FIN.11:5.2 - Turn a capital target into a recapitalization

Consider a separate corporation with debt worth 60 and ordinary equity worth 140. A qualified valuation of a proposed financing policy gives 220 for the claims remaining after its recapitalization and distribution. That value includes retained cash and the net policy effects, using FIN.5’s pricing grounds and FIN.7’s value and claim boundary; it is not inferred from the desired debt ratio. All debt is priced at par before and after, there are no other claims or fees, and the contractual and distribution conditions permit the transaction.

The chosen one-time target is debt at 40% of post-transaction debt-plus-equity value. Hence target debt is 0.40 × 220 = 88 and remaining equity is 132. Keep the existing debt 60 and obtain 28 of additional net borrowing for a cash distribution of 28 to the existing owners. Their retained equity 132 plus received cash 28 is worth 160, compared with their earlier 140. The supplied net policy gain is 20; the distribution itself transfers cash out of the corporation rather than creating another gain of 28.

Holding the old equity value fixed would give D/(D + 140) = 0.40 and D = 93.33, implying combined claims of 233.33 instead of the supported 220. That calculation mixes the old equity with the new financing. A different proposed debt amount needs a valuation consistent with its own policy; it cannot inherit the preferred answer by retaining an old denominator.

The company has cash 10 and must preserve a reserve of 10 through closing. The available loan must deliver its 28 before the distribution: cash then moves from 10 to 38 and back to 10. If loan settlement follows the proposed distribution date, paying 28 would leave −18 and the transaction is not presently funded. Move the distribution, obtain an earlier arrangement or revise the plan. Return future service and all affected restrictions to FIN.2 and FIN.12 as well.

This calculates one recapitalization on its stated value and terms. Maintaining a 40% ratio as later market values change would be a repeated rebalancing policy with new transactions, cash requirements and pricing grounds; it is not an automatic consequence of this closing calculation.