Diageo Case Essay

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Diageo Plc. Introduction Diageo was formed in 1997 through the merger of two consumer product companies Grand Metropolitan plc. and Guinness plc. Under the strategy of reducing costs through marketing synergies, cutting overhead expenses and increasing production and purchasing efficiencies. The new merger wanted to concentrate solely on the beverage alcohol business; therefore, it sold its packaged foods (Pillsbury) and fast food (Burger King) businesses. While the mandate for Managing for Value came from the highest levels of Diageo, the treasury team was given the task of establishing the cost of capital for each of the different areas where the company operated. The team had to create a simulation model which should consider new finance approaches, treasury functions to focus on, the risks for the firm, how to calculate cost of capital and finally, how to optimally structure capital. 1). Financing decisions firm must routinely make The Equilibrium Theory argues that the value of the leveraged value of a company depends on the un-levered (full equity) value of the firm, plus the present value of the tax shield minus the present value of the distress costs. The present values of tax shield and the distress costs vary with different levels of debt. Debt does not affect the un-levered value of the firm due to the fact that debt finance does not affect the operating risk of the company, however, it does affect the financial risk. As the leverage increases, the expected return from equity holders also augments along with risk. These effects cancel out making the shareholder value unmoved. However, it is important to note that as a firm borrows more, the risk of default increases making the company pay higher interests rates on new debt. There is a point in the D/E ratio (usually high) where holders of the risky debt begin to bear part of the firm's operating

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