They adjust the coverage ratio by re leveraging debt through a combination of

They adjust the coverage ratio by re leveraging debt

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brands allowed Diageo to maintain its interest coverage ratio goal. They adjust the coverage ratio by re-leveraging debt through a combination of debt issuance, repurchases, and other large transactions. Due to the fact that they had such a strong rating, it allowed them to more readily raise finances and pay the lower promised yields. The high debt rating also allotted Diageo the ability to access short term commercial paper borrowings at attractive rates. 47% of their debt was issued as short-term commercial paper with maturities of six months to one year. When comparing Diageo to its competitors, Diageo is conservative in its use of debt relative to the industry norm as well. Diageo has four different industries; wine and spirits, beer, packaged food products and fast food. In order to better understand Diageo’s use of debt we start by comparing the interest coverage between Diageo and its main competitors; Allied Domecq, Pernod Ricard, and Seagrams. From Exhibit 4, Allied Domecq has an interest coverage ratio of 5.7, Pernod Ricard has an interest coverage ratio of 10.4, and Seagram has an interest coverage ratio of 2.4 . This result tells us that Diageo’s use of debt is relatively conservative comparing with its competitors It has a
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similar interest coverage ratio as Allied Domecq but a lot less than Pernod Ricard. Since Diageo has many lines of business, it is understandable that it might have more debts than Pernod Ricard, a company that specialized in alcoholic drinks. Also, when comparing with another conglomerate like Seagram, it has a much higher interest coverage ratio, 5.0 vs. 2.4. We can see that Diageo is conservative comparing its competitors. 2. The static tradeoff theory of capital structure refers to the how a company chooses how much to finance with debt and how much to finance with equity by balancing the costs and benefits. For debt the benefits include the interest tax shield increasing value while the costs include bankruptcy costs decreasing overall value. According to this theory firms can borrow to the point where the benefits from an extra dollar of debt can equal the costs from an extra dollar of debt. At this point the firm value is highest, the WACC is lowest and you’ve reached the optimal capital structure.
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