Chapter 22—Bankruptcy and Financial Distress
MULTIPLE CHOICE
1. The case of business failure in which a firm’s liabilities exceed the fair market value of its assets is
called
a.
economic failure
b.
technical insolvency
c.
insolvency bankruptcy
d.
business failure
2. The section of the Bankruptcy Reform Act of 1978 that outlines the procedures for reorganizing a
failed or failing firm is
a.
chapter 7
b.
chapter 11
c.
chapter 13
d.
none of the above
3. A company that does not pay its debts when they come due is called
a.
insolvent
b.
debtor in possession
c.
broke
d.
financially distressed
4. The alteration of a company’s capital structure to reduce high fixed charges is called
a.
recapitalization
b.
cramdown procedure
c.
involuntary reorganization
d.
absolute priority rule
5. A creditor that has a specific asset pledged as collateral are called
a.
secured creditors
b.
unsecured creditors
c.
general creditors
d.
shareholders
NARRBEGIN: Exhibit 22-1 Liquidation
Exhibit 23-1
Unsecured creditors’ claims
Case I
Case II
Case III
Unpaid balance on second
mortgage
$ 350,000
$ 600,000
$ 250,000
Accounts payable
150,000
350,000
75,000
Notes payable
2,500,000
3,250,000
750,000
Subordinated debentures
1,250,000
2,250,000
1,250,000
Total
$4,250,000
$6,450,000
$2,325,000
NARREND
6. If the company has $3,000,000 in funds to distribute to unsecured creditors, what percentage of their
claims are going to be satisfied if Case I occurs?
a.
100.00%
b.
70.59%
c.
29.41%
d.
82.57%
7. If the company has $3,000,000 in funds to distribute to unsecured creditors, what percentage of their
claims are going to be satisfied if Case II occurs?
a.
70.59%
b.
53.49%
c.
100%
d.
46.51%
8. If the company has $3,000,000 in funds to distribute to unsecured creditors, what percentage of their
claims are going to be satisfied if Case III occurs?
a.
129.03%
b.
100%
c.
82.56%
d.
17.44%
9. If the company has $3,000,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the notes payable in Case I?
a.
$1,764,706
b.
$2,500,000
c.
$735,250
d.
$1,326,690
10. If the company has $3,000,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the subordinated debentures in Case II?
a.
$2,250,000
b.
$1,203,525
c.
$$1,046512
d.
$1,538,957
11. If the company has $3,000,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the subordinated debentures in Case III?
a.
$1,250,000
b.
$958,250
c.
$745,400
d.
$1,075,268
12. If the company has $3,000,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the subordinated debentures in Case I?
a.
$1,050,534
b.
$1,250,000
c.
$367,647
d.
$882,353
13. If the company has $3,000,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the accounts payables in Case II?
a.
$162,791
b.
$187,209
c.
$350,000
d.
$235,310
14. If the company has $3,000,000 in funds to distribute to unsecured creditors, how much do the owners
of the firm receive in Case I?
a.
$125,678
b.
$0
c.
$357,250
d.
$475,000
15. If the company has $3,000,000 in funds to distribute to unsecured creditors, how much do the owners
of the firm receive in Case III?
a.
$675,000
b.
$0
c.
$525,000
d.
$175,000
16. If the company has $2,534,000 in funds to distribute to unsecured creditors, what percentage of their
claims are going to be satisfied if Case I occurs?
a.
26.32%
b.
40.38%
c.
100%
d.
59.62%
17. If the company has $4,268,000 in funds to distribute to unsecured creditors, what percentage of their
claims are going to be satisfied if Case II occurs?
a.
100%
b.
33.83%
c.
66.17%
d.
46.23%
18. If the company has $578,000 in funds to distribute to unsecured creditors, what percentage of their
claims are going to be satisfied if Case III occurs?
a.
24.86%
b.
75.14%
c.
100%
d.
56.35%
19. If the company has $2,456,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the notes payable in Case I?
a.
