The issue:
Grand Metropolitan PLC is the world’s largest wine and spirits seller. It mainly operated in London, USA. In 1991, it beats market expectation with a 4.8% increase in pretax profits, and the company Chairman stated that company’s goal “to constantly improve on”. Despite the great performance in the world recession in 1991, the price of GrandMet shares was 10% below the average price/earnings ratio of the companies in the Standard & Poor’s 500 index. And more important, rumors had that GrandMet, valued at more than $14 billion in the stock market, maybe a takeover target. The management dilemma is to understand why the company’s stock is traded below of what considered being the right price and whether the company is truly being undervalued by the market or there are consistent issues with negative NPV projects and lines of businesses.
WACC calculation
I. Cost of debt
The purchasing power parity implies the following relationship between the home (GB £) and local (US $) costs of debt:
Local rd$ = (1 + Home rd£) {(1 + local inflation i$)/(1 + Home inflation i£)} -1
=> rd£ = (1 + rd$)*(1 + i£)/(1 + i$) -1 = (1+ rd$)*1.043/1.027 -1 (from case Exhibit 9)
= (1+ rd$)*1.015579 - 1
Similarly to convert the small amount of debt issued in Germany, we use the relative inflation rates of the two countries to get:
rd£ = (1+ rdDM)*1.043/1.04 = (1+ rdDM)*1.00288 - 1
Total debt outstanding by country are given in Exhibit 6 of the case, we use the market value of the unspecified (long term) debt in our WACC calculations:
US outstandings: Vd$ = 3,137+152+110 (Market values) = $3,399M
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