Master Student

In: Business and Management

Submitted By DDDDDaviddd
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Impact of recapitalization

With the addition of the new debt, Wrigley’s share price should quickly and fully reflect the changes in investors’ perceptions stemming from the repurchase once the company publicly discloses its intentions. Those perceptions should adjust in several dimensions

• Present value of new debt tax shields created by the recapitalization:

• Signaling effects: Generally, recapitalizations may signal to public investors the (better informed) expectations of insiders. Revelations of how the insiders view the future may cause public shareholders to revise their expectations about the firm’s future.

• Incentive effects: A large increase in leverage may bind management to deliver predictable operating results in order to service the debt. This discourages squandering the firm’s cash flow on perquisites for management or unprofitable investments.

• Clientele effects: Finally, a large change in leverage may cause some investors to bail out of the stock and others to buy in. which is similar to the phenomenon of clientele change related to major changes in dividend payout by firms.

One way to frame the issues is—immediately upon the announcement—the stock price should change to reflect the following:

Post-recapitalization equity=prerecapitalization equity value+ present value debt shield


WACC before recapitalization Wrigley’s prerecapitalization WACC is 10.9%. The cost of equity assumes a risk-free rate of 5.65% for 20-year U.S. Treasuries (case Exhibit 7), a risk premium of 7% (guidance from the instructor[1]), and uses Wrigley’s current beta of 0.75 (case Exhibit 5).

WACC after recapitalization

The increase in leverage will affect Wrigley’s WACC in at least three ways:

1. Cost of debt: Wrigley’s debt rating…...

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