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Impact on cost of capital Chandler knew that the maximum value of the firm was achieved when the weighted average cost of capital (WACC) was minimized. Thus, she intended to estimate what the cost of equity and the WACC might be, if Wrigley pursued this capital-structure change. The projected cost of debt would depend on her assessment of Wrigley's debt rating after recapitalization and on current capital-market rates (summarized in Exhibit 7). The cost of equity (Ke) could be estimated by using the capital asset pricing model. Exhibit 7 gives yields on U.S. Treasury instruments, which afforded possible estimates of the risk-free rate of return. The practice at Aurora Borealis was to use an equity-market risk premium of 7.0%. Wrigley's beta would also need to be relevered to reflect the projected recapitalization. Chandler wondered whether her analysis covered everything. Where, for instance, should she take into account potential costs of bankruptcy and distress or the effects of leverage as a signal about future operations? More leverage would also create certain constraints and incentives for management. Where should those be reflected in her analysis? Exhibit 7 THE WM. WRIGLEY JR. COMPANY: CAPITAL STRUCTURE, VALUATION, AND COST OF CAPITAL Capital Market Conditions as of June 7, 2002 U.S. Treasury obligations 3 mos. 6 mos. 1 yr. 2 yr. 3 yr. 5 yr. Other instruments U.S. Federal Reserve Bank discount rate LIBOR (1 month) Certificates of deposit (6 month) Prime interest rates 1.730% 1.840% 1.980% 4.750% Yield 1.670% 1.710% 2.310% 3.160% 3.660% 4.090% 4.520% 4.860% 5.650% U.S. Treasury yield curve 7 yr. June 7, 2002 10 yr. 20 yr. 6% 5% 4% 3% 2% Corporate debt obligations (10 year) AAA AA A BBB BB B Yield 9.307% 9.786% 10.083% 10.894% 12.753% 14.663% 1% 0% 3 mos. 6 mos. 1 yr. 2 yr. 3 yr. 5 yr. 7 yr. 10 yr. 20 yr. Impact on cost of capital Chandler knew that the maximum value of the firm was achieved when the weighted average cost of capital (WACC) was minimized. Thus, she intended to estimate what the cost of equity and the WACC might be, if Wrigley pursued this capital-structure change. The projected cost of debt would depend on her assessment of Wrigley's debt rating after recapitalization and on current capital-market rates (summarized in Exhibit 7). The cost of equity (Ke) could be estimated by using the capital asset pricing model. Exhibit 7 gives yields on U.S. Treasury instruments, which afforded possible estimates of the risk-free rate of return. The practice at Aurora Borealis was to use an equity-market risk premium of 7.0%. Wrigley's beta would also need to be relevered to reflect the projected recapitalization. Chandler wondered whether her analysis covered everything. Where, for instance, should she take into account potential costs of bankruptcy and distress or the effects of leverage as a signal about future operations? More leverage would also create certain constraints and incentives for management. Where should those be reflected in her analysis? Exhibit 7 THE WM. WRIGLEY JR. COMPANY: CAPITAL STRUCTURE, VALUATION, AND COST OF CAPITAL Capital Market Conditions as of June 7, 2002 U.S. Treasury obligations 3 mos. 6 mos. 1 yr. 2 yr. 3 yr. 5 yr. Other instruments U.S. Federal Reserve Bank discount rate LIBOR (1 month) Certificates of deposit (6 month) Prime interest rates 1.730% 1.840% 1.980% 4.750% Yield 1.670% 1.710% 2.310% 3.160% 3.660% 4.090% 4.520% 4.860% 5.650% U.S. Treasury yield curve 7 yr. June 7, 2002 10 yr. 20 yr. 6% 5% 4% 3% 2% Corporate debt obligations (10 year) AAA AA A BBB BB B Yield 9.307% 9.786% 10.083% 10.894% 12.753% 14.663% 1% 0% 3 mos. 6 mos. 1 yr. 2 yr. 3 yr. 5 yr. 7 yr. 10 yr. 20 yr