existing debt would enable Diageo to compute the proposition of the tradeoff

Existing debt would enable diageo to compute the

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existing debt) would enable Diageo to compute the proposition of the tradeoff between tax shields and cost of distress. The static tradeoff assessment is essential because Diageo needs to know how financial distress would affect its business. Financial distress might lead to strategic costs in three dimensions. First, competitors may capitalize on this situation by capturing market share from the company. Secondly, while under distress management might focus on fixing problems rather than running the business. Lastly, customers tend to be less willing to purchase from a flailing business in the long term. One of the main reasons why Diageo planned to sell its Pillsbury business and float its stake in Burger King is so the company can concentrate solely on its beverage and alcohol sectors. Since the beverage and alcohol businesses combine to create the majority of Diageo’s operating income, it makes sense to concentrate in these areas. Diageo is predicting a great deal of consolidation in the beverage industry within the near future, therefore making its competitors acquisition targets. As the world’s largest beverage spirits firm, Diageo could easily integrate new acquisitions into their established economies of scale, creating synergistic rewards and profits. Since Diageo is in a strong position to expand its beverage and spirits division, it is necessary for the firm to have the capital necessary to make these acquisitions as and when they become available. Diageo projects the need for up to $6 to $8 billion over the next three years for acquisition purposes, most of which could be obtained from the Pillsbury deal alone. From the results of the model, we got that the horizontal axis is constructed by the present value of taxes paid and distress costs, which have inverse correlations in the model. No debt or little debt means the company has to pay more tax. However, more debt could make company risk a downgrade, then paying higher interest. Therefore, we should consider both segments when adjusting the capital structure of Diageo plc. In 2000, from EXHIBIT 1, Interest coverage ratio, which is a critical variable that determined company’s rating, equals to EBITDA 1 (£2043 1 Depreciation and amortization in this industry were relatively low, so EBIT and EBITDA were similar.
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