multiplied to the indirect
bankruptcy probability of 20% and to Wrigleys total firm value. This likelihood of default
provides the investors with a debt-tax shield equal to the amount of 40% of the total $3 billion of
debt. Both the total cost of financial distress and the debt tax shield are discounted using the cost
of debt, which is 13%. The present value of this element uses the cost of debt as a discount rate
because it accurately reflects the risk associated with the debt cash flows and hence the tax relief.
Leveraging without Issuing Dividends or Repurchasing Shares: In the book value balance sheet,
assets are increased by $3 billion, to a total asset figure of $4.43 billion. This growth accounts for an
increase in working capital of $3 billion (cash obtained from debt). On the contrary, long-term debt also
increases by $3 billion. While the book value per share stays the same as before recapitalizing, the book
value of equity over the total capital reduces to 29% from 89%. 7 The reason for this is that there has been

4 Exhibit 2, EPS vs. EBIT Analysis, Column C, Row 25

5 The Wm. Wrigley Jr. Company: Capital Structure, Valuation, and Cost of Capital, Case, Exhibit 6
6 Professor Linda Caninas ICR and Bond Ratings presentation
5

no change to the common equity portion of the balance sheet, but the debt has significantly increased
from 0 to $3 billion, causing the total capital to increase.
In the market value balance sheet, total assets of $16.311 billion derive from an increase in working
capital of $3 billion, the present value of the debt tax shield at a 40% marginal tax rate, and a decrease
caused by the total cost of financial distress computed in the method above. The assets portion of this
balance sheet, as a result, increases by $8.04 billion. The difference between the present value of the debt
tax shield and the cost of financial distress is added to the owners equity. This difference is added mainly
because the cost is not an explicit one, but rather an implicit one reflected in the cost, savings, and
financing line which does not appear on the income statement. The numbers of shares remain constant;
however, the equity to capital ratio changes to 81% from 99%. 8

7 Exhibit 2, Report Ex. 1, Column J, Row 27

8 Exhibit 1, Report Ex. 1, Column J, Row 43.
6

Leveraging after Issuing Dividends: Within the book value balance sheet, total assets decrease by $3
billion due to an outflow of cash paid to investors in the form of dividends. A companys profits are
recorded to the equity account retained earnings within the owners equity portion. Since dividends are a
sharing of a companys profits with its shareholders, the retained earnings account is reduced from the
shareholder distributions. Owners equity therefore also reduces by a total of $3 billion, causing the total
capital to decrease by the same amount. This results in the negative book value of common equity to be
($1.7 billion). Likewise, the book value of equity to capital has reduced to a negative (120%).
BOOK VALUE vs. MARKET VALUE: The book value is the
accounting value once assets and liabilities have been accounted
for. Accounting values do not regard debt tax shields and the cost of
financial distress, which are also important factors to considering
when valuing a companys performance. Furthermore, as evident
the market value of fixed assets is usually greater than its historical
value. 9 While book values are common metrics used by successful
and accomplished investors, market value has a more meaningful
implication in the sense that, it is the price you have to pay to own a
part of the business.
In the market value balance sheet, the total asset of $13.31 billion is reduced by the corresponding
decrease in working capital. Cash, that was otherwise a current asset, is paid to the investors as dividends,
causing the total asset decrease by $3 billion. Likewise, common equity also decreases by $3 billion. The
decrease in common equity, given that outstanding shares stay constant, causes the share price to decrease
by 23% at $43.68.10
Leveraging after Share Repurchases: A share repurchase has the same effects as those of the special
dividend. Net working capital and common equity in both balance sheets decrease by $3 billion. The book
value per share, however, decreases to ($9619) 30% less than that of issuing dividends ($7.42).
Total number of outstanding shares: Share repurchases leads to
Wrigley Company purchasing its own shares. In case Wrigley
Company decides to purchase its own shares with a total amount of
$3 billion at a price of $56.59, it will repurchase 53,014 shares. This
in turn causes the total number of outstanding shares to decrease
to 179,818.11
In the market value balance sheet, the total assets remain to be $13.31 billion reduced by the working
capital. While the common equity decreases, so does the total number of outstanding shares, causing the
share price to increase to $56.59.
9 Exhibit 1, Report Ex. 1, Column L, Row 31, and Column L, Row 18
10 Exhibit 1, Report Ex. 1, Column L, Row 42
11 Exhibit 1, Report Ex. 1, Column N & M, Row 41
7

