Financial Distress & Air Line Industry

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UNIVERSITY OF MYSORE
DEPARTMENT OF STUDIES IN BUSINESS ADMINISTRATION
B. N. BAHADUR INSTITUTE OF MANAGEMENT SCIENCES
MANASAGANGOTRI MYSORE 570006
KARNATAKA, INDIA

Seminar Paper on
Financial Distress and Restructuring
A Case Study of
Air India Ltd & Kingfisher Airlines Ltd

Submitted to
Dr. B. Shivraj
Professor, DOSBA, UoM

Submitted by
Mr. Prasad V. Daddikar
MBA IV Semester, Roll No. 50
Reg. No. 10MBO102
INTRODUCTION

Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. Sometimes financial distress can lead to bankruptcy. Financial distress is usually associated with some costs to the company; these are known as costs of financial distress.

A common example of a cost of financial distress is bankruptcy costs. These direct costs include auditors' fees, legal fees, management fees and other payments. Cost of financial distress can occur even if bankruptcy is avoided (indirect costs): Financial distress in companies can lead to problems that can reduce the efficiency of management. As maximizing firm value and maximizing shareholder value cease to be equivalent managers who are responsible to shareholders might try to transfer value from creditors to shareholders.

The result is a conflict of interest between bondholders (creditors) and shareholders. As a firm's liquidation value slips below its debt, it is the shareholder's interest for the company to invest in risky projects which increase the probability of the firm's value to rise over debt. Risky projects are not in the interest of creditors, since they also increase the probability of the firm’s value to decrease further, leaving them with even less. Since these projects do not necessarily have a positive net present value, costs may arise from lost profits.

CAUSES AND EFFECTS OF FINANCIAL DISTRESS

• Macro-Level Factors

✓ Liquidity, Financial Distress, and Recession:
Firms maintain liquidity to avert bankruptcy. An economic slowdown strains firms’ liquidity, causing them to cut back on expenditures, further slowing the economy

✓ Trends in Competition: From Diversification to Focus When the sea change to corporate focus began, many inefficient conglomerates became distressed. Transactions such as asset sales, equity carve-outs, and spin-offs were developed to convert inefficient conglomerates to more focused and efficient enterprises.

• Industry-Level Causes of Financial Distress

Industry competition (entry/exit barriers; bargaining power of suppliers; bargaining power of buyers; threat of substitute products; and rivalry among competing firms) ✓ Industry Shocks
✓ Industry Deregulation

• Firm-Level Causes of Financial Distress

✓ Flaws in ownership and/or governance structures;
✓ Operating risk; and
✓ Leverage.

• Effects of Financial Distress
✓ Loss of Tax Benefits of Debt and Depreciation
✓ Transaction Costs
✓ Agency Costs
✓ Negative Liquidity Effects
VALUATION

Companies in financial distress undergo corporate restructuring where valuations are used as negotiating tools. This distinction between negotiation and process is a difference between financial restructuring and corporate finance. Additional modifications to a valuation approach, whether it is market-, income- or asset-based, may be necessary in some instances. There are other adjustments to the financial statements that have to be made when valuing a distressed company

OPTIONS FOR RELIEVING FINANCIAL DISTRESS

• Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations. • Failure prediction models have been used...
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