Interest Rate – based on Exhibit 8, item (b), all interest rates are linked to the US interest rate so
we used the base US rate from Exhibit 5 and then did a random variable generator to calculate an
interest rate between 2% and 14% based on the Part II instructions. The determined interest rate
was used to calculate the asset level each year. Assets began at the 2000 level of £16.1 billion
and increased each year by the calculated interest rate based on the case instructions. The
interest rate was also used to estimate interest payments for the outstanding debt.
To calculate Earnings Before Interest and Taxes (EBIT), we estimated Return on Assets (ROA)
and the impact of changes in ...view middle of the document...
We altered this assumption so the ratio was between 8 and 11 and then between 2 and
5 in order to see the variation of the capital structure on the NPV of the taxes paid and financial
In all scenarios, we assumed that if the interest coverage ratio fell below one, that the company
was in financial distress and had a permanent decrease in assets of 20%.
Once we determined whether there was a special dividend, we were able to calculate the
remaining cash balance. Diageo had a year-end zero cash balance policy so any remaining cash
after all dividends were paid would go to pay off the outstanding debt. If there was not enough
cash to cover expenses and the regular dividend, Diageo would borrow the necessary balance to
increase the outstanding debt balance.
2) Based on our simulations, we would recommend that Diageo change their future capital
structure to include additional debt. With their current structure (an interest coverage ratio
between 5 and 8) the average NPV of taxes paid is £12,038.8 million with a standard deviation of
£1,204.0 million while the average NPV for financial distress costs is £1.6 million with a
standard deviation of £71.5 million.
Increasing that range...