MERITS OF DIVIDEND AND SHARE REPURCHASES

Paying out a special dividend: A recapitalization based on a dividend will have no impact
whatsoever on outstanding shares and will furthermore give investors cash up front. On the
contrary, paying out a special dividend might lead to a significant decrease in share price, as
evident above. Dividends are also taxed higher than capital gains which may cause investors to
incline more towards a repurchase.12 The drawbacks and limitations of paying out a special
dividend are as follows:
No impact on outstanding shares: Unlike repurchasing shares, an issuance of dividends
maintains the ownership proportion of Wrigleys investors and Wrigley Family. Thus,
outstanding shares will still remain to be 232,441, allowing the Wrigley Family to remain
with its 21% and 58% holding of common and Class B, respectively.
Reward investors with cash: A dividend of $12.91 will be given per share, rewarding the
investors for Wrigleys performance.
Positive Signaling: Investors also see dividend payments as a sign of a companys
strength and a sign that management has positive expectations for future earnings. A
stock that is perceived as optimistic in the market might cause an increase in demand, and
in turn, an increase in Wrigleys stock price.
X Dividends are taxed higher than capital gains: The choice to not pay dividends may be
more beneficial to investors from a tax perspective. Most dividends are taxed to
investors as ordinary income, which means an investors tax rate on dividends is the
same as his marginal tax rate. Marginal tax rates can be as high as 33 35%. The capital
gains on sale of appreciated stock, however, can have a lower, long-term capital gains
tax rate, typically 15%.
Repurchasing Shares: Share repurchasing decreases the total number of outstanding shares, as
explained above, which in turn increases the share price. Additionally, the contraction in
outstanding shares might amend the influence of the controlling entities. The benefits and
drawbacks of repurchasing shares are as follows:
Decrease in outstanding shares: $3 billion of debt is used to repurchase 53,014 shares.
The decrease in shares outstanding leads to an appreciation of stock price by $0.22.
Positive Signaling: Investors also see an act of repurchasing shares as a signal to the
market that Wrigley considers its shares to be undervalued. This optimistic perspective
towards Wrigleys stock in the market would lead to more investors being attracted to the
company, causing the price to increase further.
Tax benefit: As explained above, taxes on capital gains are as low as 15% compared to
taxes on dividends of 33% - 35%.
X Voting Control: Since shares are being repurchased by the company, certain stockholders
and investors might lose their control in the company. In terms of the Wrigley Family,
they are reluctant to sell any of their shares. The share-repurchase can affect the family
12 http://www.investopedia.com/ask/answers/12/how-are-capital-gains-dividendstaxed-differently.asp
8

in various ways, which is explained in more detail in the next page.

SHARE REPURCHASING AND VOTING CONTROL

Currently, Wrigley owns 21% of common stocks and 58% of Class B stocks. If common stocks have one
vote per share and if Class B stocks have 10 votes per share, then there are a total of 616,210 votes
combatively. Currently, the Wrigley Family has 287,176 votes over a total of 616,210 votes, giving it a
47% voting control.13 There are two main scenarios involving repurchasing shares.
(1) Only repurchase non-family common stock: In this case, a total number of 53,013 common
shares are repurchased from non-family investors at a premium share repurchase price of $62.25.
In this case, common stock decreases from 82% of outstanding shares, to 76% of outstanding
shares.14 Class B shares stay constant since they are not repurchased. This causes a 23% decrease
in the total number of outstanding shares but only a 9% decrease in the total voting rights of
investors. In terms of the Wrigley Family, since this program assumes that they do not partake in
the share-selling program, it will retain the 287,176 votes. The total number outstanding shares
decreased, but the Family maintains its holdings. This allows Wrigleys family voting control to
increase from 47% to 51%.
This method of repurchasing is one of the most common and representative programs. Class B
shareholders would be reluctant to give up 10 votes per share, especially given the extraordinary
performance of Wrigley. Thus, selling only common stocks is a reasonable assumption. We advise
that a premium must be supplemented to the share price. In an open market repurchase, there are
0 premiums to the repurchase price. However, according to empirical studies, various tender
offers usually have a 20% premium on the stock price. That said, an average was computed,
whereby the premium on Wrigleys repurchase price will be 10%. Therefore, shares would be
bought at a final repurchase price of, $62.25.
(2) Repurchasing non-family common and Class B stocks to maintain the same ratio of total
common to class B stocks: In this case, a total number of 43,289 common shares and 9,725
Class B shares are repurchased from non-family investors at a premium share repurchase price of
$62.25. In this case, Wrigley Company maintains the 82% and 18% ratio of Common Stock
against Class B shares.15 This causes a 23% decrease in both shares outstanding and total votes.
Since the Wrigley Family does not partake in a share-repurchasing program, it maintains its
287,176 votes. This allows the family to regain its voting rights from 47% to a majority of 61%.
While this is an ideal scenario for the Wrigley Family, it is not realistic. Class B holders will
mostly ask for a higher share repurchase premium than that given to common stock holders.
Additionally, investors may be overall reluctant to sell Class B shares for the above given
reasons. Selling 10 votes (one share) is undesirable, especially given Wrigleys dominant market
position and its extremely attractive performance against its main competitors.
Therefore, we recommend that the company only repurchases non-family common stock at a share
repurchase price of $62.25. This will give the common stock holders a capital gain, in addition to the 1%
post recapitalization. It will also be less costly for Wrigley Company that it would be by paying an

