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Q22-9. What is the purpose of a prepackaged bankruptcy? Would a prepackaged bankruptcy
be more likely to be used for a liquidation or a reorganization?
A22-9. A prepackaged bankruptcy is designed to make the bankruptcy process less costly, since
details of settlements are built into the original contracts. Prepackaged bankruptcy is
Q22-10. Why would some creditors be willing to subordinate their claims to the claims of other
creditors?
A22-10. Creditors might be willing to subordinate their claims for a higher reward. For example,
Q22-11. Who would use Altman’s Z score to predict bankruptcy? Why would the ability to
predict bankruptcy be useful to them?
A22-11. Predicting bankruptcy is useful to investors. They could apply Altman’s Z to companies
Solutions to End-of-Chapter Problems
Bankruptcy and Business Failure
P22-1. Go to http://www.bankruptcydata.com, and identify the ten largest public company
bankruptcies during the previous year. Compare the list of the ten largest bankruptcies in
U.S. history presented in Table 22.1 with the current list at
http://www.bankruptcydata.com. Have any recent bankruptcies made the list?
Priority of Claims
P22-2. A firm has $450,000 in funds to distribute to its unsecured creditors. Three possible sets of
unsecured creditor claims are presented. Calculate the settlement, if any, to be received by
each creditor in each case shown in the following table.
Unsecured Creditors’ Claims
Case I
Case II
Case III
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A22-2. In Case I, assuming each unsecured creditor has equal priority, each creditor will receive
$450,000/$900,000 = $0.50 on the dollar.
In Case II, each creditor will receive $450,000/$600,000 = $0.75 on the dollar.
In Case III, each creditor will receive $450,000/$1,800,000 = $0.25 on the dollar.
The actual amounts received are as
follows:
Unsecured Creditor
Case I
Case II
Case III
P22-3. A firm has $5 million in funds to distribute to its unsecured creditors. Three possible sets of
unsecured creditor claims are presented. Calculate the settlement, if any, to be received by
each creditor in each case shown in the following table.
Unsecured Creditors’ Claims
Case I
Case II
Case III
Unpaid balance of second mortgage
$1,000,000
$2,000,000
$3,000,000
Notes payable – bank
Unsecured bonds
A22-3. In Case I, assuming each unsecured creditor has equal priority, each creditor will receive
$5,000,000/$7,000,000 = $0.714 on the dollar.
In Case II, each creditor will receive $5,000,000/$8,000,000 = $0.625 on the dollar.
In Case III, each creditor will receive $5,000,000/$9,000,000 = $0.556 on the dollar.
The actual amounts received are as follows:
Unsecured Creditor
Case I
Case II
Case III
P22-4. Keck Business Forms recently failed and will be liquidated by a court-appointed trustee
who will charge $300,000 for her services. The preliquidation balance sheet follows. Assume that
the trustee liquidates the assets for $4.8 million, with $2.6 million coming from the sale of current
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assets and $2.2 million coming from fixed assets. Also assume that the unsecured bonds are
subordinate to the notes payable. Prepare a table indicating the amount to be distributed to each
claimant. Do the firm’s owners receive any funds?
Keck Business Forms
Balance Sheet As of December 31, 2012
Assets Liabilities and Stockholder’s Equity
Cash
$ 100,000
Accounts payable
$1,200,000
A22-4. Amount available for distribution: $4,800,000
Distributions to
Claimants
Cumulative Total
Trustee expenses
$ 300,000
$300,000
Land Net plant
2,100,000
Total fixed assets
Total long-term debt
$4,500,000
Total assets
Preferred stock (5,000 shares)
Common stock (10,000 shares)
Total stockholders’ equity
$1,800,000
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Unsecured Creditors
Accounts payable
$1,200,000
Creditors through the first mortgage-holder will be paid in full, and the second mortgage-holder
will receive $700,000 from the sale of secured assets, for a total initial payment of $3,350,000.
This left $4,800,000 – $3,350,000 = $1,450,000. The unsecured creditors’ claims total
$4,600,000. Assuming the unsecured creditors have equal priority, they will receive $1,450,000/
$4,600,000 = $0.315 on the dollar. This will be paid as follows:
Shares
of Proceeds
Actual Payouts
Accounts payable
$ 378,000
$
378,000
Predicting Bankruptcy
P22-5. Sosbee Foods has a working capital/total assets ratio of 0.2, a retained earnings/total
assets ratio of 0.1, earnings before interest and taxes/ total asset ratio of 0.25, market
value of equity/book value of equity ratio of 0.6, and a sales/total assets ratio of 0.8.
