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 changes3.)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 paidTherefore the market value of equity will equal 100 000 x R7 = R700 000Since 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 unaffectedThe market value of equity will be equal to 70 000 x R10 = R700000Since the excess cash has been utilised the total assets will also equal R700 000Share repurchase increases the EPS49 000/70 000 = R0.70Scenarios will result in the following values, which are the same for both:Excess Cash0Equity700 000Other Assets700 000Debt0Total Assets700 000Total Capital700 000It 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 firm7 | P a g eExample (page 53)Consider the following information for Tango Company:Total Assets R100 000Equity (book value)R100 000Debt (book value)0Number of Shares Outstanding50 000Current market value (price) of sharesR25Book value per shareR2Market value of equityR 1 250 000Market / Book ratioR12.50(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 shareAs companies with no or low levels of leverage often become targets – Tango decided to introduce debtThe amount of debt introduced will depend on the effect on the market share Consider the following options:SFPNo Debt5% Debt10% Debt25% DebtTotal Assets R100 000R100 000R100 000R100 000Debt (BV)062 500125 000312 500Equity (BV)100 00037 500- 25 000- 212 500Total Capital100 000100 000100 000100 000a)Debt = % debt x current market value of equityb)Equity = total capital - debtHow did the leverage recapitalisation affect the market value of Tango?
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