13 Exhibit 5, Voting Control, Column D & J, Row 8

14 Exhibit 5, Voting Control, Column B. Rows 9 & 15
15 Exhibit 5, Voting Control, Colum B, Rows 22 & 23 vs. Column B, Rows 10 & 11
10

additional premium to Class B shareholders. Lastly, and more importantly, it not only maintains but also
gains Wrigley Familys control in the company.

11

EFFECTS OF RECAPITALIZATION ON WACC

Weighted Average Cost of Capital
The Weighted Average Cost of Capital is 10.9% before recapitalization, 11.21% post-recapitalization
without any actions, and 11.28% after paying dividends, or repurchasing shares.
Before Recapitalization: In order to understand the impact of the inclusion of debt, it is necessary to
compare and contrast the effects to the Weighted Average Cost of Capital (WACC) before and after the
recapitalization. The initial cost of equity is 10.90%. The cost of equity is calculated using the risk-free
rate of 5.65% for the 20 Year US Treasury rate, an equity-market risk premium of 7%, and an unlevered
beta of 0.75. 16
After Recapitalization: An increase in leverage affects Wrigleys cost of debt, cost of equity, and the
overall capital structure, which in turn affect the overall cost of capital.
Cost of Debt: By taking on debt, Wrigleys debt rating will change from AAA to B. According to Ms.
Dobrynin, Wrigleys pretax cost of debt, based on the new bond rating, would be around 13%. In order to
verify this rating, a debt-reiteration was computed using the initial rate of 13%. Upon calculating the
initial interest expense, an Interest Coverage Ratio of 1.352 was computed, giving the debt a rating of B.
Additionally, to confirm the rating, a Debt / Total Capital and an operating income / sales ratio was also
calculated. The yield of a B-rated bond lies between 12.753% and 14.663%. Since Wrigleys performance
is startling, it is safe to err on the side of a lower interest rate. For that reason, we decided to stick with the
13% rate. 17
Cost of Equity: Debt increases the cost of equity as a result of the change in the order cash flows are
received. Now, the debt holders are placed ahead of the preferred and common stockholders.
The cost of equity after recapitalization is 11.73%. 18 When considering paying dividends or repurchasing
shares, cost of equity rises to 11.97%.19 The change is brought about by the reflective modification in
Beta. After recapitalization, the beta increases by 0.12, to 0.87. 20 This increase primarily derives from the
addition of debt into Wrigleys capital structure. A higher debt implies a riskier capital structure, which in
turn reflects a higher beta.
Likewise, the beta when paying dividends or repurchasing shares is 0.90. 21 In this instance, the additional
$3B of debt is used externally (by paying dividends or repurchasing shares) this causes the stockholders
equity portion of the balance sheet to decrease, and thus increasing the Debt to Equity ratio in Wrigleys
capital structure.
16 Exhibit 6, Weighted Average Cost of Capital, Table WACC Before Recapitalization
17 Exhibit 5, EPS vs. EBIT Analysis
18 Exhibit 6, Weighted Average Cost of Capital, Table WACC After Recapitalization
19 Exhibit 6, Weighted Average Cost of Capital, Table WACC After
Recapitalization(Dividend) & (Repurchase)
20 Exhibit 6, Weighted Average Cost of Capital, Table WACC Before Recapitalization
Column E, Row 14
12

Capital Proportions: Initially, the capital weights of Wrigley were 100% equity. The addition of debt,
however, reduces equity proportion to 81% and increases the debt portion to 19%. After recapitalization,
before share repurchase or dividends, the new value of equity is $13.15 billion and the debt increases to
$3 billion. However, with the repurchase of shares or the payment of dividends, the value of equity
decreases by $3 billion to $10.15 billion.

