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 dollars. 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?

Question

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The value of the firm based on the proposed financial structure is:

$2,000,000 = $750,000 (new mortgage debt) + $250,000 (subordinated debt) + $1,000,000 (new equity)

The total amount owed to all creditors is $2.5 million. Since the secured creditors have a mortgage lien on the factory for $1.5 million, they will receive the full amount of their claim first. This leaves $1 million to be split among the unsecured creditors.

The secured creditors will receive $1.5 million, which is choice (D).

The Management of Magic Mobile Homes Has Proposed to Reorganize