An important U.K.-based conglomerate is reassessing its debt policy as it reframes its business structure. The treasury team designs and identifies the compromisesand adjustments between the advantages and disadvantages of raising finance through debt, utilizing Monte Carlo simulation to approximate the money saved from the interest tax shields and predicted financial distress costs under various different bundles of leverage rules. The CFO, who is the group treasurer, must determine if and through what means the simulation results should be made part of a proposal to the BoD, and mostly, what proposal to offer related to the company’s leverage rules and practices.
Interst Coverage Ratios
Grand Metropolitan 1997
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%)
2. Why is Diageo selling Pillsbury and spinning off Burger King? How might value be created through these transactions?
3. Based on the result 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 way? Note: I do not expect you to do your own Monte Carlo Simulations. The emphasis should be on understanding conceptually how the model helps evaluating Diageo’s capital structure, and what the possible shortcomings of this approach could be?