$1,444,706
b.
$2,500,000
c.
$1,055,294
d.
$1,863,685
20. If the company has $5,245,000 in funds to distribute to unsecured creditors, what is the settlement that
is received by the holders of the subordinated debentures in Case II?
a.
$420,300
b.
$1,829,700
c.
$2,250,000
d.
$1,256,200
21. If the company has $4,152,000 in funds to distribute to unsecured creditors, how much do the owners
of the firm receive in Case I?
a.
$0
b.
$98,000
c.
$128,000
d.
$253,000
22. If the company has $2,475,000 in funds to distribute to unsecured creditors, how much do the owners
of the firm receive in Case III?
a.
$75,000
b.
$0
c.
$150,000
d.
$225,000
23. Bavarian Sausages has a working capital/total assets ratio of 0.8, a retained earnings/total assets ratio
of 0.2, an earnings before interest and taxes/total assets ratio of 0.34, a market value of equity/book
value of equity ratio of 1.2, and a sales/total assets ratio of 0.75. What is the company’s Z score?
a.
3.25
b.
2.78
c.
1.65
d.
3.83
24. Bavarian Sausages has a working capital/total assets ratio of 0.3, a retained earnings/total assets ratio
of 0.4, an earnings before interest and taxes/total assets ratio of 0.24, a market value of equity/book
value of equity ratio of 0.4, and a sales/total assets ratio of 0.55. What is the company’s Z score?
a.
2.50
b.
1.75
c.
3.25
d.
2.85
25. Bavarian Sausages has a working capital/total assets ratio of 0.1, a retained earnings/total assets ratio
of 0.2, an earnings before interest and taxes/total assets ratio of 0.14, a market value of equity/book
value of equity ratio of 0.2, and a sales/total assets ratio of 0.35. What is the company’s Z score?
a.
0.86
b.
1.96
c.
1.33
d.
2.13
26. Smart Products has a working capital to total assets ratio of 0.15, a retained earnings to total assets
ratio of 0.2, an EBIT to total assets ratio of 0.4, a market value of equity to book value of equity ratio
of 1.3, and a sales to total assets ratio of 0.75. What is Smart Products’ Z-score?
a.
2.60
b.
3.31
c.
5.74
d.
2.79
NARRBEGIN: Needsalift APRs
Needsalift, Inc. APRs
Needsalift, Inc. has $10 million in funds to distribute to its unsecured creditors. Two sets of possible
claims are presented below.
Case I
Case II
$ 2 million
$ 4 million
$ 6 million
$ 2 million
$ 4 million
$ 6 million
$ 2 million
$ 6 million
$14 million
$18 million
NARREND
27. For Case I, how much will the bank receive for its notes payable claim?
a.
$3.75 million
b.
$4.29 million
c.
$6.00 million
d.
nothing.
28. For Case I, what settlement will the unsecured bondholders receive?
a.
Nothing
b.
$2 million
c.
$1.43 million
d.
$1 million
29. For Case II, what settlement will the unsecured bondholders receive?
a.
$4 million
b.
$3.25 million
c.
$2.22 million
d.
Nothing
30. For Case II, what settlement will the accounts payable holders receive?
a.
$3 million
b.
$3.34 million
c.
$4.65 million
d.
$6 million
31. Which factor in the Z-score model will most affect the likelihood of bankruptcy predicted?
a.
working capital to total assets ratio
b.
EBIT to total assets ratio
c.
market value of equity to book value of equity ratio
d.
retained earnings to total assets ratio
32. Polaroid’s bankruptcy filing is an example of a failure due to
a.
business cycle downturn
b.
corporate maturity
c.
poor financial actions
d.
illiquidity
33. If a company’s financial position is characterized by current liabilities greater than current assets, it is
a.
bankrupt.
b.
illiquid.
c.
insolvent.
d.
liquidated.