21 Exhibit 6, Weighted Average Cost of Capital, Table WACC Before Recapitalization

Column H &K, Row 14
13

EFFECTS OF RECAPITALIZATION ON VALUE

Adjusted Present Value Approach: The firm value of Wrigley using the Adjusted Present Value (APV)
approach is $13.20 billion directly after recapitalization. If, however, dividends are paid or if shares are
repurchased, then the firm value of Wrigley decreases to $10.20 billion. The APV method is famously
known as a divide & conquer approach. As analysts, we first evaluate the project as if an unlevered
company were considering it. In this regard, we ignore all the financing effects such as the tax shield of
debt and the likelihood of default. The unlevered firm value for Wrigley is its equity value, which is
simply calculated by multiplying share price to outstanding shares.
The cost of debt is used as a discount rate because this accurately reflects the risk associated with the debt
cash flows and hence the tax relief. The total value of the debt relief is $1,200,000, and using a 13%
discount rate, its present value is $9,230,769.
Likewise, having obtained a credit rating of B, the cost of financial distress was also calculated. The
negative amount was then added to unlevered firm value and the debt tax shield. Without paying
dividends and repurchasing, the firm value of Wrigley significantly increases by 0.7%. On the other hand,
if dividends are paid or if shares are repurchased, firm value decreases by 22%.
Full Value Approach: The firm value of Wrigley using the Full Value Approach is $11.58 billion directly
after recapitalization. If, however, dividends are paid or shares are repurchased, then firm value of
Wrigley decreases to $11.26 billion. We begin by computing Wrigleys current cash flow from assets
using its most recent income statement and its tax rate of 31%. Based upon the current cost of capital of
10.90%, we solved for the implied growth rate. After having obtained an 8.55% growth rate, we assumed
that Wrigley shifted its capital structure with an additional $3 billion worth of debt. The value of the firm
decreases if the firm moves to the new debt ratio, which illustrates that the D/E ratio is not an optimal
one.
Comparisons of the two approaches: Conceptually, the APV is relatively easy to understand. The
method separates the investment decision from the financing decision by breaking the traditional cash
flow discounting into two parts. The first part, that is the investment decision, discounts un-leveraged
cash flows to the present value at the cost of equity of 10.90%. The second part, the financing decision,
discounts both the debt-tax shield and the cost of the financial distress at the cost of debt. The two parts
are then summed to derive the value of the entire enterprise.
On the contrary, when pursuing an APV approach, the concept of estimating probabilities of default and
the cost of bankruptcy is solely based on assumptions and historic ratings. In fact, various institutions
ignore expected bankruptcy costs when valuing an organization.
The full value approach, on the other hand, has two main limitations. Firstly, the growth rate implied
seems to be extremely high. While Wrigleys revenues are currently growing at an 8.55% rate, there is no
guarantee that this shall exist in perpetuity. Likewise, the Weighted Average Cost of Capital assumes a
stationary debt to equity ratio. Many companies, however, do not expect to have a static level of debt to
equity, particularly in situations involving highly leveraged transactions.

14

EFFECTS OF RECAPITALIZATION ON EARNINGS PER SHARE

Assuming the 2001 operating cash flow of $513,356 is constant; the additional $3 billion in debt
will reduce the EPS due to the payment of interest expense. After recapitalization, interest
expense becomes $390,000. The introduction of interest causes the net earnings to decrease from
$363,986 to $94,783, thus reducing the expected EPS from $1.56 to $0.41 with a special issue of
dividend, or $0.53 with a share repurchase program, the only difference being the number of
shares outstanding. EPS after recapitalization is clearly much worse, however, if management
ought to select research suggests that investors should base their investing decisions on intrinsic
ratios that focus on discounting cash flows rather than EPS.
CONCLUSION
Aurora Borealis should advise the Wrigley Company to include debt in its capital structure.
While a 0% debt is remarkable, current market conditions provide an opportunity to improve the
companys capital structure. An inclusion of debt increases the value of Wrigley using the
Adjusted Present Value method. Likewise, an optimal debt to equity ratio would lead to an
optimal Weighted Average Cost of Capital and as a result a maximized firm value. Despite the
decrease in value after repurchasing shares, Wrigley Company would signal positive messages to
the market that attest to the stocks undervalued price and complacent management structure.
Lastly, with the debt recapitalization, the Wrigley family is also able to regain and maintain its
voting control within the firm. In conclusion, we believe a leverage recapitalization would
benefit stockholders, the Wrigley Family, and the Wrigley Company both financially and
personally.

15