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Introduction and BackgroundDiageo 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 so 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 the company operated The team had to create a simulation model which should consider new finance approaches treasury functions to focus on what the firms risk footprints will be how to calculate cost of capital and finally how to optimally structure capitalHow has Diageo managed its capital structureBoth Grand Metropolitan and Guinness had little debt prior to the merger which allowed them to benefit from relatively high ratings on their bonds AA and A respectively Straight after the merger Diageos management announced it would maintain similar policies to the ones adopted by the two previous companies This decision took the form of an implicit promise not to get into a debt level that would lead to a reduction in the credit rating of the company which was aiming at an interest coverage between 5 and 8 A second target was set to keep EBITDATotal Debt at 30-35 level This tranquilized investors and financial markets and as a consequence the company was given an A rating by credit agenciesTable 1 presents some key financial indicators extracted from the case As it can be observed Diageos debt level is low market gearing level is around 25 which together with the favorable credit rating A puts the company in a good borrowing position in case of such need From the data shown in Table 2 we can see that the companys
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