Video Transcript: Anatomy of a Recapitalization

hello, welcome. We're going to discuss the anatomy of a recapitalization. We'll  continue with the Strasburg example. So Strasburg could recapitalize, meaning  that it should issue enough additional debt to optimize its capital structure and  then use the debt proceeds to repurchase stock, as shown in a previous figure,  a capital structure with 40% debt is optimal. But before tackling the recap, as it  is commonly called, let's consider the sequence of events, starting with the  situation before Strasburg issues any additional debt, the valuation analysis of  Strasburg at a capital structure consisting of 20% debt and 80% equity. These  results are repeated in column one, along with the shareholder wealth, which  consists entirely of 200 million in stock before the repurchase. The next step is  to examine the impact of Strasburg's debt issuance. We can look at the chart  here, and we can notice the difference between the three different opportunities. The next step in the recap is to issue debt and announce the firm's intent to  repurchase stock with the newly issued debt at the optimal capital structure of  40% debt the value of the firm's operations is 257.86 million, shown in our figure here. This value of operations is greater than the 250 million value of operations  for WD of 20% so our weight of debt is 20% because the weighted average cost of capital is lower. Notice that Strasburg raised its debt from 50 million to 103.14  million, an increase of 53.14 million. You can see that they have increased their  debt load from 50 million to 103.14 million, because column two reports data  prior to the repurchase Strasburg has short term investments in The amount of  53.14 million can see 53.14 million of short term investments, the amount that  was raised in the debt issuance, but that has not yet been used to repurchase  stock. As the chart shows, Strasburg's intrinsic value of equity is 207.8 6 million.  You can see our shareholder wealth, 207.86 million. Because Strasburg has not  yet repurchased any stock, it still has 10 million shares outstanding, therefore  the price per share after the debt issue, but prior to the repurchase is $20.79 so  we take the 207 86 our shareholder wealth. We divide that by 10 for a 20.791  20.79 stock price. Column two of the figure above summarizes these  calculations and shows the wealth of the shareholders. The wealth of the  shareholders is worth 207.86 million. Strasburg has not yet made any cash  distributions to shareholders. So the total wealth of shareholders is the 207.86  million. The new wealth of 207.86 million is greater than the initial wealth of 200  million. So the recapitalization is added value to shareholders. Notice also that  the recapitalization caused the intrinsic stock value to increase from $20 to  $20.79 summarizing these results, we see that the issuance of debt and the  resulting change and the optimal capital structure caused one, the weighted  average cost of capital to decrease. Two, the value of operations to increase.  Three, shareholder wealth to increase, as well as the stock price to increase. So we'll conclude the class on corporate. Finance, I've hoped that you've enjoyed  your time with me learning the fundamentals of corporate finance. I really do  hope that you can take these fundamentals and apply them to your day to day 

operations in whatever you do, or have a better understanding of how financial  markets, capital markets and businesses operate. We just pray that you can  utilize these and use them to affect others in a positive manner. God Bless.