Deck 30: Financial Distress

Question 1

The management of Magic Mobile Homes has proposed to reorganize the firm.The proposal is based on a going-concern value of €2 million.The proposed financial structure is €750,000 in new mortgage debt,€250,000 in subordinated debt and €1,000,000 in new equity.All creditors,both secured and unsecured,are owed €2.5 million euros.Secured creditors have a mortgage lien for €1,500,000 on the factory.The corporate tax rate is 34%.How much should the secured creditors receive?

A)€1,000,000
B)€1,250,000
C)€1,333,333
D)€1,500,000
E)None of the above.

Answer 1

€1,500,000

Question 2

Firms deal with financial distress by:

A)selling major assets
B)merging with another firm
C)issuing new securities
D)exchanging debt for equity
E)All of the above.

Answer 2

All of the above.

Question 3

The Steel Pony Company,a maker of all-terrain recreational vehicles,is having financial difficulties due to high interest payments.The estimated "going concern" value if Steel Pony is €4.0 million.The senior debt claim is on all fixed assets.The balance sheet of the firm is as shown:

Answer 3

If Steel Pony decides to file for formal bankruptcy and expects to sell the firm for the "going concern" value and pay administrative fees which amounts to 5% of the total going concern value,determine the distribution of the proceeds under the rules of absolute priority. Administrative expenses .05(€4,000,000)= €200,000 Senior (secured)debt = €2,200,000 Subordinate debt = €4,000,000 - €200,000 - €2,200,000 = €1,600,000 Equityholders = €0

Question 4

Magic Mobile Homes is to be liquidated.All creditors,both secured and unsecured,are owed €2 million.Administrative costs of liquidation and wages payments are expected to be €500,000.A sale of assets is expected to bring €1.8 million after all costs and taxes.Secured creditors have a mortgage lien for €1,200,000 on the factory which will be liquidated for €900,000 out of the sale proceeds.The corporate tax rate is 34%.How much and what percentage of their claim will the secured creditors receive,in total?

A)€ 900,000; 75%
B)€ 981,818; 81.82%
C)€1,009,091; 84.1%
D)€1,200,000; 100%
E)Not enough information to answer.

Question 5

Many corporations choose Reorganisation bankruptcy proceedings voluntarily because the management can:

A)take up to 120 days to file a reorganization plan.
B)continue to run the business.
C)reorganize if the required fractions of creditors approve of the plan and it is confirmed reorganization takes place.
D)All of the above.
E)None of the above.

Question 6

Prepackaged bankruptcies are:

A)described as a combination of a private workout and a liquidation.
B)the easiest way to transfer wealth to the shareholders.
C)described as a combination of a completed private workout and the formal bankruptcy filing.
D)All of the above.
E)None of the above.

Question 7

The absolute priority rule:

A)is set to ensure senior claims are paid first.
B)is the priority rule in liquidations.
C)distributes proceeds of secured assets sales to the secured creditors first and the remainder to the unsecured.
D)All of the above.
E)None of the above.

Question 8

A firm in financial distress that reorganizes:

A)continues to run the business as a going concern.
B)must have acceptance of the plan by the creditors.
C)may distribute new securities to creditors and shareholders.
D)All of the above.
E)None of the above.

Question 9

What is the absolute priority rule of the following claims once a corporation is determined to be bankrupt?

A)administrative expenses,wages claims,government tax claims,debtholder and then equityholder claims
B)administrative expenses,wages claims,government tax claims,equityholder and then debtholder claims
C)wage claims,administrative expenses,debtholder claims,government tax claims and equityholder claims
D)wage claims,administrative expenses,debtholder claims,equityholder claims and government tax claims
E)None of the above.

Question 10

In a prepackaged bankruptcy the firm:

A)and creditors agree to a private reorganization outside formal bankruptcy.
B)must reach agreement privately with most of the creditors.
C)will have difficulty when there are thousands of reluctant trade creditors.
D)All of the above.
E)None of the above.