Calculate and interpret the company’s Z score.
A22-5. Altman’s Z = 1.2 × X1 + 1.4 × X2 + 3.3 × X3 + 0.6 × X4 + 1.0 × X5
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P22-6. The following balance sheet and income statement are for Weber Industries. The
firm’s stock currently is priced at $6.00 per share. Calculate and interpret the
company’s Z score.
Weber Industries
Balance Sheet As of December 31, 2012
Assets
Liabilities and Stockholder’s Equity
Cash
$ 400,000
Accounts payable
$ 5,000,000
Accounts receivable
3,000,000
Notes payable – bank
1,000,000
Inventories
Total current liabilities
$ 6,000,000
Land
Debentures
6,000,000
Net plant
Total long-term debt
$10,000,000
Net equipment
Preferred stock (100,000 shares)
Total fixed assets
Common stock (500,000 shares)
1,000,000
Total Assets
$21,400,000
Paid-in capital in excess of par
Retained earnings
1,400,000
Total shareholders’ equity
Total liabilities and equity
Weber Industries
Income Statement for the Year
Ending December 31, 2012
Sales:
$6,000,000
Less: Cost of goods sold
Less: Selling and administrative expenses
Earnings before interest and taxes
Less: Interest
Earnings before taxes
$ 400,000
Less: Taxes (39%)
Net income
$ 280,000
A22-6. Altman’s Z = 1.2 × X1 + 1.4 × X2 + 3.3 × X3 + 0.6 × X4 + 1 × X5
Working capital/total assets = ($7,400,000 – $6,000,000)/$21,400,000 = 0.0654
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Where
X1 = Working capital /Total assets = 0.0654
P22-7. Compute the Z score for Giant Motors Corporation (GMC) given the following information
for year-end 2012:
At what share price would GMC have a Z score equal to 3.00? How does the future look
for GMC?
A22-7. 1.2*[($55,515,000 – $74,892,000) ÷ $482,029,000] + 1.4*[$14,428,000 ÷ $482,029,000] +
P22-8. Compute the Z score for Central Manufacturing Corporation (CMC) given the following
information for year-end 2012:
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Based on its Z score, is CMC likely to go bankrupt in the near future?
A22-8. 1.2*[($41,224,000 – $73,911,000) ÷ $91,047,000] + 1.4*[-$70,610,000 ÷ $91,047,000] +
P22-9. Compute the Z score for FAST Motor Company given the following information for year-
end 2012:
What proportion (measured as a percentage) of the Z score is composed of 0.60(X4)? Is
FAST likely to go bankrupt in the near future?
A22-9. 1.2*[($34,124,000 – $49,178,000) ÷ $163,429,000] + 1.4*[-$16,145,000 ÷ $163,429,000] +
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P22-10. Compute the Z score for Win-Mart, given the following information for year-end 2012:
What proportion (measured as a percentage) of the Z score is composed of 0.60(X4)? What
proportion (measured as a percentage) of the Z score is composed of 1.00(X5)? Is Win-
Mart likely to fail in the near future?
A22-10. 1.2*[($48,949,000 – $55,390,000) ÷ $163,429,000] + 1.4*[$63,660,000 ÷ $163,429,000] +
THOMSON ONE Business School Edition: Because P22-11 and P22-12 are based on using a
live data base, answers will vary from moment to moment. For instructions on using Thomson
ONE, refer to the Thomson ONE problems at the end of Chapters 1–6.
Answer to MiniCase
Bankruptcy and Financial Distress
Flanan Photography Studios, Inc. (FPS) is preparing for a court-ordered bankruptcy and has issued
the following preliquidation financial statements.
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TruValue Trustees Services (TTS) has been appointed to oversee the sale and disbursement of
funds from the liquidation and will charge $450,000 for the service. TTS can obtain $7,250,000
Assignment
1. Calculate the amount to be received by each claimant.
2. Calculate and interpret the firm’s Z score.
Answers
1.
Proceeds from liquidation ($7,250,000 + $49,850,000)
$57,100,000
Expenses of administering bankruptcy
Wages owed workers
Taxes owed governments
$55,315,000
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2.
Factor
Weight
Amount
Weighted
Amount
Working capital/total assets
1.2
0.0402
0.0482
Retained earnings/total assets
1.4
0.0087
0.0122
EBIT/total assets
3.3
0.0810
0.2672
0.0480
Sales/total assets
1.0
0.1818
0.1818
0.5574
Second mortgage, paid from remainder of $49,850,000 proceeds
$27,000,000
Unsecured Creditors’ Claims
Amount
Settlement @ 60%
Accounts payable
Total