34. In order to move forward in a financial crisis without many of the costs of legal bankruptcy, a firm
may seek
a.
a consent procedure.
b.
a cram-down procedure.
c.
a chapter 11 reorganization.
d.
a voluntary settlement.
35. A firm that is subject to Chapter 7 of the Bankruptcy Reform Act is one that
a.
is in involuntary reorganization.
b.
is facing a cram-down procedure.
c.
is to be liquidated.
d.
is seeking a recapitalization.
36. The debtor in possession (DIP) is
a.
the lenders who are owed money by the bankrupt firm.
b.
the trustee of the bankrupt firm.
c.
the bankrupt (filing) firm.
d.
none of the above.
37. If absolute priority rules are enforced in a Chapter 7 bankruptcy, which of the following is least likely
to receive payment?
a.
local, state, or federal governments owed taxes
b.
owners of common stock
c.
owners of bonds
d.
banks holding loans secured by collateral
38. If absolute priority rules are enforced in a Chapter 7 bankruptcy, which of the following is most likely
to receive payment?
a.
local, state, and federal governments owed taxes.
b.
owners of common stock
c.
owners of bonds
d.
banks holding loans secured by collateral
39. A firm has outstanding debt of $100 million. Suppose it voluntarily agrees to pay all creditors 40 cents
on the dollar. This is
a.
an extension.
b.
a composition.
c.
a combination of the two in (a) and (b).
d.
a cram-down.
40. A firm has outstanding debt of $100 million. Suppose it voluntarily agrees to pay a group of creditors
40 cents on the dollar immediately and to pay the remaining creditors 60 cents on the dollar in four
periodic installments. This is
a.
an extension.
b.
a composition.
c.
a combination of an extension and a composition.
d.
a cram-down.
41. A firm has outstanding debt of $100 million. Suppose it voluntarily agrees to pay all creditors in full in
six periodic installments. This is
a.
an extension.
b.
a composition.
c.
a combination of the two in (a) and (b).
d.
a cram-down.
42. Suppose a firm has a Z score of 1.6, and the following financial characteristics: working capital to total
assets ratio of 0.05, retained earnings to total assets ratio of 0.10, market value of equity to book value
of equity ratio of 1.1, and sales to total assets ratio of 0.4. What must be its EBIT to total assets ratio?
a.
0.15
b.
0.10
c.
0.05
d.
0.0
43. Gizmo Co. has a Z-score based on its most recent financial information of 2.3. Based on this,
a.
Gizmo has a high probability of failure.
b.
Gizmo has a low probability of failure.
c.
Gizmo’s probability of failure is uncertain.
d.
None of these, since the Z-score does not predict firm failure.
44. Gizmo Co. has a Z-score based on its most recent financial information of 1.2. Based on this,
a.
Gizmo has a high probability of failure.
b.
Gizmo has a low probability of failure.
c.
Gizmo’s probability of failure is uncertain.
d.
None of these, since the Z-score does not predict firm failure.
45. Gizmo Co. has a Z-score based on its most recent financial information of 3.0. Based on this,
a.
Gizmo has a high probability of failure.
b.
Gizmo has a low probability of failure.
c.
Gizmo’s probability of failure is uncertain.
d.
None of these, since the Z-score does not predict firm failure.
46. Gizmo Co. has the following financial measures: working capital to total assets ratio of 0.05, retained
earnings to total assets ratio of 0.10, EBIT to total assets ratio of 0.3, market value of equity to book
value of equity ratio of 1.1, and sales to total assets ratio of 0.4. What is Gizmo’s Z-score?
a.
2.40
b.
2.35
c.
2.30
d.
2.25
47. Which of the following is not an example of mismanagement?
a.
oil price increases
b.
overexpansion
c.
ineffective sales force
d.
poor financial actions
48. Financial distress
a.
always leads to bankruptcy.
b.
imposes direct and indirect costs on the firm.
c.
has no effect on the firm’s customers.
d.
all of the above.