Example exchange preference shares for ordinary

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Example – exchange preference shares for ordinary shares and exchange debentures for ordinary shares - NB to remember that companies have no obligation to pay dividends to ordinary shareholders, they do however have obligation to preference share holders and debentures - By allowing this exchange, can reduce the financial obligation of the company Leveraged Buyouts (LBOs) and Management Buyouts (MBOs) - LBOs – refers to the purchase of a company by a small group of investors, financed largely with debt. - MBOs - when incumbent managers make the purchase - LBOs often result in companies going private - Became very popular in USA in 1980’s due to three reasons: 1.) Favourable market and economic conditions 2.) Regulatory changes 3.) Development of the junk bond market - Junk bonds – offering investors potentially high returns but pose a high risk and high probability of default - LBOs not as common in South Africa because: 1.) Markets aren’t as sophisticated 2.) Interest rates are usually substantially higher 6 | P a g e *When pay a cash dividend - the market value of the shares will decrease by the value of the dividend paid Therefore the market value of equity will equal 100 000 x R7 = R700 000 Since the excess cash has been utilised the total assets will also equal R700 000 * When engage in share repurchase – the market value of shares is unaffected The market value of equity will be equal to 70 000 x R10 = R700000 Since the excess cash has been utilised the total assets will also equal R700 000 Share repurchase increases the EPS 49 000/70 000 = R0.70 Scenarios will result in the following values, which are the same for both: Excess Cash 0 Equity 700 000 Other Assets 700 000 Debt 0 Total Assets 700 000 Total Capital 700 000 It is however not realistic to ignore the influences of commissions, taxes and other market imperfections.
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Leveraged Recapitalisations - Use of debt capital (leverage) can increase the value of the firm 7 | P a g e Example (page 53) Consider the following information for Tango Company: Total Assets R100 000 Equity (book value) R100 000 Debt (book value) 0 Number of Shares Outstanding 50 000 Current market value (price) of shares R25 Book value per share R2 Market value of equity R 1 250 000 Market / Book ratio R12.50 (a) Book value per share = Book value of equity / number of shares outstanding (b) Market value of equity = market value per share x number of shares outstanding (c) Market / Book Ratio = Market value per share / Book value per share As companies with no or low levels of leverage often become targets – Tango decided to introduce debt The amount of debt introduced will depend on the effect on the market share Consider the following options: SFP No Debt 5% Debt 10% Debt 25% Debt Total Assets R100 000 R100 000 R100 000 R100 000 Debt (BV) 0 62 500 125 000 312 500 Equity (BV) 100 000 37 500 - 25 000 - 212 500 Total Capital 100 000 100 000 100 000 100 000 a) Debt = % debt x current market value of equity b) Equity = total capital - debt How did the leverage recapitalisation affect the market value of Tango?
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