Diageo_plc_Team_21 - Diageo plc A Harvard Business School...

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Diageo plc A Harvard Business School Case Study Part I 1) Diageo plc is a conglomerate formed in 1997 through the merger of Grand Metropolitan plc and Guinness plc, two consumer product companies. Their goal was to become an industry leader by achieving cost savings through marketing synergies, cutting overhead expenses, and developing production and purchasing efficiencies. Although diversified within the packaged food, beverage alcohol, and fast food industries, Diageo sought to focus exclusively in beverage alcohol by selling their packaged food (Pillsbury) and fast food (Burger King) enterprises. This would create more investment dollars to purchase other leading beverage alcohol companies without taking on excessive debt, thereby realizing Diageo’s goal of becoming a market leader in the industry. The company’s capital structure strategy was crucially important in terms of credit rating and predicting financial distress, and the company intended to maintain the highest rating possible to keep debt maintenance costs down. Ultimately, the company conducted a Monte Carlo Analysis to analyze the trade-off of restructuring the company’s capital structure. 2) Corporations routinely face decisions regarding new investments and must determine the best way to finance those investments. The method by which this financing occurs can have a significant impact on the overall value of the firm, therefore financing decisions must be made very carefully. Corporations finance new ventures either through debt or equity or some combination of the two. When choosing the optimal mix of these elements, firms must carefully consider the effects of
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Diageo plc FIN6425 Team 7 taxes and the costs of bankruptcy and financial distress. Market timing effects as well as readily available financial slack may also come into play when firms are determining their capital structure. Some firms adhere to the Pecking Order Theory where they use internal financing, if available, and choose debt over equity when external financing is required. Other firms may adhere to the Trade-Off Theory where the tax benefits of debt are “traded-off” against the costs of financial distress. Regardless of the method employed, every firm shares the same goal of choosing an optimal capital structure that maximizes firm value. 3) Diageo, like most UK firms, had a more conservative approach in their financial policies. Before the merger, both Grand Metropolitan and Diageo used little debt to finance themselves, which led each firm to have high credit ratings (AA and A respectively). Post-merger, uncertainty regarding the restructured financing policies put them on credit watch, but Diageo made the decision to maintain the basic premise of the original capital structure and maintain low debt numbers. They also sought to keep their interest cover ratio at 5 to 8 times, which eased the
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This note was uploaded on 03/07/2012 for the course FIN 6425 taught by Professor Nimalendran during the Summer '10 term at University of Florida.

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Diageo_plc_Team_21 - Diageo plc A Harvard Business School...

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