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Chapter 25: Bankruptcy, Reorganization, and Liquidation
1. A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled
interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling
asset values.
a.
True
b.
False
ANSWER:
True
2. In the event of bankruptcy under the federal bankruptcy laws, debtholders have a prior claim to a firm's income and
assets before both common and preferred stockholders. Moreover, in a bankruptcy all debtholders are treated equally as a
single class of claimants.
a.
True
b.
False
ANSWER:
False
3. The basic doctrine of fairness under bankruptcy provisions states that claims must be recognized in the order of their
legal and contractual priority.
a.
True
b.
False
ANSWER:
True
Chapter 25: Bankruptcy, Reorganization, and Liquidation
4. The primary test of feasibility in a reorganization is whether the firm's fixed charges after reorganization can be covered
by its projected cash flows.
a.
True
b.
False
ANSWER:
True
5. Even if a firm's cash flow projections indicate that it will soon be unable to meet its interest payments, a bankruptcy
case cannot begin until the firm actually defaults on a scheduled payment.
a.
True
b.
False
ANSWER:
False
Chapter 25: Bankruptcy, Reorganization, and Liquidation
6. One of the actions that can be taken in bankruptcy under the standard of feasibility is to replace existing management
with a new team if the quality of management is judged to have been substandard.
a.
True
b.
False
ANSWER:
True
7. Bankruptcy plays no role in settling labor disputes and product liability suits. Such issues are outside the bounds of
bankruptcy law and are covered by other statutes.
a.
True
b.
False
ANSWER:
False
Chapter 25: Bankruptcy, Reorganization, and Liquidation
8. Bankruptcy laws have been used to help reach settlements in major product liability lawsuits. By using financial
projections to show that contingent claims against the company jeopardize its existence, agreements are reached, partially
satisfying claimants, and allowing the firm to continue operating.
a.
True
b.
False
ANSWER:
True
9. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the
Bankruptcy Act? 1 is the highest claim, 5 is the lowest.
(1)
Trustees' costs to administer and operate the firm.
(2)
Common stockholders.
(3)
General, or unsecured, creditors.
(4)
Secured creditors, who have a claim to the proceeds from the sale of specific property
pledged to secure a loan.
(5)
Taxes due to federal and state governments.
a.
5, 4, 1, 3, 2
b.
4, 1, 5, 3, 2
c.
5, 1, 4, 2, 3
d.
1, 5, 4, 3, 2
e.
1, 4, 3, 5, 2
ANSWER:
b
Chapter 25: Bankruptcy, Reorganization, and Liquidation
10. Chapter 7 of the Bankruptcy Act is designed to do which of the following?
a.
Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to
meet debt payments.
b.
Ensure that the firm is viable after emerging from bankruptcy.
c.
Allow the firm to negotiate with each creditor individually.
d.
Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent
debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
e.
Protect shareholders against creditors.
ANSWER:
d
11. Which of the following statements is most CORRECT?
a.
Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are
governed solely by state laws.
b.
All bankruptcy petitions are filed by creditors seeking to protect their claims against firms in financial distress.
Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management.
c.
Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a
reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed
in Chapter 7 of the Act.
d.
"Restructuring" a firm's debt can involve forgiving a certain portion of the debt, but it cannot call for changing
the debt's maturity or its contractual interest rate.
e.
Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that
time.
ANSWER:
c
Chapter 25: Bankruptcy, Reorganization, and Liquidation
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12. Which of the following statements is most CORRECT?
a.
The primary test of feasibility in a reorganization is whether every claimant agrees with the reorganization
plan.
b.
The basic doctrine of fairness states that all debtholders must be treated equally.
c.
Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the
"public interest" is not a relevant concern.
d.
While a firm is in bankruptcy, the existing management is always allowed to retain control, though the court
will monitor its actions closely.
e.
To a large extent, the decision to dissolve a firm through liquidation versus keeping it alive through
reorganization depends on a determination of the value of the firm if it is rehabilitated versus the value of its
assets if they are sold off individually.
ANSWER:
e
