Financial Analysis: Netflix Debt Recapitalisation and Cost Estimation

This report provides a comprehensive analysis of Netflix's debt recapitalisation strategy, examining its potential impacts on the company's financial health. The report delves into the concept of financial distress, discussing how changes in capital structure, specifically increased debt, can lead to difficulties in meeting financial obligations and potentially result in bankruptcy. It highlights the risks associated with debt recapitalisation for Netflix, emphasizing the increased burden of debt repayment and the potential for financial instability. Furthermore, the report explores agency costs, stemming from conflicts between shareholders and management, and their adverse effects on investors. It also addresses the estimation of financial distress costs, outlining methods to assess the probability of such costs and minimize related risks, including the use of Net Present Value (NPV) calculations and analysis of interest rates. The conclusion emphasizes the importance of effective debt recapitalisation, careful management of agency costs, and accurate estimation of financial distress costs to ensure the long-term financial stability of Netflix. The report references various books and journals to support its analysis.

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TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Debt recapitalisation...............................................................................................................1
Estimating financial distress costs..........................................................................................2
CONCLUSION................................................................................................................................3
REFERENCES................................................................................................................................4

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 (Sadiq and et.al, 2018).
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.
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 (Kopecky
and et.al, 2018). 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.
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
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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. 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 (D'Mello, Gruskin and Kulchania, 2018).
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. 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.
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. 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.
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 (Wilkinson, 2013). 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. 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.
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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%.
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.
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REFERENCES
Books and Journals
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/>
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