Definition of Capital Restructuring in Finance
What is corporate restructuring in finance? The corporate restricting in finance is any changes in a company’s capital structure, operations or ownership which reorganizing some aspects of a company. The financial decision making is the process of choosing between two or more alternatives of action.
The main purposes of capital restructuring are increasing overall profitability or improvement the market position of the company.
The types of corporate restructuring strategies are the followings:
- Expansion: Mergers, Acquisition, Takeovers
- Contraction: Sell-offs, Split-offs
- Corporate Control: Share Repurchases
- Changes in Ownership
Corporate Restructuring Examples ABB PLC and CDD Ltd
ABB PLC decides to takeover CDD Ltd as this operation will increase the end-of-year cash inflows from £12 million to £14million. The merger of CDD Ltd will cost £27.5 million. The main question for analytics is the minimum level of return or cost of capital for acceptance this expansion.
The needed steps for the estimated cost of the capital merger are the followings:
- Estimate before-merger value of ABB PLC
- Estimate after-merger value of ABB PLC
- Define the cost of capital from expansion
Step 1. Estimation before-merger value of ABB PLC
If the annual cash inflow (CF) of ABB Co. equals £12million and cost of capital (WACC) of 20%, the value of the firm will be computed using the following formulas:
Value before-merger = CF/WACC,
Value before-merger = £12/ 20% = £60 million
Step 2. Estimation after-merger value of ABB PLC
The after-merger value of ABB PLC is the summary before-merger value and merger price.
Value after-merger =Value before-merger+ Merger Price = £60 +£27.5 =£87.5 million
Step 3. Calculation the cost of capital after merger
As the company will receive the end-of-year cash inflow of £14 million after the merger, while the value of the firm will rise to £87.5 million, the cost of capital will be calculated the following formulas:
WACC = CF after merger/Value after merger
WACC = £14/£87.5 =0.16 or 16%
From the table above, the ABB PLC cost of capital will be 16% from the combined operation as the value of the firm increase from £60 to £87.5 million while end-of-year cash inflow will rise from £12 million to £14 million.
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