Diageo was conglomerate involved with food and beverage industry in 1997. Initially founded with a merger between Grand Metropolitan and Guinness, the organization went to become significant player in the market. For several reasons (low borrowing cost, investor confidence), Diageo elected to help keep a conservative capital structure with lower levels of debt. Three primary factors governed the main city structure guidelines of Diageo. They incorporated Interest coverage ratios, EBIT to debt ratio along with a target rating of the . The simulation model built through the treasury number of Diageo clearly reflected that the organization was under leveraged and may increase its market price by dealing with more debt and taking advantage of it to invest in internal growth and purchases. Although, the simulation provided an thorough analysis for making decisions it didn't have analysis around the operational factors affecting the main city structure guidelines. Furthermore, additionally, it overlooked the advantages of a greater EBIT caused by expansion through debt.
Interst Coverage Ratios
Grand Metropolitan 1997
Describe briefly Diageo’s business, putting particular emphasis on the potential sources of risk, and your evaluation thereof. Identify major sources of risk for equity holders and for debtholders.
Describe Diageo's current approach to managing its capital structure. What are the key variables that guide its capital structure policy?
What factors should Diageo consider in determining its capital structure? What information would you collect and what analyses would you conduct in order to determine the appropriate level of gearing?
How does the Treasury Group's simulation work? What aspects of Diageo's business does it capture? What does it ignore? What key assumptions does it make? How could you improve the model to adjust any missing factors?
What are the managerial implications of the summary results shown in Figure 2 of the case? As Ian Cray, what questions would you ask the Treasury team in reviewing their work? What should Cray recommend for Diageo's gearing when it becomes a pure beverage alcohol business? Frame your recommendation in terms of a target level of interest coverage or a target bond rating.