Essay on Diageo Plc

1193 Words Sep 18th, 2012 5 Pages
DIAGEO PLC
1. What do you think about the capital structure policies Diageo has pursued in the past. Do they make sense? How does it compare to Diageo’s competitors’ policies? Which competitors would make for the best comparison? 2. Why is Diageo selling Pillsbury and spinning off Burger King? How might value be created through these transactions? 3. Based on the results of the simulation model, what recommendations would you make for Diageo’s capital structure? Does the model capture all of the important risk factors faced by Diageo? Would you want to adjust the model I any way?

Up until 2000 capital structure policy at Diageo was conservative, maintaining quite a high the [book] equity-to-assets ratio inherited from its predecessors:
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Proposed cash and equity swap for the Diageo’s packaged food business implies an EV/EBIT multiple of ca. 21x and generates proceeds of ca. $10.5 billion - 30% of the Diageo’s Market Capitalization while packaged food business contributed for 25% of the consolidated operating profit, the difference can be accounted for the unlocked value by eliminating the “conglomerate discount”. No clear

indications was given regarding the expected value of the Burger King’s spin-off, but still we could expect that the value of the standalone publicly listed company will be higher than this business unit had within the Diageo’s “portfolio of assets” and the deal’s structure is expected to be a tax-free. Empirical evidence shows that conglomerates do the poor job in the diversification and companies’ shareholders can diversify their portfolio in much better and efficient manner and thus the divestiture of the non-core assets creates shareholders’ value.

Consistent with the Opler, Saron and Titman’s article on the Capital Structure to create a Shareholder Value, the optimal debt ratio is exactly at the level where the sum of the present value of the taxes paid and present value of the financial distress are at minimum, which is, for the Diageo’s Monte-Carlo simulation is in range of 4.2 interest coverage ratio and, all else being equal, this would be the recommended capital structure if one can derive the

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