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? (40%) Diageo was formed from the merger of Grand Metropolitan plc and Guinness plc. Before the merge, both companies used little debt (based on the book D/E ratio and net debt to total capital in the table below) to finance themselves which helped them gain and maintain high credit rating (A and AA respectively). After the merge, Diageo wanted to take the same path by maintaining the interest coverage between 5 and 8 (through actions such as new debt issuance, share repurchase programs shown in figure 1) and having
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This would allow the firm to expand its core business and focus on the alcoholic beverage industry. From the text, Walsh’s new strategy involves focusing on “beverage alcohol, driving growth through innovation around our unrivalled portfolio of brands and providing an improved base for sustained profitable top line growth”.
Not only, Diageo considered its major rivals as potential rival bidders for firms and brands but also as potential acquisition targets. Selling Pillsbury and spinning off Burger King would allow Diageo: * to have cash handy to pay its obligations in the short-term (high amount of short-term liabilities from exhibit 6). * to have the cash needed to invest in acquiring other firms for efficiencies and synergies (cost savings in manufacturing, procurement and supply, enhanced ability to reach customers through distribution systems). General Mills would pay Diageo $5.1 billion in cash and 141 million shares (totaling $5.4 billion). * to benefit from the synergies created by the merger of General Mills and Pillsbury as a shareholder owning 33% of the joint business.
3. Based on the results of the simulation model, what recommendation 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 in any