(4) Voluntary bankruptcy; and (5) Involuntary bankruptcy. Answer: See Chapter 25 Mini Case Show
years? Answer: See Chapter 25 Mini Case Show
Net fixed assets 5.0 Notes payable (to banks) 5
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A B C D E F G H I
1/15/2015
Current assets $40.00 Accounts payable $10.00
Chapter 25. Mini Case for Bankruptcy, Reorganization, and Liquidation
Kimberly MacKenzie, president of Kim’s Clothes Inc., a medium-sized manufacturer of women’s casual clothing, is
worried. Her firm has been selling clothes to Russ Brothers Department Store for more than ten years, and she
has never experienced any problems in collecting payment for the merchandise sold. Currently, Russ Brothers
Kim’s immediate concern was whether or not her firm would collect its receivables if Russ Brothers went
bankrupt. In pondering the situation, Kim also realized that she knew nothing about the process that firms go
through when they encounter severe financial distress. To learn more about bankruptcy, reorganization, and
liquidation, Kim asked Ron Mitchell, the firm’s chief financial officer, to prepare a briefing on the subject for the
entire board of directors. In turn, Ron asked you, a newly hired financial analyst, to do the groundwork for the
briefing by answering the following questions:
(3) Which size of firm, large or small, is more prone to business failure?
h. Assume that Russ Brothers did indeed fail, and that it had the following balance sheet when it was liquidated
(in millions of dollars):
d. Briefly describe U.S. bankruptcy law, including the following terms: (1) Chapter 11; (2) Chapter 7; (3) Trustee;
b. What key issues must managers face in the financial distress process?
c. What informal remedies are available to firms in financial distress? In answering this question, define the
e. What are the major differences between an informal reorganization and reorganization in bankruptcy? In
answering this question, be sure to discuss the following items: (1) Common pool problem; (2) Holdout problem;
f. What is a prepackaged bankruptcy? Why have prepackaged bankruptcies become more popular in recent
Federal Taxes 0.5 0.5 0.0
First Mortgage 3.0 2.5 0.5
Second Mortgage 0.5 0 0.5
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Notes Payable 5.0 3.25 5.0 100.0%
Accrued Wages 0.0 0.3 100.0%
Federal Taxes 0.0 0.5 100.0%
Other Taxes 0.0 0.2 100.0%
First Mortgage 0.5 0.325 2.825 94.2%
Second Mortgage 0.5 0.325 0.325 65.0%
Sub. Debt 4.0 2.6 0.85 21.3%
a Pro rata amount = $13/$20 = 0.65.
b Includes priority distribution and $1.75 transfer from subordinated debentures.
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A B C D E F G H I
State and local taxes 0.2
Current liabilities $16.00
First mortgage $3.00
aThe debentures are subordinated to the notes payable.
The liquidation sale resulted in the following proceeds:
Priority Distribution (millions of $)
Creditor Claim Distribution Unsatisfied
Accrued Wages 0.3 0.3 0.0
Notes:
(1) First mortgage receives entire proceeds from sale of fixed assets, leaving $0 for the second mortgage.
(2) $16.5 – $3.5 = $13.0 remains for distribution to general creditors.
General Creditor Distribution (millions of $)
Creditor Final Amount % Received
Accounts Payable 10.0 6.50 6.5 65.0%
For simplicity, assume that there were no trustee’s fees or any other claims against the liquidation proceeds. Also,
assume that the mortgage bonds are secured by the entire amount of fixed assets. What would each claimant
receive from the liquidation distribution?
Remaining
Claim
Second mortgage 0.5
Total long-term debt $7.50
Preferred stock $1.00
Common stock 13
Paid-in capital 2
Retained earnings 5.5
Total equity $21.50
Total assets $45.00 Total claims $45.00