Question 11

If a firm has a equity based insolvency in both book and market value terms and liquidates:

A)the payoff will not be 100% to all investors.
B)the unsecured creditors are likely to get less than full value.
C)the equityholders typically should receive nothing.
D)All of the above.
E)None of the above.

Question 12

Approximately ____ of all firms going through a Reorganisation bankruptcy successfully reorganize.

A)0%
B)15%
C)25%
D)50%
E)85%

Question 13

The Here Today Corporation has applied to your bank for a loan.You have their financial statements and the revised Z-score model of:
Z = 6.56 (Net Working Capital/Total Assets)+ 3.26 (Accumulated Retained Earnings/Total Assets)+1.05 (EBIT/Total Assets)+ 6.72 (Book Value of Equity/Total Liabilities)where:
Z < 1.23 predicts bankruptcy.A Z score between 1.23 and 2.90 indicates gray area.A Z score greater than 2.90 indicates no bankruptcy.From the financial statements you gathered net working capital of €237,500; accumulated retained earnings of €120,000; book value of equity of €950,000; total assets of €4,750,000; EBIT of €261,250; and total liabilities of €3,800,000.Should the bank lend to Here Today?

Question 14

The management of Magic Mobile Homes has proposed to reorganize the firm.The proposal is based on a going-concern value of €2 million.The proposed financial structure is €750,000 in new mortgage debt,€250,000 in subordinated debt and €1,000,000 in new equity.All creditors,both secured and unsecured,are owed €2.5 million euros.Secured creditors have a mortgage lien for €1,500,000 on the factory.The corporate tax rate is 34%.What will the equityholders receive if they had 5 million shares with a par value of €0.50 each?

A)€0
B)€35,714
C)€583,333
D)€1,000,000
E)None of the above.

Question 15

The net payoff to creditors in formal bankruptcy may be low in present value terms because:

A)the financial structure may be complicated with several groups and types of creditors.
B)indirect costs of bankruptcy may have been costly in lost revenues and poor maintenance.
C)administrative costs are high and increase with the complexity and length of time in the formal bankruptcy process.
D)All of the above.
E)None of the above.

Question 16

A firm that has a series of negative earnings,sales declines and workforce reductions is likely head to:

A)a change in management.
B)a merger.
C)financial distress.
D)new financing.
E)None of the above.

Question 17

The management of Magic Mobile Homes has proposed to reorganize the firm.The proposal is based on a going-concern value of €2 million.The proposed financial structure is €750,000 in new mortgage debt,€250,000 in subordinated debt and €1,000,000 in new equity.All creditors,both secured and unsecured,are owed €2.5 million euros.Secured creditors have a mortgage lien for €1,500,000 on the factory.The corporate tax rate is 34%.How much should the unsecured creditors receive?

A)€ 500,000
B)€ 667,000
C)€ 750,000
D)€1,000,000
E)None of the above.

Question 18

Magic Mobile Homes is to be liquidated.All creditors,both secured and unsecured,are owed €2 million.Administrative costs of liquidation and wages payments are expected to be €500,000.A sale of assets is expected to bring €1.8 million after all costs and taxes.Secured creditors have a mortgage lien for €1,200,000 on the factory which will be liquidated for €900,000 out of the sale proceeds.The corporate tax rate is 34%.How much and what percentage of their claim will the unsecured creditors receive,in total?

A)€ 100,000; 12.50%
B)€ 290,909; 36.36%
C)€ 300,000; 37.50%.
D)€ 600,000; 75.00%
E)Not enough information to answer.

Question 19

Equityholders may prefer a formal bankruptcy filing because:

A)the firm can issue debtor in possession debt.
B)they can delay pre-bankruptcy interest payments.
C)the lack of information about the length and magnitude of the cash flow problem favors equityholders.
D)All of the above.
E)None of the above.