Debt Recapitalisation and Financial Distress Costs

This presentation discusses the concept of debt recapitalisation and its impact on financial distress costs. It focuses on the case of Netflix Organisation and explores the risks and challenges associated with changing the capital structure. The presentation also highlights the importance of estimating financial distress costs and managing debt and equity effectively. References are provided for further reading.

Critical and Creative Thinking

Table of Contents
• INTRODUCTION
• Debt recapitalisation
• Estimating financial distress costs
• CONCLUSION
• REFERENCES

INTRODUCTION
• Recapitalisation financial leverage is one of the
crucial approach by the company.
• The present report deals with Netflix Organisation
which is engaged in business of online streaming of
various shows and is planning for debt
recapitalisation.
• The results could be such that it may lend
organisation to bankruptcy if debt is not timely paid.
• Moreover, report discusses about agency costs and
estimation of cost of financial distress is made as
well.

Debt recapitalisation
• The financial distress may be caused due to change in the
capital structure of the company.
• Netflix Organisation which is engaged in providing live
streaming of shows to customers.
• The debt recapitalisation decision will inject financial distress
in quite adverse manner.
• The term financial distress means that firm may face difficulty
in paying off obligations which becomes due.
• Inability of business to pay liabilities will raise various issues
in which bankruptcy is major problem for the company.

Cont.
• Netflix debt recapitalisation will evolve negatives to it.
• Recapitalisation means that firm will raise funds from debt only
and equity will be reduced up to high extent.
• This will raise burden of paying liabilities along with the interest
on it.
• Firm will be fully dependent on debt to carry on operational
activities and as such, chances of bankruptcy may be evolved
which is the negative sign for the company.
• It will be unable to pay timely payments to various parties
involved in the process and moreover, creditors will call for
making outstanding payments.

Cont.
• Debt recapitalisation will also have negative effect on
agency costs.
• This will eventually increase financial distress of the
company in adverse way.
• Agency cost arises from the conflicting agreement of
shareholders and management in the company.
• In simple words, principal and agent do not meet at
the same point for the betterment of the company.

Cont.
• This disagreement of between these two parties will
have adverse effect on the investors of the company.
• Netflix Organisation has investment in optimum
quantum and as such, conflicting situation of
management and shareholders will have serious
repercussions on investors.
• The investment will become low and value of
Netflix's stock will also decline causing into
reduction in earning price of shares quite adversely.

Cont.
• The major example of agency cost is that if management do
not agree to take on project as if it fails, business may be
doomed in loss.
• On the other hand, shareholders will take risk because if
project succeeds nicely, there earnings will be maximised.
• Thus, conflict arises between them which affects firm in the
bad manner.
• The above example of shareholder maximisation value is of
monitoring costs which fall under type of agency costs.
• Bonding cost also rises when agent commits that he will stay
with the company even if it is acquired by another company.

Cont.
• Thus, agency costs rises because of debt recapitalisation and
Netflix Company will incur agency costs up to high extent.
• Moreover, company will also have financial distress quite
adversely.

Estimating financial distress costs
• Financial distress costs have negative effect on the
company as more of the debt is utilised and equity is
reduced up to high extent.
• Financial distress may have serious repercussions as
firm gradually increases debt structure in the financial
leverage.
• This results into paying more liabilities and also
payment obligations are hiked and to be paid within
stipulated time frame.

Cont.
• This may even lead to bankruptcy which is the serious issue
for the company.
• Thus, organisation should always adequate mix of debt and
equity so that advantages of both the capital can be utilised
up too maximum possible extent.

Cont.
• In this relation, it is required to estimate costs of
financial distress so that risk may be minimised quite
effectively.
• The financial distress also rises from the issue of
bond and as such, risks gets doubled.
• Cost of financial distress can be easily calculated
when bond is issued by the company.
• Netflix Company is changing capital structure and as
such, major funds will be raised from issuing of bond.

Cont.
• For analysing financial distress cost, it is required that
firm should analyse present value of cash inflows
such as calculating NPV (Net Present Value).
• This is the main challenge to company to arrive at
NPV to assess cost of financial distress.
• The research approach is to find out default rates to
effectively estimate probability of cost of financial
distress and attaining risk free rate to find out
eradicate such costs.

Cont.
• For estimating financial distress, firm's annual report
is required.
• From that total amount of debt needs to be arrived at.
• Next step is to determine, interest rates paid by
organisation which are not under financial distress.
• The firms are AAA credit ratings one.
• Thus, for analysing cost of debt, it is required that
these firms rate of interest which they pay on issue of
bonds are assessed.

Cont.
• After analysing, Netflix Organisation can easily
determine such cost.
• For estimation purpose only, there is 6 % interest rate
which are paid to investors for AAA rating.
• Next step is to compute weighted average cost of
debt.
• If company has 10,00,000 in borrowings and interest
rate is 2,50,000 is raised to 8 % and remaining
7,50,000 is raised to 10%.

Cont.
• Thus, weighted average cost can be calculated by finding loan
% and multiplying by interest rate (Donker, Ng and Shao,
2018).
• In this estimation case, 2,50,000 has 2% and remaining
investment has total of 7.5%.
• Now adding these two, total interest rate is 9.5%. Original rate
was 6% and now increased one is cost of financial distress
which is 3.5 %.
• Now, Netflix Organisation has 10,00,000 of borrowings and
financial distress is 3.5%.
• Thus, in terms of currency, total cost is 10,00,000 * 3.5% =
3,50,000.

CONCLUSION
• Hereby it can be concluded that debt recapitalisation
should be effectively done by the firm.
• This is required so that company may not lend in
bankruptcy and as such, debt paying capacity should
be strong enough.
• Agency and financial distress costs are required to be
calculated so that risks can be assessed and managed
in the best possible way.

REFERENCES
D'Mello, R., Gruskin, M. and Kulchania, M., 2018. Shareholders valuation of long-
term debt and decline in firms' leverage ratio. Journal of Corporate Finance. 48.
pp.352-374.
Donker, H., Ng, A. and Shao, P., 2018. Borrower Distress and the Efficiency of
Relationship Banking. Journal of Banking & Finance.
Kopecky, and et.al, 2018. Revisiting M&M with Taxes: An Alternative Equilibrating
Process. International Journal of Financial Studies. 6(1). p.10.
Sadiq, R. and et.al, 2018. Effect of Recapitalization on Banks’ Financial Performance
in Nigeria. International Journal of Contemporary Research and Review. 9(01).
Online
Wilkinson, 2013 Financial Distress Costs [Online] Available
Through:<https://strategiccfo.com/financial-distress-costs/>

THANK YOU